At the end of the day, CIT had nothing. Their asset quality was poor, their systemic risk implications seemed limited, Sheila Bair dug in her heels, and Jeffrey Peek (CEO) didn’t have sufficiently strong connections to get her overruled.
CIT had friends, but not enough – and maybe this tells us something about the shifting political sands. The Financial Services Roundtable (top financial CEOs) came out in force, the House Committee on Small Business reportedly made worried noises, and Barney Frank sounded supportive. But the American Bankers Association (the broader mass of bankers) publicly stood on the sidelines and Senate Banking – and prominent senators – seemed otherwise engaged.
CIT’s small and mid-size customers are important to the recovery. But the reckoning is that this business can be easily sold to someone else – after all, this is exactly what bankruptcy can get right in the U.S.
So the question became: is CIT too big – on its liabilities side – to fail? And if $80bn financial firms are now “too big to fail”, what does that imply for other potential bailout conversations and for our fiscal future?
In the final analysis, CIT wasn’t even big enough to meet Secretary Geithner face-to-face – he’s still out of the country.
The bottom line: we need fewer $800bn firms and more $80bn firms. If Goldman Sachs were broken into 10 independent pieces, we could all sleep much more soundly.
By Simon Johnson
(More in my NYT.com column this morning – what are the implications of CIT’s failure for overall levels of capital in the banking system? This will run shortly.)
The Baseline Scenario 
Sheila Bair dug in her heels huh? Were those 6 inch stiletto??? Definitely a more exciting image to my mind than Sarah Palin.
Seriously, I think Sheila Bair is a great woman. Thankfully for us she can hold her own ground and knows what is the suitable role for FDIC and what is NOT the suitable role for FDIC.
The villagers unanimously applaud.
The FDIC should not be insuring the bonds of ANY firms, especially not the bonds of firms that are only “banks” in the sense that all financial firms are now banks. Last I checked, the “D” in FDIC stands for “Deposits”, which are all they should be insuring.
In a way, I’m sympathetic to CIT in that their failure will have a real impact on small business, which is something we need more of. On the other hand, I’m glad that we’re taking (at least a small) stand against the idea that we must socialize all loss and risk in order to maximize private profit.
There is no financial institution that is too big to fail and there never was. What we have is financial regulators that lack the courage to do the right thing consistently – let them all fail, open the discount window and flood the system with liquidity. Thank goodness they stopped at CIT.
Conventional wisdom seems pretty certain about what would have happened if the gov’t hadn’t supported AIG, and certain that a few more like Lehman would have done us in for good. But the certainty is for the most part unexamined. What, if anything, does academic research have to say about the realities of the “too big to fail” concept? How is it that Treasury giving AIG $300 Mn (or so) to then give to Banco Santander prevented the global financial system from imploding? In effect, such bail outs concentrate the incidence of risk. Absent such a bail out, the losses would be spread among AIG’s counterparties, entities which for the most part are able to assume their share of the debacle, and which rightly should pay for not monitoring the health of their trading partner.
It’s as if we’ve unanimously concluded that the economy will collapse if bondholders in large financial firms are required to take losses, and concluded further that the correct way to address this is to have smaller firms, rather than to have bondholders face risk, regardless the size of firm. While it’s obvious that Lehman sent a severe shock through the system (as would be expected), it’s not actually obvious that without government intervention this development would progress into total global meltdown. The Lehman shock was the bond market reacting to their incorrect bet that they did not face risk in their Lehman investments. The US missed a rare opportunity to use the pain of Lehman to ensure that the financial system of the future would benefit from the power of a much more skeptical and diligent bond market, thereby reducing the likelihood and severity of future crises. And as we’ve seen, the gov’t is able to temporarily substitute for bondholders during a panic, and could do so without also protecting bondholders from losses. Instead, we face yet another round of the regulatory apparatus bulking up, with the promise that it will be able (this time, for sure!) to successfully substitute for the risk-control that counterparties should be exerting, if only they had the motive. The benefit of the current (repeatedly failed) approach is that it is politically appealing because it involves increasing government power, and it reduces the apparent cost of capital, since bondholders need demand a lower risk premium.
Sheila Bair is part of the biggest on-going theft ring in world history. That’s not greatness, sir, that’ll be indictment worthy when the time comes. Here’s one “villager” that thinks the most honorable thing she could do at this point would be to resign and spend the rest of her life scrubbing floors in a convent.
Twotenths writes:
“The US missed a rare opportunity to use the pain of Lehman to ensure that the financial system of the future would benefit from the power of a much more skeptical and diligent bond market, thereby reducing the likelihood and severity of future crises.”
Moral hazard?
Reading your post–which I believe accurately captures what is going on with CIT–was very depressing. One comes away with the view that getting Uncle Sam to bail you out depends not on the lone public criterion for taxpayer dollars going to corporations–TBTF–but on who your friends are and whether they’ll give you a boost in a time of need.
One only has to say “Goldman Sachs” to see the other side of this story.
Disgusting, disturbing, as well as costly and corrupt.
Great thought… breaking up Goldman Sachs! BTW, last night on Glenn Beck’s show, Dr. Patrick Byrne complimented you, Simon, as one of those who understands what’s going on. The discussion centered on the criminal organization that GS has become. Watch it… Byrne appears around the 7′ 40″ point: http://www.youtube.com/watch?v=_wVQ3_ZaYB4
We know now that “too-big-to-fail” is firmly embedded into our system now. Too small to support means more consolidation and less competition and an eternal need for the feds to jump in to salvage the economy from the mistakes of TBTF institutions.
Looks like in America, only those small enough to lack clout will be held accountable for their mistakes.
“But the reckoning is that this business can be easily sold to someone else – after all, this is exactly what bankruptcy can get right in the U.S. ”
Except for the growth of the “someone else”. How do firms get Too Big to Fail? In part, they acquire other firms in bankruptcy or facing bankruptcy. And the regulators encourage that sort of thing. Apparently they even twist arms from time to time. Better to keep ’em small to start with.
Amen!
On flooding the system with liquidity, this involves direct expansion of the federal role, which has become ideologically charged.
My greater fear is that the all-wise leaders will develop the courage to let banks fail, but then become paralyzed when they try to deploy the federal apparatus to compensate for the massive monetary contraction that will result.
Hoover 2.0
No one (except Hank Paulson) was certain that civilization would have ended if we hadn’t backstopped AIG’s obligations.
Very few people really wanted to take the risk to find out.
Someone was recently quoted as saying that the bottom line of the response to this financial crisis is that the financially ‘most important people’ in the US are the bondholders of the largest (read “too big to fail”) banks and financial institutions.
The treatment of CTI, whose market is the ‘little people’ is one more ringing confirmation of the bondholders’ supremacy. To the victors go the spoils.
Stats Guy, can I ask you what would be the appropriate way to deal with mopping up the massive mistakes made by the financial sector?
I’ve been desperately trying to educate myself on this topic since last fall, but still feel woefully ill-informed.
We’ve evolved to a point where catastrophic collapse would ensue if the financial firms are held accountable for their mistakes (Paulson reiterated this point the other day.) They absolutely must be propped up with large infusions of money – or else.
And this sector needed to be propped up because all the Ivy MBAs in charge apparently believed that making no-doc mortgages to large numbers of people who would never be able to pay back the loans was okay because the price of homes would never cease to rise – and if something happened, AIG would be there with the insurance – AIG, who issued this insurance without examining what it was they were insuring. Those are astonishing business decisions, if this is truly what happened, which have resulted in cataclysmic tremors felt throughout the economy.
We see a situation where – even after the rescue – our economy is in the worst shape since the Depression. So not propping up the financial sector would have been unimaginably grim.
We see Goldman Sachs and Chase, two very big players in a sector that HAD to be propped up or else the economy would be even worse than what we see today, reporting some of their very best profits ever.
[Granted, I’m not a numbers girl but I truly do not understand how such vast profits can be made by two firms who received such enormous amounts of tax support last fall. Were GS and Chase exceptionally healthy all the time – and Paulson handed over money to them – just because? Were they truly in need of a bailout – but have somehow crawled out of the abyss in record time? How can a company go from falling off a cliff to summitting Everest in less than a year? I realize they face significantly less competition, etc. – but still… seems odd.]
Would love to know your thoughts on this. Do you think we are now forever going to need to bailout the TBTF financial firms when they make similarly stupid mistakes?
Hi ALDANTE,
You might find today’s by Paul Craig Roberts at Counterpunch interesting. He has a way of getting to the heart of things:
http://www.counterpunch.org/roberts07162009.html
A synopsis of TBTF. Guest Starring George Kennedy as Larry Summers. #32Egg in a cameo as CTI Group.
Correction above—CIT Group. Apologies
“If Goldman Sachs were broken into 10 independent pieces, we could all sleep much more soundly.”
This is the very nub: antitrust enforcement. SLP is a per se violation of Sec. 2 of the Sherman Act, carried out coercively through a conspiracy of former Goldman employees and paid agents in regulatory bodies. Discriminatory resolution of Goldman’s competitors, by increasing industry concentration, suppresses competition under a rule of reason test. This is a straightforward antitrust case. The only wrinkle is Goldman’s role in suborning regulators, which can cut two ways: our bent bureaucrats would fight the Antitrust Division tooth and nail; on the other hand, the egregious scope of regulatory capture can support criminal charges if Goldman resists a civil settlement.
But the Obama administration is the oligarchy’s cadet corps. They won’t be able to feather their nests if they acknowledge the scope of official corruption. Nothing’s going to happen without external pressure. Time for multilateral sanctions. Let’s see what the G-20’s made of.
Congratulations on the WSJ piece on blogs….
I was surprised that NakedCapitalism
and
ZeroHedge
got no mention.
…(new) Beautiful Lady in Red
Whoa! Why the hate? In the Geithner vs. Bair battle, I will gladly stand behind Sheila. She’s the only one it seems who doesn’t seem to kowtow to the big banks. No wonder Geithner tried to get rid of her.
From Bloomberg:
Geithner, president of the Federal Reserve Bank of New York, has argued Bair isn’t a team player and is too focused on protecting her agency rather than the financial system as a whole, according to two congressional officials and a person familiar with his thinking. Bair has battled with Geithner and fellow regulators over aid to Citigroup Inc. and other emergency actions, making her enemies in the Bush administration.
“The idea of having an independent actor on the stage with you who might not be singing the same tune can make you nervous,” said Wayne Abernathy, a former Treasury official who is now executive vice president with the American Bankers Association in Washington. “They recognize that she’s a very independent person.”
Goldman Sachs represents the cancer afflicting USA, capitalist oligarchs downloading on the taxpayer mere bailout crumbs while taking bailout $ that will never be fully paid.
CIT had not access (membership card as a political contributor) to the plutocracy (polically supported oligarchy). What a shame! Well, I guess it’s “go fish” for their customers (thousands of small businesses, heavily retail and small manufacturer oriented. Maybe this is a trend. But, since they aren’t even a bank, how did Sheila Bair even get into the discussion? I guess it’s the “any port in an economic storm” mentality, so prevalent these days.
I hope that this really is a signal for the future of all institutions, not just the mid-sized ones. Time to get on with separating the chaff from the valid businesses.
Hello Desolation Row,
The problem we face here has little to do with who in the system might be more and who might be less destructive. The problem is the system itself, now so utterly corrupted by financial, foreign policy, arms and drug interests as to be irreformable. To think of it as a functioning democracy with meaningfully contending majority and opposition parties is today the very definition of disordered perception. Sheila Bair IS Timothy Geithner and Timothy Geithner Is Sheila Bair. They are interchangeable, creatures solely of the vermin that own them. We have a government of poseurs, whores and it will remain that way as long as people continue to entertain the myth that things are otherwise, that they have real choices to make and that party labels or political philosophy have any meaning in such a context.
Not that I think that CIT necessarily deserved to be saved anymore than AIG, but what exactly differentiated it except that AIG owed Goldman $10B and other big banks on the Street and friends of Paulson? While CIT may not really have deserved to have its bonds guaranteed by the FDIC on an objective, stand alone basis, it’s hard to say that any company should now be measured on that basis given what has transpired.
Since much of the pain of a CIT failure will be borne by small to medium sized business, rather than large to mega sized multinationals, have we made the right judgments about who to save and who to throw to the wolves? The CIT saga only reinforces the notion that if you don’t have the right political clout in DC, you won’t be able to maneuver the financial waters. If the IMF were involved, they would have taken over the management of the economy, asserting that this was third world kleptocracy that needed to be thoroughly cleansed before it could return to the global marketplace.
I must say, I never expected to see video of Paul Newman in tighty whities on a blog about the economic crisis! How did you find this?
Lavrenti,
I substantially agree with your description of what is wrong and what ultimately needs to take place. However in the contest to shape public perception of the problem, which is the most crucial contest for any revolutionary project right now, it is obviously the case that Sheila Bair and Elizabeth Warren and others like them are allies.
No?
WSJ never mentioned “Rortybomb” either. WSJ better get off the premium content arrogance train and join the free ride coupe. WSJ letting bank CEOs write Op-Eds. Conservative hacks.
I thought making the analogy between eggs being swallowed and saving the banks was humorous. I guess that went over like most my jokes. Sorry Anne
You can’t argue with these people DesRow, they’re not going to read a 7 page New Yorker article. They just see two people’s pics on the TV screen in a 30 second segment on FOX and are instant experts. That’s why people vote the way they vote and we get what we get. The majority voted for Bush TWO TIMES. Then they want to cry in their soup. They’ll NEVER know the difference between Bair and Geithner. You can’t teach people who in their own mind ALREADY know all the answers.
Ted – no need to apologize! Didn’t quite get the reference, but I’m one of those for whom subtle humor is often missed.
Did appreciate the vision of Paul Newman in his prime…
It is my thought that CIT will find private financing. This is a century old company caught in a 100 year flood.
The economy has hit bottom, as many deep thinkers have reported, and it would be a tragedy to let CIT fail.
The current government’s only goal seems to be government growth and financial consolidation and Americans are buying into sucking on the tit of government for every desire. It’s time for the private sector to kick government out of its’ business. Start by supporting CIT.
http://www.beaconintegration.com/service.htm
Brendan,
Nothing will shape public perception of the problem any more profoundly than the “real crisis” to which Paul Craig Roberts referred at Counterpunch yesterday:
http://www.counterpunch.org/roberts07162009.html
And we’re not quite there as yet. In the meantime The Elizabeth Warrens and the Sheila Bairs of the exercise serve to provide the Bill Moyers crowd with the illusion that there is as yet reason to hope. But it is too late, there is no hope. In any serious contestation, Elizabeth Warren would be emasculated – if such were even possible for her – then eaten for lunch by those owning the enterprise. Any more than you might expect the House of Representatives to pass an anti-Iranian resolution by less than 95% given its predictible response to the threats and financial inducements of AIPAC, should you look for anything effectual in the Warren appointment. Elizabeth Warren is simply a prop on the set, she means and will mean nothing.
CIT was ‘regulated’ by the Fed, as a bank holding company, but the affiliated bank was NOT a Fed member bank.
Think about it, have any Fed member banks been left to fail?
Won’t tomorrow be a hoot getting to see how the Fed took liberty to put 23trillion on their balance sheet even though only 700billion was authorized by Congress? HMMMM sounds illegal to me…better audit the fed–call your elected officials and let them know that you expect it HR 1207. If they don’t listen, vote them out of office.