CIT’s dead reckoning

July 17, 2009

NEW YORK, July 17 (Reuters) – Three cheers for progress. After the government refused to back CIT debt, the firm’s bondholders got on the phone to discuss a debt for equity swap. Now it appears that JPMorgan Chase and Goldman Sachs may still ride to the rescue with emergency financing.

But whatever happens, with no prospect for a bailout, the CIT situation will be resolved privately, at no additional cost to the taxpayer. It’s unfortunate that the Obama administration hasn’t been this unforgiving with the housing market and banking sector. That’s the only way for the economy to find solid footing.

CIT is presumably insolvent. The company lacks sufficient cash flow to meet lending commitments and future debt maturities. Now as customers race to draw down credit lines, the company faces a liquidity squeeze. The government could continue lending — CIT has already blown through $2.3 billion of TARP cash — but to what end?

Those arguing for a bailout say that small businesses dependent on CIT credit lines may themselves be forced into bankruptcy. But this misses the point. CIT no longer has sufficient capital to lend. A government lifeline thrown their way would just make Uncle Sam the lender of last resort to yet another sick segment of the economy, putting taxpayers on the hook for more credit losses.

Taxpayers are already stretched to the breaking point. We are borrowing fantastical sums of money to finance previous bailouts, stimulus and, presumably, a new national healthcare plan. We should try to borrow more from China so that Dunkin’ Donuts franchisees don’t lose their credit lines?

Obama can’t rescue everyone. If he tries, the bond market will cut him off. We’ll be in far worse shape than if we had let lenders like CIT fail in the first place.

In the aggregate, the U.S. economy is insolvent. That was noted by the “Black Swan” author, Nassim Nicholas Taleb, who earlier this week recommended “immediate, forcible and systematic conversion of debt to equity.”

He’s right that balance sheets across the economy need to be recapitalized. But we don’t need a legislative decree to make it happen all at once. Bankruptcy law in the United States is very robust. Debtors and creditors can work out debts themselves, in or out of court, which is precisely what’s happening with CIT now that the government has gotten out of the way.

If the administration stopped propping up the housing market and too-big-to-fail banks, bankruptcies would be able to clear much more bad debt.

11 comments

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because, you know, there aren’t other banks capable of lending to small and medium sized business. Without CIT, where would they go?

Posted by Andrew | Report as abusive

CIT financed 10′s of thousands of small businesses, including auto many dealerships… many sole proprietor’s who file a schedule “C”… many, if not most sell goods an services… fully dependent upon consumer spending…

Now let’s follow the progression… due to the housing crisis consumers have stopped consuming… when people do not go to the mall, do not buy clothing, do not buy appliances, do not buy “things, do not spend on home improvement, do not buy cars, do not go on vacations, do not dine out… when people in fear of losing their homes, hunker down and buy only that which is an absolute requirement of survival the first businesses impacted are the CIT type business… and they go out of business…

The last time that I checked, vacant retail and office space does not pay rent… commercial property owners become delinquent… and the commercial real estate market starts on the same slippery slope that residential real estate has “enjoyed” for these past two years…

Without, immediate, fast, true, effective rate and term loan modification this fiasco will continue for no less than another three years…This month alone Bank of America has scheduled over 18,000 trustees sales in California! Many may not go to sale, but the mere number of filing from just one lender is mind boggling…

Unlike every past downturn, this crisis originated in residential real estate…all down turns effect real estate, but this is the 1st whose root cause is residential real estate…it is the true problem with state revenues and despite what the media and government wishes to believe ZERO has been done to end the bloodbath…the programs in currently place are doomed to failure…

It’s the foreclosures stupid…. it’s the foreclosures…

Mr. Brody, thanks for the comment. IMHO, foreclosures aren’t the problem, they’re a symptom of it. The problem is too much debt. Writing it off is the only way out. Whether in court (bankruptcy) or out, the remedy is clear.

Posted by Rolfe Winkler | Report as abusive

If CIT can blow through the $2.33 billion the firm received through the TARP program in a matter of months what are their plans with the short term loans from JP & Goldman? Another good question JP Morgan should get confirmation on before lending CIT money is what caused the company’s cash flows to dry up so quickly? Concerns have been risen on the affects on small to mid-size businesses that CIT services when really people should be asking what has the affect been on CIT from the small business sector? The downfall of CIT may not lead to the financial downfall of small businesses; the collapse of small businesses may have brought down CIT.

This CIT situation maybe the first example of the consumer-end freezing the credit lines of the lender itself.

Rolfe, you don’t think the government has a hand in this at all? Can you try to FOIA the FDIC and Treasury for their discussions with JPM and GS in the past 48 hours?

Posted by Minh | Report as abusive

I respectfully disagree, Mr. Winkler. I am also curious as to your opinion: Should we have even bailed them out in the first place? I shudder to think of the consequences had we not done so, although I agree that we can’t rescue everybody.

I also think that foreclosures are a symptom, as is too much debt although here we deviate on subject matter, owed to Mr. Brody’s comment. Mr. Winkler, do you mean to say that there was too much debt on the part of CIT, small-and medium-sized businesses or consumers? Since it was consumers that trigger the drop in commercial business as Mr. Brody pointed out, I will focus on there as well, since as he also pointed out, if no one’s buying, no one’s selling and few are making money.

In my own opinion, too much debt is a symptom of both an overconsumptive (sp?) nation as well as a failure of wages to keep up with the cost of living so that people are often reliant on credit to live. I place more emphasis on the former than the latter. It sounds unpatriotic to say it though I shall anyway: Americans brought this upon themselves, whether it was rampant house pricing speculation on the consumer end or the laissez-faire mortgage lender intermediary writing irresponsible loans or the investors blindly purchasing high-risk, high-yield mortgage-backed securities.

As one journalist whose name eludes me pointed out, in this nation rationing is a dirty word. Start talking of rationing and people may believe one is a Communist or un-American or what-have-you when a bit of rationale would have saved billions of dollars as well as tens of thousands of homes. I agree that overleveraging and/or too much debt is a part of the problem although I think we are going to have a difficult time selling the rest of America on the concept. Even China is starting to be wary of it…

Posted by J. Garcia | Report as abusive

Its foreclosures because increasingly, mortgage payments are exceeding more and more families’ incomes–due to job or income loss. We are not dealing with sub-prime or speculators anymore. The new foreclosure risk is more related to income than debt. Employment has to be bolstered, and nobody is doing anything about that. Obama talks the talk and then 6 months into the process only spends 10% of stimulus, and only a fraction of this on job creation. The repubs just want to make sure the internationals and big banks are taken care of–neither party has any true sense of loyalty to American workers. Both parties say America should not want the manufacturing jobs anyway. That is ridiculous talk from the few who “think” they will be the lucky ones who manage the foreign workers, and those who do not have to work for a living now. And Education is not the answer either. We have plenty of qualified professionals for any job opening.

Posted by D. Chambers | Report as abusive

“If the administration stopped propping up the housing market and too-big-to-fail banks, bankruptcies would be able to clear much more bad debt.” This is exactly what Senator Bob Corker said last October when GM and Chrysler were begging for hand-outs. And eventually, bankruptcy came to pass, and it didn’t turn out so
bad.;-)

Mr. Chambers….thanks for the comment. You’re right to emphasize incomes as a crucial factor. I should modify my previous point. Debt, per se, isn’t the problem….too much debt relative to income–i.e. leverage–is the problem.

IMO, going into debt is always to be avoided since you never know when you could lose your income.

Posted by Rolfe Winkler | Report as abusive

I particularly appreciate Mr. Rinkler’s succinct statement of CIT’s problem: “The company lacks sufficient cash flow to meet lending commitments and future debt maturities. Now as customers race to draw down credit lines, the company faces a liquidity squeeze.” CIT’s credit problems made people worried, but it’s the liquidity problem that is so suddenly bringing it to its knees.

Similarly, while AIG had credit problems, the thing that brought AIG down so precipitously was not immediate credit losses, but a covenant AIG had agreed to on their Financial Products business that required them to put up collateral if they were downgraded; the existence of this requirement actually triggered the downgrades, which then resulted in accelerating collateral calls that only the US government could cover. Again a liquidity squeeze, though one of AIG’s own making.

Similarly, the September ’08 problems became the October Crisis when liquidity between banks (and anyone) froze up. It is actually the Fed’s job to protect the system from such panics, so the Fed and FDIC were right to step in to restore confidence in the system. Rescuing the banking system last year wasn’t a “bailout”, it was the Fed doing it’s job.

But once that confidence has been restored, businesses (like CIT) need to establish stable funding sources not based on unreliable short-term borrowing or on Fed intervention. (This is one of the reasons the corporate bond market has seen such high issuance this year.) This made it a hard call for the Fed – once the FDIC refused to support CIT (for reasons not yet fully disclosed), it was apparent CIT was going to face a liquidity problem, which rapidly became a self-fulfilling prophecy.

The Fed (and the FDIC) appear to have decided that the system can withstand CIT’s default without precipitating a broader liquidity panic. Let’s hope they are right, and that bankruptcy (or a private market rescue) can preserve CIT’s very valuable capabilities as a lender to small business, perhaps in the hands of a different set of owners. If so, CIT’s moment of crisis could turn out to have been a turning point for confidence, instead of a new catastrophe.

Posted by T Buerger | Report as abusive

Looking back on the earlier years of this decade, in the context of these mortgage meltdowns in Florida and in California, I am forced to remember the flood of loan solicitations I used to receiver from loan brokers. For at least three years, I was getting twelve or more phone calls or e-mails per day, offering ARM financing !!

In an average week I would also get many solicitations by mail from newly-minted mortgage brokers, sometimes offering no-principal loans, i.e., interest-only payments with a two-year reset. This did not happen by accident, friends, as nothing like that tsunami of re-fi solicitations can happen without planning and backing !!

Letters cost money to print and mail. Brokers have to have some way to handle the responses, even if they work from a home office. Now we know that hundreds of these operations were basically ‘fly-by-night’ constructs.

We know too that there was a mighty handsome “rake off” embedded in these financing offers. Maybe most of these brokers failed to get rich off it all, but money was being handled constantly which means money was being made all along the way. Who thought this was a good idea and who backed these “pools” of money and why ??

The big builders had no problem borrowing heavily to build huge houses — McMansions — in California and in Florida, as they watched house-hungry speculators swarming into that market. Now what ?? Entire areas in Florida are basically ghost towns, now, those new houses looted for copper and aluminum and unfinished projects abandoned. This was not something that happened by some providential accident. Get to the bottom of that and we can get to the bottom of why so many buyers, including many first-time buyers, bought big houses and then failed miserably: and, the changes in the bankruptcy laws which devious politicians engineered to protect the VISA and MASTERCARD providers had the ‘unintended consequence’ of making it smarter to abandon a new house after two years ( or less ), than to lose a credit card.

Let’s look into that aspect of the great housing swindle and maybe we can all get a clearer understanding of who made out like Mongolian bandits and who got savaged, in the first real estate bubble of this new century.

Posted by Richard C. Green | Report as abusive