CIT Group is apparently in trouble and now negotiating with Treasury, the Fed, and the FDIC for some sort of “bailout”, e.g., in the form of a guarantee for its debt.
Traditionally, CIT provided vanilla loans to small and medium-sized business. “But under its current chief executive, Jeffrey M. Peek, a well-liked Wall Street veteran who lost out several years ago in a race to run Merrill Lynch, CIT made an ill-timed expansion into sub-prime mortgage and student lending” (NYT today).
What happens to CIT will help define exactly where we are with regard to “too big to fail.”
At the end of 2008, CIT had total assets around $80bn, which was about 1/10th the size of Goldman (and about 1/25th the size of Citigroup) and puts it just outside the top 20 publicly traded financial services company. Presumably, it just missed the cut for inclusion in the government’s recent “stress tests”.
Its assets are between 2 and 3 times those of the largest “hedge funds” – although obviously what gets that label these days is somewhat arbitrary, and the leverage in any individual fund could mean system risks roughly of the same scale as for CIT.
CIT’s bailout possibilities are now in the realm of political choice. The rest of the financial sector, including hedge funds and the American Bankers’ Association (ABA), should be lobbying for it not to get bailed out – otherwise the bar for “too big to fail” will be lowered (by roughly an order of magnitude), and there will be many more voices arguing that even medium-sized banks/funds need to be broken up or otherwise severely constrained.
However, given that hedge funds have no discernible political strategy – other than to cry in public about impending European regulation – we should not expect any coherent response from that quarter. And the ABA mistakenly thinks they can take on all comers on all issues; their hubris does not lend itself to thinking through this particular part of the chess game. So both of these powerful forces are likely to sit on the fence.
The decision therefore largely comes down to the administration. On this front, the lack of strong connections between CIT’s CEO and senior Treasury officials looks like a weakness. CIT seems to sit at the edge of the charmed circle, with regard to meetings, shared social engagements, and intellectual entanglements. This is a close call, but I think it is just on the outside of the circle – in the sense that with the overall financial market situation more stable, the GM bankruptcy well-managed relative to expectations, and other credit support programs still in place, the balance of official opinion will tilt against CIT.
So then it all comes down to political donations. At least in terms of what is in the public record, Mr. Peek has not been overly generous, but he did give money to John McCain – and not to any Democrats. If this is in fact the limit of his recent contributions, I think you know the outcome.
By Simon Johnson