US financial system can weather CIT collapse – Treasury bets

The U.S. spurning of CIT Group Inc.’s aid request suggests officials are betting they’ve fixed the financial system enough to withstand the bankruptcy of a mid-sized lender.

“I hate to say this, but it was probably expendable,” said Dennis Santiago, chief executive officer of Institutional Risk Analytics, a Torrance, California, research firm that studies systemic risk. “It may have just missed the boat” on federal rescues, Santiago said.

Yesterday’s decision to forego a lifeline for CIT came 10 months after Lehman Brothers Holdings Inc. filed for bankruptcy. Lehman’s collapse ushered in the depths of the credit crisis to date, and resulted in the establishment of a $700 billion bailout fund; officials yesterday indicated programs created with that money would help fill any lending gap left by CIT.

Treasury Secretary Timothy Geithner, en route to Paris as CIT acknowledged policy makers had turned it down, is also wagering the administration will weather any political fallout. Unlike Bear Stearns Cos. or American International Group Inc., which got extraordinary aid last year, New York-based CIT specializes in loans to smaller firms, counting 1 million enterprises, including 300,000 retailers, among its customers.

A Treasury official said the department anticipates losing the $2.3 billion of taxpayer funds that it had already injected into the company from the Troubled Asset Relief Program should it file for bankruptcy.

‘Disruption’ and ‘Anger’

There will be “a lot of disruption and anger among voters, particularly among people who rely on firms such as CIT for funding,” said Sean Egan, head of Egan-Jones Ratings Co. in Haverford, Pennsylvania, which rates CIT below investment grade.

“A major provider of capital in the middle market is likely to be out of business in the near future,” and investors will be concerned, at least in the “short run” about CIT, Egan said.

CIT, whose stock trading was halted by the New York Stock Exchange before the close, said late yesterday it was told “there is no appreciable likelihood of additional government support being provided over the near term.” CIT added that it was “evaluating alternatives” with its advisers.

The Treasury then highlighted in a statement that the government has enacted “powerful” mechanisms to revive credit markets. “Even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies,” the department said.

Administration Rationale

An Obama administration official separately said CIT didn’t receive more government assistance because it hadn’t gone to private capital sources to rebuild its balance sheet, something that several of the biggest Wall Street and regional lenders did earlier this year.

The official, who requested anonymity to discuss the deliberations, said the government also determined that CIT didn’t pose systemic risk to the economy if it failed to receive more aid.

Yesterday’s collapse in talks between regulators and CIT followed reluctance by the Federal Deposit Insurance Corp., the bank’s main regulator, to give it permission to participate in the agency’s debt-guarantee program.

The Federal Reserve had separately considered whether to let CIT put some of its parent assets into a banking unit, a move that could have increased its potential borrowing from the central bank. No such aid was forthcoming. The Fed has doubled its balance sheet to more than $2 trillion as it engaged in Wall Street rescues and emergency loans to banks across the nation.

‘Very Big Losses’

“If the government would have rescued them they would have been in there for a very long time, and they would have taken very big losses,” said Eric Hovde, who manages $1 billion at Hovde Capital Advisors LLC in Washington, which concentrates on financial and real-estate related companies.

Part of the Fed and Treasury efforts to shore up the financial markets have been directed at restarting lending to small businesses. The two agencies in March jointly started the Term Asset-Backed Securities Loan Facility, or TALF. Under the program, the Fed lets investors borrow to purchase securities backed by auto, credit-card and other loans, with the idea that should spur lenders to extend more credit.

TALF loans from the Fed totaled $24.9 billion as of last week, compared with the program’s planned capacity of $1 trillion, backed by $100 billion of funds from the $700 billion Troubled Asset Relief Program.

TALF Aid

Fed officials credit the existence of the TALF with spurring the market for new asset-backed securities and reducing the difference, or spread, between yields and benchmark rates.

“So far, the evidence indicates that the program is working as designed,” New York Fed President William Dudley said in a speech last month. Yield premiums on consumer asset- backed securities have dropped “sharply,” he said.

The three-month London Interbank offered rate for the dollar, a benchmark for liquidity stresses among banks, has fallen every week since mid-March. The rate dropped to 0.51 percent yesterday from 1.43 percentage point at the start of the year.

Other evidence of a stabilization in the financial industry emerged this week, with Goldman Sachs Group Inc. reporting record profits. The Standard & Poor’s 500 Financials Index has rallied 11 percent this week.

Fed policy makers still regarded financial markets as “fragile” and the economy as “vulnerable to further adverse shocks,” minutes of their June 23-24 meeting, released yesterday in Washington, showed.

Regulatory Overhaul

The spurning of CIT comes amid a growing debate among officials, regulators, lawmakers and the financial industry over how to address the issue of firms deemed too big to let fail.

President Barack Obama is seeking the biggest overhaul of banking rules in decades, and wants to give the Fed new powers to oversee capital and liquidity standards. FDIC Chairman Sheila Bair, along with some lawmakers and central bankers, has urged stronger efforts to address the too-big-to-fail issue.

Gary Stern, president of the Minneapolis Fed, said the Obama plan “fails to come to grips” with the challenge, partly because it doesn’t threaten creditors with the risk of loss. House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, plans a hearing on the matter July 21.

CIT was created in 1908, after founder Henry Ittleson noticed wholesalers repeatedly short of cash while he was a purchaser for a St. Louis department store. He wanted to create a new company that would serve customers overlooked by larger financial institutions, according to the firm’s Web site.

“I’ve heard from a lot of people, including a lot of people involved in small business, that it would cause a serious problem” for CIT to fail, Frank said in an interview yesterday before the firm’s announcement.

Among financial firms, “especially those on the edge, there’s going to be a scramble to figure out whether you’re in or out” of bailouts, said Joseph Mason, Louisiana State University finance professor. “This classification of systemic risk really is something like pornography — Fed and Treasury know it when they see it. You really can’t pre-commit.”

Source: Bloomberg