The Bailout Lords say “NO!” to CIT Group

The Bailout Lords of Washington D.C. have decided to stop handing out free lunches. After giving out a few trillions, they seem to be saying, "Enough is enough". That's too bad for CIT Group, a financial company that provides business loans, financial services and financing solutions worldwide.

The Lords have decided that the failure of CIT Group is not a systemic risk to the U.S. and world economies and, therefore, will go into bankruptcy if necessary. That means that the Federal Reserve believes that the bankruptcy of CIT Group will not create a domino effect of other failures and/or generate a panic. Whether that's true or not, we'll find out. Yay! Lehman Brothers proved to be a wrong call, so the odds may be on their side and they're right.

Let's dig into this matter.

Here is an excerpt from their website:

CIT (NYSE: CIT) is a bank holding company with more than $60 billion in finance and leasing assets. For more than 100 years, CIT has provided lending, advisory, and leasing services to small and middle market businesses guided by unparalleled industry expertise and focus. Headquartered in New York City, CIT is a Fortune 500 company and member of the S&P 500.

...

CIT Small Business Lending Corporation has been designated the #1 SBA [Small Business Administration] 7(a) lender for the 9th consecutive year in a row!

The translation of the fancy writing is that CIT Group is one of the biggest lenders to American small businesses. One of the biggest services they provide is factoring, which is:

A financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business.

Source.

So, if you're a small business and you sell on credit, but you need to pay your employees, you get the money upfront from CIT so you can keep operations running. In simple words, this kind of lending is essential for thousands of small businesses to keep things going.

The debate revolves around the "too-big-to-fail" concept. It's the idea that if CIT Group goes bankrupt  it will dramatically short-cut credit to small businesses that are already going through tough times. This could thus create a wave of small business failures due to the lack of credit.

Here is an excerpt from a great article at The Wall Street Journal:

Disrupting the flow of cash to this important sector would be catastrophic. Small businesses employ about half of all private-sector workers, represent half of the nation's payroll and are responsible for 28.9% of U.S. exports, according to the U.S. Small Business Administration.

And, of course, small businesses have created 60% to 80% of all the new jobs created in the last decade.

So, there's no doubt that a CIT bankruptcy would be disruptive, but should they get a bailout?

From an economic perspective, NO. Why? The financial system (seems) to have stabilized and a CIT bankruptcy would not break the system. This is different from September/November 2008 when everything was going down the drain and multiple failures of multiple big financial institutions would have probably collapsed the financial system. Therefore, given that the collapse risk  is out of the question, it should follow that CIT files for bankruptcy and we all just absorb the bad hit.

It's not great, but that's how our system works. The weak gets weeded out...(that is, sometimes).

Now, what about from, say, a moral point of view?

Do we let CIT Group fail and negatively affect thousands of small businesses after we just saved Big Business and all the people making millions and millions of dollars per year? Therefore, after saving the "pigs", do we let the average American get even more squeezed? It's a tough question, but it seems like we know what's going to happen. Additionally,we cant' forget that economics (and what is best for the economy and the financial system) does not always go hand-in-hand with the moral thing to do.

CIT Group's share plunged 75% today and it's looking for $2-4 billion to keep things running. I think it's highly unlikely someone throws money at them, which means we should all just get ready for a nice science experiment. The experiment being what happens to small businesses after a big financial arm in that industry goes down.

Well, if you're a small business that depends on services such as factoring, you could be in a bad spot. Additionally, if the worst case scenario does happen (domino effect of failures), that could mean a sharp stock market downturn. Markets were up 1% today and completely dismissed the issue. The Green Shoots (good earnings from JP Morgan, IBM, Intel, and Goldman Sachs) are winning the battle and sending the market higher.

Nevertheless, a downturn similar to the one after the Lehman collapse could mean bigger job losses across the country and even slower growth. Therefore, that economic recovery I been looking for in the dark tunnel...could become further away.

Let's just hope CIT goes into bankruptcy, liquidates or properly re-organizes itself, and the economy does not get a big hit. I believe a CIT bankruptcy is also not "too" dangerous for the system. We'll take the hit, get up, and continue forward. For now, let's cross our fingers.

The Lords have retired...it seems. Here is another great cartoon I found. Too funny.

Cheers!