Think about the potential collapse of CIT Group right now. It got $2.3 billion in TARP money but now has an overhang of debt service that it might not be able to meet. Part of its claim to fame is a large minority and female lending operation. And now it wants to play the "small business" card.

A collapse would ripple across the �small and medium-sized businesses who rely on CIT to operate -- to pay their vendors, ship goods to their customers and make their payroll,� the New York-based lender said in internal documents obtained by Bloomberg News that make the case for its importance to the U.S. economy. CIT spokesman Curt Ritter declined to comment on the documents.

CIT executives spoke with regulators during the past two days, according to a person familiar with the talks, after its bonds and shares tumbled on concern that the Federal Deposit Insurance Corp. won�t allow the lender into its bond-guarantee program created last year to unfreeze debt markets.

The proper course of action here will be to find a merger (they've hired a reputable law firm to assist already) and for the government to monitor the situation but not interfere. It would sound confidence in the financial system and would be a win for the Geithner Treasury. But alas it appears Treasury is pushing the panic button, mindful that it bailed out GMAC. Of course, the latter has ties to a new union-owned business. So if you hear today someone from the Congressional Black Caucus speaking about CIT and minority owners, you'll have found the connection they are making to get the same political deal GMAC did.

It appears that it's FDIC and Ms Bair that are arguing for tough love, at least according to John Carney. I'm in the middle of House of Cards right now, and the similarities to the Bear Stearns collapse -- the markdown of credit ratings, the drying up of short-term lending to CIT -- are scarily familiar. And they point up once again the problems of the current regulatory regime that Minneapolis Fed President Gary Stern pointed up in a recent speech. (Square brackets indicate where I've spelled out abbreviations Stern uses.)

Just as we should not rely exclusively, or excessively, on [supervision and regulation], I do not think that imposing an FDICIA-type resolution regime on systemically important nonbank financial institutions will correct as much of the TBTF ["too-big-to-fail"] problem as some observers anticipate. To be sure, society will be better off if policymakers create a resolution framework more tailored to large financial institutions, in particular one that allows operating the firms outside of a commercial bankruptcy regime once they have been deemed insolvent. This regime would take the central bank out of rescuing and, as far as the public is concerned, �running� firms like AIG. That is a substantial benefit. And this regime does make it easier to impose losses on uninsured creditors if policymakers desire that outcome.

But I am skeptical that this regime will actually lead to greater imposition of losses on these creditors in practice. Indeed, we wrote our book precisely because we did not think that FDICIA put creditors at banks viewed as TBTF at sufficient risk of loss. We thought that when push came to shove, policymakers would invoke the systemic risk exception and support creditors well beyond what a least-cost test would dictate. We thought this outcome would occur because policymakers view such support as an effective way to limit spillovers. I don�t think a new resolution regime will eliminate those spillovers (or at least not the preponderance of them), and so I expect that a new regime will not, by itself, put an end to the support we have seen over the last 20 months.

Wasn't the Geithner Treasury supposed to have come up with a solution to all this? The cost of delay is rising. And since it appears Geithner has pushed Bair and other TBTF worriers aside, hang the cost of this next bailout squarely on the Obama Administration.

UPDATE: Simon Johnson wonders if campaign contributions had anything to do with it:

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.

You're only too big to fail if you pay.

Labels: banking, economics