Washington's CIT riddle

    How to respond to distress signals at a big lender to small businesses?

    By Colin Barr

    A self-styled bridge between Wall Street and Main Street is showing some cracks. Now the question is whether Washington might try to shore it up.

    CIT Group (CIT, Fortune 500), the New York-based lender to small and midsize companies that got $2.3 billion in taxpayer funds in December, spent Monday trying to persuade policymakers to give it more help. CIT said late Sunday it was "in active discussions with its principal regulators."

    CIT's shares have plunged 37% in the past month to just $1.35 each. And the cost of insuring against a default on its bonds has skyrocketed. The company has also reportedly hired lawyers to explore a possible bankruptcy filing.

    The problems at CIT mark the administration's first brush with financial crisis since the spring's stock market rally.

    While CIT is much smaller than Lehman Brothers, which failed last September with disastrous consequences, the debate in Washington hasn't changed: Policymakers must weigh the health of the financial system against holding the private sector accountable.

    "It's a balancing act. Everyone has been worrying about bailouts creating moral hazard," said Douglas Elliott, a former investment banker who is now a fellow at the Brookings Institution. "At the same time, they're still trying to rebuild confidence in the economy."

    Speaking in London Monday, Treasury Secretary Tim Geithner said of CIT, "I'm actually pretty confident in that context we have the authority and the ability to make sensible choices."

    Cash crunch

    The immediate problems at CIT, which says it has been the top Small Business Administration lender nine years running, center on the company's lack of access to funding.

    Like many finance companies, CIT funded its operations by borrowing in the debt markets. But the collapse of Lehman all but closed those markets to finance companies -- prompting CIT and bigger players, ranging from Goldman Sachs (GS, Fortune 500) and American Express (AXP, Fortune 500), to hurriedly convert themselves to banks.

    But unlike those firms, CIT has not gotten access to a program that allows financial firms to issue debt backed by the Federal Deposit Insurance Corp. CIT applied in January to join that Temporary Liquidity Guarantee Program, under which banks and finance companies have issued some $285 billion of guaranteed debt since November.

    But CIT's application is still pending. And an analyst at Fox-Pitt Kelton said last month approval now appears unlikely, given the long lag since the application was filed and the agency's desire to wind the program down. The program is scheduled to expire in October.

    An FDIC spokesman said the agency has been having evaluating the exposure it would take on were it to allow CIT to issue FDIC-backed debt. The Fed said it couldn't offer any guidance on the CIT situation.

    At the same time, CIT's finances have been weakening. It lost $438 million in the first quarter, as revenue dropped 35%. Moreover, it has $1 billion in maturing debt to pay off next month, as well as $10 billion through the end of 2010.

    As a result, all the major ratings agencies have downgraded the company's bonds over the past week. On Monday both Moody's and S&P cut CIT's ratings, with Moody's citing the firm's "inadequate progress" in boosting liquidity.

    The CIT crisis comes just seven months after the firm sold stock, swapped some new debt for old bonds and submitted to regulation by the Federal Reserve in hopes of regaining its access to funding markets. Executives claimed the moves would be an "inflection point" for CIT, but events haven't played out as they might have hoped.

    "As the bridge between Wall Street and Main Street, CIT remains one of the few significant sources of liquidity for small and mid-sized businesses who are struggling to survive in today's challenging environment," CEO Jeffrey Peek said in a statement last November, when CIT applied with the Fed to become a bank holding company.

    Now, it seems, CIT is struggling to survive as well.