Think of our economy like a bleeding patient, dying in the emergency room. The triage nurse comes in, evaluates the patients, and prioritizes their suffering, deciding who gets treated first. In the case of our financial system, the Federal Reserve saved the wrong patient: if a bank bailout was necessary it should have been focused on banks whose primary business is lending, which fuels the economy, not trading, which doesn't.
Paul Krugman wrote an enlightening column in Monday's Times about the state of the financial industry. Among his more compelling conclusions: lending, "the part of banking that really matters," remains unprofitable and the economy will not turn around until this activity returns to normal.
While trading, what Krugman calls, "the wheeler-dealer side of the financial industry" is profitable again, "lending, which fuels investment and job creation - is not. Key banks remain financially weak, and their weakness is hurting the economy as a whole."
Take CIT Group, the embattled commercial lender who is a key player in lending to industrial clients, for example. In normal times, CIT provides financing for a variety of small and mid-sized industrial firms (70 percent of CIT's retailing clients have under $50 million in annual sales), with clients in wholesaling, manufacturing, transportation, aerospace, and many more. Like many in the industry, however, CIT has since come into hard times. On December 31, 2008, Treasury injected $2.33 million in an attempt to revive the bank. Unfortunately, this capital has failed to restore the bank to health and CIT has been on life support since this summer.
While Goldman Sachs, which makes most of its money from trading, received a chunk of bailout money thanks to America's taxpayers, CIT, which provides capital to small and midsize firms, which in turn fuels economic growth, has been left to flounder.
Despite CIT's continuously precarious outlook, its leadership has remained resolute in its quest to keep the company. Facing a near certain failure, the bank applied for participation in the FDIC's debt guarantee program in late July, but its request was denied. In a last ditch effort, CIT reached out to its bondholders, who gave the bank a lifeline by offering $3 billion in emergency financing. This deal prevented what would have been the fifth-largest bankruptcy filing ever. More importantly, this prevented the complete elimination of credit for CIT's 2,000 clients that sell goods to over 300,000 retailers. Mallory Duncan, senior vice president and general counsel for the National Retail Federation, put it bluntly, saying that without CIT, "suppliers don't have operating capital."
Today, CIT is likely in its worst position since the summer. It reported a loss of $1.68 billion in the second quarter and has seen its stock price continue to hover just above $1, tumbling from over $60 in the summer of 2007.
Thus, to lighten its debt burden and get another breath of oxygen, CIT proposed a restructuring plan last week that would swap new notes and preferred stock for holders of over $30 billion in bonds. As an alternative, Carl C. Icahn, a CIT bondholder and billionaire investor offered CIT a $6 billion loan on Monday that could end up saving the company $150 million. Neither plan has garnered much support, and many are once again saying that a prepackaged bankruptcy is the most likely destination for the bank. Michael Gallo, a partner and head of the finance group at the law firm DeCotiis FitzPatrick Cole & Wisler, said that the company was "just forestalling the inevitable."
Given CIT's dismal outlook, either the US government needs to step up and lessen the load of CIT's balance sheet through the Small Business Administration's Loan Guarantee Program, or CIT's bondholders need to be more lenient and lower CIT's payments so it isn't forced into bankruptcy. Or another option is to have an outside group gobble up the bank and ensure its continuity of operations. Having failed to pay back its preferred stock or redeem its outstanding warrants, Treasury is reluctant to offer it another lifeline and the FDIC has already demonstrated its unwillingness to get involved. If CIT is pushed over the brink into bankruptcy there is no clear substitute for the businesses and clients that rely on it to keep their doors open, especially during the key winter months when many wholesalers gear up for the holiday rush. Without an ambitious action, we could be even worse off than Krugman foresaw, with a precipitous drop in lending to some of the biggest drivers of our economy and the biggest bankruptcy in the financial sector since Lehman Brothers.
Lucas Puente is a senior at the University of Georgia where he is pursuing a double major in finance and international affairs. He is a member of the Roosevelt Institute’s Campus Network.