Not too big to fail...
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The bust that workedNov 5th 2009 | NEW YORK
CIT might just be that rarest of things: a financial-services firm
that emerges from bankruptcy largely intact. The small-business lender
filed for Chapter 11 protection on November 1st with the backing of
most bondholders in a so-called “prepackaged” filing. A judge this week
agreed to rule on its reorganisation plan on December 8th. If all goes
well, a new, creditor-owned company, shorn of $10 billion of debt,
could be up and running by the beginning of next year.
If CIT can persuade the judge to approve its plan, its fate will
then rest with its regulators, including the Federal Deposit Insurance
Corporation (FDIC). Badly burned when bond markets seized up, the
company wants to move some important businesses to its Utah-based bank,
where they can be funded by cheaper deposits. At the moment it is
paying much more to borrow than it can charge for its loans.
But the bank remains hobbled by a “cease and desist” order from the
FDIC that limits its deposit-gathering. CIT’s advisers hope this will
be lifted but, as one admits, regulators are “in no mood to do
favours”. It is not alone in its predicament. GMAC, which was also
tripped up by a combination of wholesale funding and risky loans, has
been forced to reduce its deposit rates, which it had hiked in a
desperate bid to attract savers. The former financing arm of General
Motors (GM) is in talks over a third injection of public capital.
CIT’s plight is meanwhile being used as ammunition in a rancorous
debate over how to handle failed financial firms. The Obama
administration wants Congress to hand regulators power to circumvent
the bankruptcy process and take over troubled lenders large enough to
threaten overall stability. But critics say CIT’s reasonably orderly
filing shows that bankruptcy works, even for financial firms.
It should be the first choice wherever possible, they argue, because
it provides creditors with predictability that is sorely lacking in the
government’s proposed resolution regime. The Obama plan is vague about
which creditors would take losses, and when. And it would invite
meddling of the sort already seen in the bail-outs of GM and Chrysler,
as lawmakers press regulators to treat their constituents favourably,
says Peter Wallison of the American Enterprise Institute, a think-tank.
Worse, officials with resolution authority might be tempted to
follow a “better safe than sorry” policy, rushing to take over firms
whose failure would cause disruption but not systemic breakdown. The
Treasury came close to doing just this with CIT, at first urging the
FDIC to provide the firm with debt guarantees after concluding,
incorrectly, that its collapse would send shock waves through the
economy.
Nevertheless, the path trodden by CIT is not a template for the
whole industry. It may be America’s fifth-largest bankruptcy (see
chart) but it is relatively modest in size for a financial firm. And
its decline was gentle enough to allow it to get creditors behind its
reorganisation. Lehman’s failure showed that straightforward bankruptcy
is not ideal as a tool for resolving the biggest, most connected firms.
Joseph Smolinsky of Weil, Gotshal & Manges, a law firm, thinks it
is worth considering an adapted form of bankruptcy that gives the
government the power to, say, sell assets or make management changes
while leaving most creditors’ rights intact.