It’s Too Hard to Know Who Is Too Big to Fail: Jonathan Weil
Two years ago if you had asked whether the commercial lender CIT Group Inc. (CIT) was too big to fail, the answer would have been an emphatic no. The Treasury Department had rejected its latest bailout plea. In November 2009, after 101 years in business, CIT filed for bankruptcy.
Ask that same question about CIT today, though, and the best answer would be: Who knows?
Last month U.S. banking regulators approved new rules that would treat all bank-holding companies with more than $50 billion of assets as systemically important financial institutions, based on average total assets for their previous four quarters. For CIT, which exited bankruptcy in December 2009, that figure was $50.7 billion as of June 30.
No one is sure what exactly this new designation means -- except that, on paper at least, it’s more likely now than it was two years ago that regulators would intervene to stabilize a collapsing CIT. Somehow, in the government’s eyes, CIT is more important to the financial system today than it was when it blew up, even though it has about $20 billion less in assets.
The newfound uncertainty also has a mirror image. Not long ago it would have been pretty much unthinkable to assert that American International Group Inc. (AIG) and Ally Financial Inc. didn’t have the U.S. Treasury Department’s full backing. (Ally is the lender formerly known as GMAC that once was the finance arm of General Motors Co.) The government bailed them out numerous times and remains the majority owner of both companies. Yet lately their bond prices have been plunging.
By the Numbers
AIG’s $800 million of 4.875 percent notes due in September 2016 were trading this week for about 92 cents on the dollar, down from 99 cents when AIG issued the bonds last month. If investors were fully confident the government would stand behind AIG’s debt, they wouldn’t demand a 6.7 percent annual yield, compared with 0.9 percent for Treasuries of the same duration. Ally’s $2 billion of 8 percent notes due in November 2031 fetched 85 cents on the dollar, for a 9.7 percent yield, down from 110 cents in July.
What gives? One possible explanation is that the government keeps sending mixed signals about its intentions, mainly because it has no idea what they are. The Dodd-Frank Act passed by Congress last year prohibits equity injections of the sort we saw under the $700 billion Troubled Asset Relief Program. Yet it doesn’t end taxpayer-supported bailouts.
Consider the liquidation plan outlined in Dodd-Frank for dismantling a systemically important bank. The act would let the Federal Deposit Insurance Corp. borrow money from the Treasury to finance a company’s operations for as long as five years, shielding bondholders and counterparties from immediate losses as a way to promote calm and head off bank runs. Putting CIT on the important list would tell creditors they might get special protections unavailable at most other companies.
Weighing the Backlash
At the same time, the public backlash against government bailouts of any sort would seem to make them less likely than three years ago. The odds that Congress would pass TARP II look slim, as long as Republicans control the House of Representatives.
Small wonder, then, that investors have gotten panicky about the common shares of the biggest U.S. financial companies, such as Bank of America Corp. (BAC), Citigroup Inc. (C) and Morgan Stanley (MS), which trade for far less than what their balance sheets say their net assets are worth. If AIG doesn’t have an unswerving federal safety net, maybe those other companies don’t anymore either. Nobody knows for sure.
Meanwhile, the notion that CIT could pose a genuine threat to the financial system seems as unrealistic as the idea that the U.S. might let Bank of America, Citigroup or Morgan Stanley fail. Ditto for Ally, with its $179 billion of assets, making it a midget compared with Bank of America, which has $2.3 trillion of assets. Yet Dodd-Frank tells us no bank is fail-proof nowadays, assuming Congress doesn’t change its mind, which it could, like it did in 2008.
For most European governments, the question of whether they would save their countries’ largest banks in the face of the region’s debt crisis hinges mostly on whether they have the wherewithal to do it. There’s little doubt France would if it could, for example. In the U.S., the question is more about whether the government has the political will.
At the rate the markets are going, we may find out the answers sooner than anyone would like.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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