CIT Faces Grim Prospects After Failed Bailout Bid

This movie seemed to be following a familiar script, to the point of being almost formulaic: Big financial outfit faces liquidity crunch, seeks federal bailout, draws concerns about the broader impact of its possible failure. But the plot twist at the end was a shocker.

After nearly a week of intense negotiations with Obama Administration officials, small business lender CIT Group (CIT) surprised Wall Street late on July 15 with news that there was "no appreciable likelihood" of immediate government aid and that it was "evaluating alternatives." And "immediate" was the key: With its own lenders pulling funding and its small business borrowers drawing down credit lines as fast as they could, CIT's inability to secure government help leaves the New York-based firm with few options other than bankruptcy.

Why the government didn't come through with a lifeline isn't entirely clear. While Administration officials negotiated around the clock with CIT, the Treasury Dept.'s only public comment afterward was a cryptic statement noting that "Even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies." Efforts to reach CIT officials for comment were unsuccessful.

So while conspiracy theorists had argued that CIT was caught in the middle of a turf war between the Treasury and the Federal Deposit Insurance Corp., or FDIC—each of which tried to fob a CIT rescue off on the other in hopes of preserving their own dwindling rescue funds—the real reason that CIT may have been allowed to collapse is much simpler: Administration officials concluded that CIT was too far gone—and that it wasn't "too big to fail."

Doubts About CIT's Viability

One Administration official told BusinessWeek after CIT's bombshell announcement that regulators from Treasury and the Federal Reserve explored various options for stabilizing CIT. But in the end, sources say, CIT executives weren't able to convince regulators that they could revamp the lender's business plan or balance sheet enough to remain viable.

"It would really have been throwing good money after bad," said an Administration official.

Among the options the Administration explored were mechanisms to transfer assets between the holding company and its bank in Utah, which the bank could then pledge as collateral to receive short-term funds from the Fed's discount window. The Administration also explored ways to arrange financing for the company through the Small Business Administration. Neither approach proved viable.

Even before CIT disclosed that a bailout wasn't in the offing, small business lobbyists were warning that the lender's demise could ripple through the economy. The pain could be most acute in the retail sector, where CIT is a big player in "factoring"—the business of giving credit to apparel makers and their suppliers, and then collecting on the payments due them from retailers. CIT's clients in this business include Burlington Coat Factory, Bon-Ton Stores (BONT), and Dillard's (DDS), all of which are currently placing orders for the critical holiday season.

Small Biz: Little Problem Getting Credit

"CIT is most certainly too important to the retail industry to be allowed to fail, and the retail industry is too important to the economy to be placed under additional stress," Tracy Mullin, CEO of the National Retail Federation, wrote in a letter to Treasury Secretary Timothy Geithner . Financial-services groups, perhaps worried that CIT's failure could precipitate a lack of confidence in other lenders, were similarly urging the Administration to act.

"We're disappointed—we really wanted to see it all work out," says Scott Talbott, a lobbyist for the Financial Services Roundtable, which represents large financial firms, including CIT. "There could be small businesses that go under because of this."

But the government's calculation that it could let CIT slide with little repercussions is, for now at least, proving to be the case. Even on a day when trading was halted in CIT's stock, the markets rallied with most major indexes up 3%—and largely held those gains in after-hours trading, when the CIT news was public.

More important, there's growing evidence that other lenders will be available to step into the breach if CIT is forced to downsize—or worse, liquidate—in coming months. A survey released earlier this week by the National Federation of Independent Businesses revealed that the majority of small businesses surveyed said they had little problems getting credit. According to the survey, only 6% of the 758 small businesses polled by the NFIB in June said they considered financing to be their "top business problem." More specifically, 30% of the businesses surveyed said their borrowing needs were being met—two percentage points higher than in May—and the share of owners reporting that loans were harder to come by fell two points, to 14% of all firms.

The bottom line? CIT was no Citigroup (C).

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