What’s in play at CIT?
First, CIT was allowed under the bank regulators’ umbrella and, now, it’s being pushed out. Inconsistent, contradictory policy like this sharply increases resolution cost to the FDIC and risk to the economy.
· Survival Odds: Press reports indicate that the Fed ran a stress test on CIT Tuesday night and concluded the firm is $4 billion in the hole. This makes little sense to us because CIT’s small-business book is largely asset-backed – very different paper than run through the stress test on the biggest banks’ corporate books. Asset-backed paper is secured through a firm’s receivables, making it essentially collateralized lending to handle borrower cash flow. The more public attention on CIT, the more borrowers draw lines to ensure their own liquidity and the worse the stress on CIT, but this is liquidity and credit risk – not just the credit risk run through the Fed’s stress test.
· TARP 2: The Bush Administration set up an “exceptional” assistance program in TARP, which is how Citi and BofA got their second round of capital and guarantees. The Obama Administration has reaffirmed its commitment to this program, which is available for anyone deemed important for any reason by Treasury – it isn’t limited just to systemically-significant institutions. However, this type of TARP aid comes with significant strings attached not only with regard to compensation, but also warrants, control and other strategic issues CIT may still be unwilling to concede.
· There is no policy rationale to the CIT decision. GMAC got TLGP even though it was in extremis, but CIT apparently still can’t persuade the FDIC to give it up. Is this because we like lenders for autos better than small business? Policy made on a one-off basis results in credit allocation to favored sectors, very poor public policy.
· Treasury and the bank regulators wouldn’t be in this pickle in the first place if they hadn’t last fall allowed CIT to become a BHC. The problem now isn’t lack of a useful non-bank resolution regime, it’s that non-banks on a one-off basis have been allowed to come under the FRB without clear, advance consideration of how to supervise them, how risky they were in the first place and what to do with unique institutions. There’s no technical difference between resolving CIT and Citi – it’s just that the regulators know even less about what they’re doing.
· CIT is principally a liquidity risk not a solvency one (although to be sure its loan book is far from pretty). All of the banks bailed out to date through TARP and the Fed were supported on grounds that they had principally liquidity problems, although as we said at the time and since, the bulk of their woes in fact result from credit risk (mortgages, etc.). In fact, big banks are still buried in real credit risk, despite the breathing room granted by mark-to-market revisions. CIT is stuck because it funds through the holding company, not the bank and thus can’t access brokered funds, the FHLB or other liquidity sources available to even the sickest banks. Had it not been allowed to become a latter-day BHC, this could have been addressed through bankruptcy or private-capital injections and would have been done last year, not now when the cost is still higher.