Government refusal to bail out CIT may send lender into bankruptcy, untold market consequences

CIT won’t get bailout, raising bankruptcy prospect

WASHINGTON — CIT Group Inc. shares tumbled more than 70 percent Thursday as its inability to get emergency government funding raised expectations that the commercial lender will file for bankruptcy protection.

It is unclear how a bankruptcy filing by a company that lends to thousands of small and mid-size businesses would affect shaky financial markets hobbled by an economy in recession and bleeding hundreds of thousands of jobs a month. Small businesses are seen as keys to economic recovery.

CIT said late Wednesday that negotiations with regulators about a possible rescue had broken off after days of round-the-clock talks.

The move marked a defining moment for the Obama administration and showed it’s drawing a line in the sand on federal rescues for troubled financial firms.

In a last-ditch effort to avoid bankruptcy, CIT is trying to line up $2 billion to $4 billion in rescue financing from its debtholders within the next 24 hours, a source familiar with the talks told The Associated Press. The person requested anonymity because they weren’t authorized to speak publicly.

But investors were acting as if bankruptcy were unavoidable, sending CIT shares skidding $1.18, or 72 percent, to 46 cents in morning trading after sinking as low as 31 cents earlier in the session.

Meanwhile, shares in the broader market traded in a tight range. In late morning trading, the Dow Jones industrial average rose 10.28 to 8,626.49. The Standard & Poor’s 500 index fell 0.94 to 931.74.

The muted response by the overall market to CIT’s woes suggests investors are more focused on signs that the economic slump may be easing, said Paul Baiocchi, senior market strategist at Delta Global Advisors in San Francisco.

CIT’s small size relative to other big commercial banks may also ease worries of a ripple effect. Though a major lender to small and midsize U.S. business with about a million clients, CIT is one-eighth of the size of Lehman Brothers when massive credit losses forced the investment bank into bankruptcy last fall.

CIT had also begun cutting back on lending in recent months, diminishing the risk a possible bankruptcy could cause significant damage to the broader economy. The lender had $5.3 billion in credit lines to customers as of March, down from $6.1 billion at the end of 2008.

“That shows they were pulling back and should lessen the immediate blow of this,” said Kathleen Shanley, an analyst at corporate bond research firm Gimme Credit. “I don’t see a real contagion effect here.”

And neither, it seems, does the Obama administration’s financial rescue program, headed by Treasury Secretary Timothy Geithner. By withholding aid, the administration is betting that CIT’s likely failure won’t pose a critical risk to an economy weighed down by rising unemployment.

CIT, which got $2.3 billion of bailout money in December, has warned that depriving it of more federal aid could imperil about a million corporate borrowers — from Dunkin’ Donuts franchisees to retailer Dillards Inc.

The Bush administration paid a price for its decision not to save Lehman Brothers, whose collapse helped spark the financial crisis last fall.

Asked about CIT, a Treasury Department spokeswoman said in an e-mail that “even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies.”

With its assets deteriorating and dangerously little cash on hand, the news left CIT with few options outside of bankruptcy.

A bankruptcy filing would wipe out CIT’s shareholders and the government’s $2.3 billion stake. But CIT’s clients would not automatically lose their lines of credit, longtime banking analyst Bert Ely said.

Still, with other lenders to retailers already under financial strain, many CIT clients may lose their financing options.

“The industry just won’t be able to absorb the amount of volume,” said Michael Cipriani, executive vice president of Rosenthal & Rosenthal Inc., a competitor of CIT that’s considered healthy.

New York-based CIT was negotiating with officials from the Treasury, Federal Reserve and Federal Deposit Insurance Corp. for much of the week. FDIC Chairman Sheila Bair resisted lobbying by CIT and other regulators for her agency to come to the rescue.

An agreement on aid appeared close at midday, but trading of CIT’s shares was halted Wednesday afternoon. CIT said late Wednesday that negotiations had stopped.

“I think it makes a bankruptcy filing a near certainty,” Ely said. “It’s quite possible they could file before trading on Thursday.”

The company in April posted a larger first-quarter loss than expected and has seen funding options disappear as investors shy away from purchasing all but the safest forms of debt. The lender has $7.4 billion in debt coming due in the first quarter of 2010, plus other obligations.

A spokesman for the Fed declined to comment. A spokesman for the FDIC could not be reached for comment Wednesday evening.

Though a fraction of the size of big commercial banks, CIT’s holdings are substantial. The company had $75.7 billion in assets as of March 31, according to a corporate filing.

Lehman Brothers, which collapsed after former Treasury Secretary Henry Paulson declined to save it, listed $639 billion in assets when it filed for bankruptcy Sept. 15.

Paulson, serving under President George W. Bush, was lambasted for letting the company fold, a move that unleashed chaos in world markets.

But nearly a year later, the government faces growing criticism over its policy of propping up companies — including General Motors, Chrysler and large insurers — that claimed to be systemically important.

The latest decision could come back to haunt the administration if CIT’s failure proves devastating to the firm’s many small business borrowers. Small businesses are considered crucial to economic recovery, employing about half of the private-sector work force.

“CIT may not be ‘too big to fail,’ but they are systemically important,” said Scott Talbott, top lobbyist with the Financial Services Roundtable, which represents CIT and other big financial firms. “Many small businesses will be severely impacted by today’s actions, and the effect could lengthen the economic crisis.”

Jacobs reported from New York. AP Economics Writers Jeannine Aversa and Martin Crutsinger in Washington, and AP Retail Writer Anne D’Innocenzio in New York contributed to this report.