CIT is a warning sign

July 13, 2009

agnes1If it’s not a risk to the financial system, let it fail.

That’s the message from the government’s reluctance to swoop in and bail out one of the nation’s biggest commercial lenders, CIT Group Inc, as it struggles to stay afloat. But even though CIT doesn’t have the firepower to take down the global financial system, its failure would certainly be felt by some of the struggling small businesses that rely on its financing.

CIT is negotiating with its regulators to find a solution to its near-term liquidity problems, but speculation that it will file for bankruptcy has intensified after the Wall Street Journal reported that it was preparing for a possible filing.

Not that you can blame the Federal Deposit Insurance Corp and the tough-minded Sheila Bair for thinking twice about supporting a junk-rated lender that has already sucked in more than $2 billion of government funds.

A failure, however, could still hurt Main Street since it’s sure to make already tight credit conditions even more restrictive for businesses already on the ropes. This is important for regulators as well as investors to keep in mind.

For the last two years, dangers in the esoteric corners of the opaque credit markets were the ones that needed minding. Problems with complicated and difficult-to-understand structured credit products helped fell financial giants like

Lehman Brothers and AIG who were supposed to know best how to manage risk.
Regulators have responded in kind with a blueprint for overhauling the system and a commitment to supporting firms that are too big to fail.

But the dangers are shifting. Though credit is flowing to large companies seeking to drum up funds through the debt markets, smaller ones are still finding it difficult to access funds. The National Federation of Independent Business reported that 16 percent of small-business owners reported loans were harder to get in May — the highest reading since the recession of 1980-82.

A potential CIT failure could make matters worse. Though it may not be a household name, it is a major middle-market lender. Among its many business lines, the company is an important source of financing for thousands of small- and medium-sized businesses that don’t have the heft to raise funds in the capital markets.

The lender’s best business bits would certainly be picked up by larger banks, but that would most likely only take care of the most credit-worthy clients. There’s sure to be some that would fall through the cracks into a world where access to credit is still challenging.

Even credit cards are harder to come by. Advanta, which specialized in small business credit cards, shut down its credit card accounts for future use after it ran into trouble.

This isn’t to say the government needs to come to the rescue every time a financial institution gets in trouble. It doesn’t. But CIT’s potential failure should be a warning sign that while systemic risk has been cured, the credit crisis has not.

That means more pain is yet to come and the much-desired economic recovery could prove elusive for some time.

Update: See what my colleague Matthew Goldstein has to say on CIT here. And Rolf Winkler argues here why CIT shouldn’t be bailed out.

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