Monday, November 2, 2009

CIT's Bankruptcy Lesson - Treasury proves it can't identify systemic risk

CIT's Bankruptcy Lesson. WSJ Editorial
Treasury proves it can't identify systemic risk.
The Wall Street Journal, page A20

The $2.3 billion of Troubled Asset Relief Program money that will likely be lost in the bankruptcy of commercial lender CIT is hard to swallow, but it may be the most instructive loss taxpayers absorb all year.

Just as the Treasury Department is urging Congress to junk the bankruptcy process and hand over virtually unlimited bailout authority to the executive branch, CIT is proving two things: Bankruptcy works—even for financial firms—and the U.S. Treasury judges systemic risk out of its political hip pocket.

Treasury provided the $2.3 billion TARP injection last December. Then when CIT was on the ropes last July, Treasury urged the Federal Deposit Insurance Corp. to provide debt guarantees to help the company raise capital. Treasury made the case that a CIT failure posed a systemic risk given the number of small and medium-sized companies that rely on CIT for short-term financing.

We argued against this in July. More importantly, FDIC Chair Sheila Bair rejected it. Since her wise decision, CIT has been providing a laboratory to observe the recuperative pain of bankruptcy in an experiment uncontrolled by politicians.

With no federal lifeline coming, the company's major bondholders quickly agreed to a $3 billion secured loan facility and the company began restructuring its liabilities. It became clear that bankruptcy would be necessary and the company recently gained the support of almost 90% of its voting debt holders for a prepackaged reorganization plan that could allow the lender to emerge from Chapter 11 by the end of the year.

While the holding company declared bankruptcy on Sunday, its operating subsidiaries remain outside Chapter 11 and continue to serve customers. Some are choosing to continue with CIT, others are choosing to go with a competitor. Armageddon it is not.

Bankruptcy is a process under the rule of law that is demanded by the Constitution. "Markets not ministers," says former SEC Chairman Richard Breeden in summing up his preference for bankruptcy guided by judges over interventions crafted by politicians. Let's hope CIT's example brings the former back into fashion.