Thursday, July 16, 2009
1. As I've often said, while capital wounds, liquidity kills. And CIT's an interesting example of a supposedly highly capitalized institution unable to obtain private funding.
2. Being a bank-holding company doesn't guarantee survival. And one need only look at the other 50+ bank holding companies that have failed this year to see this.
3. "Too big to fail" has been replaced with "too entwined to fail." And in CIT's case, while large in terms of assets, it wasn't adequately tied to other firms. (Now this isn't to say that CIT is unimportant economically, and unless others step up to take its place -- either directly or through the purchase of CIT's key businesses -- there will clearly be an economic impact.)
4. The finance-company model is dead. And in this, those non-banks that recently converted to bank-holding companies need to be seriously concerned, especially those without access to the Temporary Loan Guarantee Program (or TLGP).
Which brings me to my final point: the TLGP.
5. Of all of the alphabet-soup programs implemented during this crisis, I expect that economic historians will debate the TLGP the most. As we saw yesterday, the market has determined that those with access to it have ensured survival while those without access to it can fail. But with the word "temporary" in its name, the program is meant to have a finite life.
At the risk of going too far out on a limb, I'd offer that unless the new non-bank bank-holding companies are able to replace their existing unsecured debt with government-insured deposits, they have no exit strategy from the TLGP. Put simply, the commercial-paper market and the medium- and long-term debt capital markets no longer afford these firms' sustainable, stand-alone, cost-effective funding.
To my mind, the Treasury just threw a very large rock in the pool. And while I'm certain they looked at the ripples associated specifically with CIT, I don't believe that they saw the bigger wave they created. And unfortunately, from where I sit, they just made the financial system more, not less, dependent on government support.
As a result, extricating our financial markets from this crisis just became considerably more difficult.
in my view, the critical understanding of the jeopardy in which the financial system remains has much less to do with assets and equity than with funding. liabilities, and how they are managed, will determine how this crisis finally plays out.
it wasn't until lawrence summers and tim geithner affirmatively backstopped the banks with the combined efforts of the federal reserve, FDIC and therefore treasury in march that the death spiral of finance touched off by the housing bust and bear stearns was stanched. the status of the funding guarantees which make up this backstop is all-important. CIT demonstrated all too well that to be beyond the perimeter is extremely hazardous.
the commercial paper market has unwound at a dizzying pace since september as large financial institutions have rapidly issued TLGP debt to replace part of this funding -- $339bn worth through june 30, 43% of the program's cap. this is notably the same level as prevailed at the end of march. fully 61% of this is in notes of at least two years duration.
this flight from the private funding markets to the government is ultimately a consequence of another movement in international capital flows -- that is, the jeopardized wholesale funding market consists in aggregate of deposits borrowed from overseas through the current account deficit. as the current account deficit has diminished over the duration of the crisis, wholesale bank funding has got harder to obtain. despite the efforts of many governments, this is likely to continue as american households reduce consumption and increase savings. those savings, in the form of deposits, will become funding for depository banks and bank holding companies to replace their more expensive wholesale funding; for non-depository financial institutions like CIT, however, this is a one-way street to illiquidity and bankruptcy. and, as minyan peter notes, as the TLGP winds up, it becomes a hazard for even depository institutions who lose the battle for deposits and remain heavily dependent on wholesale funding. this potentially and most notably include former investment banks and large money center banks.
This will change receivables and stifle vender notes, etc.
Even if 'solvent' it is hard to see how many of CIT's clients will be able to finance themselves day to day particularly as CP evaporates. Just try to get a line of credit from a bank.
More bankruptcies, more vacant stores, more pressure on CRE; the train wreck continues ...
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