You Get A Rescue, You Get A Rescue...

Initially, the top 20 banks received bailout funds from the TARP program. Number 21 on the list was CIT, a small-business lender. And predictably, without bailout money they are a threat to go under, and in turn dissolve a lot of funding for small businesses. So the Obama Administration may rescue them as well.

While CIT has about $75 billion in assets, it was not included in the government's stress tests of major financial firms, and most analysts agree that its failure would have relatively modest consequences for the financial system. But it has grabbed the administration's attention because of its focus on small-business lending, an area of outsize political importance. The New York company is mounting an increasingly public case that its failure would crumple thousands of fragile firms.

Administration officials met yesterday afternoon to review CIT's problems and to consider possible responses, according to a person familiar with the matter. Some officials would like to leave CIT alone, to show that the economy is strong and that the government will not rescue every faltering firm. But at a time when the administration already is working on ways to increase lending to small businesses, other officials see rescuing CIT as a necessary and obvious step.

This isn't playing out on the necessity of rescuting CIT, but the politics. And that's the wrong way to determine this. Whether or not people take lessons from CIT, their presence or absence will have an effect on the economy at large, and we can plot that in a cost-benefit fashion. Basing these decisions on political questions is why we rescued Wall Street and offered no conditions or strings on much of that aid in the first place.

It looks as if the aid package will go through. Hopefully that makes sense on the merits.

Simon Johnson has more on this, coming down on the side of not allowing a rescue to CIT.

The issue of the day is obviously CIT. It’s hard to sort out the real news from clever PR/planted stories in this situation, but it looks like the FDIC is coming out strongly against being involved in a rescue package. Given Sheila Bair’s successful political positioning and strong popular appeal, it’s hard to see how – once dug in – the FDIC can be moved [...]

Essentially, by trying to refloat an undercapitalized banking system, Treasury has created pervasive financial vulnerabilities to CIT-sized shocks. These are now the basis for more bailouts and even great fiscal costs.

If CIT is determined to be “too big to fail” in today’s context, this has far reaching implications. Instead of financial entities with assets of at least $500bn creating systemic risk, we now have to worry about anyone who has not much more than $50bn. This is a profound change – and a point that seems to have escaped the Financial Services Roundtable, which is pushing hard for a CIT rescue.