This week there was a big discussion about whether the U.S. should use $6 billion of TARP money to save CIT Group (CIT) -- which provides short term financing to a million retailers like Dunkin Donuts -- from bankruptcy. Under Bush, the test case of too-big-to-fail was Lehman Brothers and under Obama it's CIT.
Bush was wrong to let Lehman fail and Obama is right to let the market handle CIT's failure. The collapse of Lehman Brothers was the final straw that broke the financial system and it now appears that all the U.S.'s major banks would have collapsed if the government had not stepped in thereafter.
What should be done about institutions that are too-big-to fail? As I've posted, the too-big-to-fail doctrine is a failed idea -- if a bank can't clean up its own mess in an economic collapse, the government should break it up preemptively or require it to carry huge reserves if it insists on remaining independent. But it's clear that CIT is not too big to fail.
How so? For one thing, the stock market has done quite well during the last week when talk of CIT's collapse was spreading. If the market had been worried, we would have seen a spike in the rate on credit default swaps for all major banks and people would have been scrambling to pull out their funds.
But there's something else going on here. Now that Goldman Sachs Group (GS) and JPMorgan Chase (JPM) have paid back their TARP money -- though they still depend on taxpayer subsidies from the FDIC and Treasury for debt financing -- they see themselves as free to pay huge bonuses to their people.
And with that freedom comes a new responsibility. Those two banks will have to step in and provide debtor-in-possession (DIP) financing to CIT to keep it operating in bankruptcy. Absent these two having the financial strength to provide such financing, the U.S. would have been compelled to use TARP money to rescue CIT.
I think this is a fair trade -- although I continue to believe that banker bonuses should go into escrow accounts. It is critical for the U.S. to get out of the business of subsidizing failure so that Wall Street can return to taking responsibility for solving its own problems.
I would not be at all surprised to see CIT file for bankruptcy this weekend with Goldman and JPMorgan providing $6 billion in DIP financing. And such a move might help deflect a tiny piece of the rage that the American public feels towards these Wall Streeters which are now poised to pay themselves record bonuses -- thanks to taxpayer-financed rescues.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing. He has no financial interest in the securities mentioned.