NEW YORK, July 20 (Reuters) - Why did shares of CIT rally as much as 100 percent today? Presumably investors saw headlines with the word “rescue” and thought it made sense to take a flyer. This is foolish.

CIT is highly leveraged and its assets are deeply troubled. Even if CIT is “saved” through a restructuring, there’s no prospect that the equity will have any value. The only hope is a backdoor bailout, and that’s highly unlikely.

To understand why CIT’s stock is essentially worthless, all you need to know is one equation: Assets = Liabilities + Equity. For a financial company like CIT, assets are the loans it makes to borrowers. Its liabilities are the dollars it borrows from lenders and depositors to fund those loans. Shareholder equity is what’s left over.

As the economy has deteriorated, so has the value of CIT’s assets. But the value of its liabilities remains fixed. Equity acts like a buffer to protect the value of liabilities as asset values fall. In other words, stock investors eat losses so that lenders and depositors don’t have to.

Lenders see the value of CIT’s assets has declined and, consequently, aren’t interested in lending anymore. This leaves CIT facing the same type of liquidity emergency that led to the failures of Bear Stearns and Lehman Brothers. And any lender-sponsored “rescue” would divvy up what remains of CIT’s assets amongst themselves, leaving equity holders with nothing.

Under its “base case” stress test scenario, ratings firm CreditSights estimates that CIT may face as much as a $4.6 billion capital shortfall. A more severe economic environment could leave CIT facing a $7.6 billion shortfall. Unsecured senior and subordinated debt holders face “a significant haircut” and preferred shareholders are likely to see “diminutive returns.” There isn’t enough pie for creditors to split, so shareholders shouldn’t expect anything left over for them.

So why take a a gamble on the stock? Maybe investors think Ben Bernanke will successfully reflate the economy, or perhaps CIT will find a buyer. As long as the company can kick the can down the road, there’s always hope, right? Actually no. With unemployment headed towards 10 percent, the underlying default rate on CIT’s assets will get worse before it gets better.

The other possibility is a bailout. True, FDIC has denied CIT’s request to access its debt guarantee program and yes, Treasury is unwilling to extend additional credit after losing the $2.3 billion of TARP money it already invested in CIT.

But an implicit bailout may still be available: FDIC-insured deposits. CIT Group has an FDIC-member subsidiary, CIT Bank. If CIT can’t convince the Feds to back its debt directly, maybe it can persuade them to allow an asset transfer from the holding company to the bank subsidiary in order to access more FDIC-insured deposits. Compare the 13 percent interest rate CIT is likely to pay bondholders to “rescue” its business with the two percent interest rate it would likely pay on one-year CDs guaranteed by FDIC and you understand why deposits are a preferable funding mechanism.

But it will take much regulatory forbearance to make that happen. Both the Federal Reserve and FDIC would have to sign off. We already know that Sheila Bair isn’t a fan of CIT’s business model. She didn’t grant them access to the ebt guarantee program because she clearly does not want to expose her agency to more losses. Thankfully for taxpayers, who ultimately stand behind insured deposits, it’s a safe bet she won’t let CIT raise any more.

With no bailout on the horizon, CIT’s balance sheet will continue to deteriorate, which means its shares are worthless. Investors should stay away.

I noticed an odd paragraph in this morning’s WSJ story on bondholder plans to rescue CIT:

CIT and its bondholders hope that their effort to stabilize the company will cause bank regulators to look more favorably on a CIT plan to transfer more of the company’s loans from the holding company to its bank in Utah. CIT has trouble borrowing money, but its bank can finance itself by taking in deposits. To transfer more assets to the bank, however, CIT needs an exemption from the Federal Reserve and a nod from the Federal Deposit Insurance Corp.

I understand why CIT would want to transfer assets to the bank, sort of.  Deposit funding is clearly much cheaper than other options they have.  Backed by FDIC insurance, deposits can be had at interest rates far below CIT could get in the bond market.

But as everyone points out, you can’t build a deposit base overnight.  Not unless you’re offering a high interest rate on brokered deposits, I suppose.  And FDIC will most certainly NOT let them do that.

But why would bondholders be in favor of a plan to transfer assets out of the holding company?  If those assets go to the bank, then they would back deposit liabilities.  Bondholders need those assets to back their debt.

Hmmm…..

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.

CIT’s press release this evening:

CIT Group Inc….has been advised that there is no appreciable likelihood of additional government support being provided over the near term.

The Company’s Board of Directors and management, in consultation with its advisors, are evaluating alternatives.

The company likely has only one alternative….bankruptcy.

With the fall in CIT’s preferred stock, taxpayers’ money is already lost.  WSJ:

U.S. Treasury Department officials believe they will lose their entire $2.3 billion investment in CIT Group Inc., a spokeswoman said, which could mark the first loss of public money injected in banks through the Troubled Asset Relief Program.

Big kudos to Sheila Bair.  Everyone wanted her to open up the debt guarantee program and she said no.  This is progress, folks.  Bankruptcies, not bailouts, are the proper way to work out bad debts.  Extending a bigger lifeline would only compound taxpayer losses.

Reuters: Tribune may have Cubs file bankruptcy

The Chicago Cubs baseball team may file for Chapter 11 in order to speed its sale by bankrupt media company Tribune Co, two sources familiar with the process said on Monday….

Such an approach would likely be taken to ensure the storied baseball team and related assets are free of liabilities so as to speed a sale, said the other source, who also asked not to be identified. Tribune filed for bankruptcy last December, but the Cubs were not part of that filing….

The company has reached an agreement to sell the Cubs, their home park of Wrigley Field and a stake in a regional sports cable network for slightly less than $900 million to the Ricketts family, sources previously told Reuters. However, the company also remains in talks with a second group led by private equity investor Marc Utay, sources have said.

The team is fine; it can pay its bills.  The official story is that buyers don’t want to deal with potential future liability from Tribune Co’s bankruptcy.

The unofficial story is that the Cubs want to void the last five years of Alfonso Soriano’s contract.  The guy is on pace to hit .230 and strike out 150 times.  And he’ll be paid something like $17 million.

As CIT hangs by a thread, some news outlets are reporting that it would be the biggest bank to fail since WaMu.  Measured by total firm assets this is true, but measured in terms of deposits, CIT is a fraction of WaMu’s size.  That’s why Sheila Bair is willing to let CIT go under.  And she’s right.

CIT Group’s balance sheet is plenty big ($76 billion of assets as of 3/31/09), but it’s funded primarily with debt, not deposits.  If the firm goes boom, investors will lose, not FDIC’s deposit insurance fund.

So from FDIC’s perspective, CIT clearly isn’t too big to fail, which is likely why it doesn’t want to give the company access to TLGP.  The debt guarantee program is a bit of a scam to rescue the deposit insurance fund, which would buckle if most of the big banks it protects went under.  The ones FDIC can’t handle closing, those that are “too big to fail” it offers an implicit guarantee against failure.  CIT Bank isn’t in that category.

The argument that CIT needs to be rescued because small businesses rely on its lines of credit is a bad one.  Similar arguments are made in favor of prospective homebuyers who are judged good risks, but who can’t get credit to buy a house.

The issue isn’t creditors, it’s lenders.  Lenders like CIT simply don’t have sufficient capital to make new loans.  Creditors that complain they can’t get other people’s money to fund their operations are missing the point:  Other people don’t have money to lend.

If businesses actually are good credit risks, then they shouldn’t have a problem securing a line of credit from another, stronger lender.  If they can’t get another line of credit despite being a “good” risk, it’s because the system doesn’t have enough capital to support the creation of new loanable funds.

Business models that rely totally on borrowing in order to fund working capital aren’t as robust as those that can fund themselves with cash from earnings.  Many will, and should, fail.

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*For more details, do a quick search for “CIT Bank” in FDIC’s bank find tool.  You’ll find CIT Bank on page 2 of the search results.

I notice this morning that NYT’s Weekend Opinionator quoted me in an article about GM emerging from bankruptcy.  While I appreciate the link, the way they characterized my quote was off the mark.  I didn’t say GM’s road from here “should be a piece of cake.”  I said early reports of the economy’s demise, should GM file, were premature.

My point was less about GM and more about the lessons its bankruptcy provides for other busted debtors relying on government support.  The primary argument defending bailout packages for banks and homeowners is we can’t let them go bust, it would be too harmful to the overall economy.  No doubt it would be harmful.  But what did we learn from GM?  Primarily this:  Writing blank checks to failed debtors is tantamount to flushing money down the toilet.  That’s far more harmful to the economy.  We build up more unpayable debt while accomplishing nothing.  Better to spend the money restructuring those debts so that the business can be properly recapitalized.

This is what needs to happen with ALL of the country’s largest banks.  Their busted assets need to be written down and their shareholders and (some) creditors need to be wiped out.  Do that, and the financial system will emerge leaner and healthy. This will certainly involve government support, primarily via FDIC as it absorbs losses of received assets.

But that’s better than straight bailouts, which only keep dead banks walking.  More money doesn’t make them any less dead…not until their balance sheets are fixed.