The current dustup over CIT will tell us a lot about the intentions of the Treasury with respect to the banking industry.

If you aren’t familiar with the story, CIT converted to a bank holding company last year in order to qualify for TARP funds and the other goodies that supposedly come with that Charter. It got about $2.3 billion of TARP funds but the other plum it had its eyes on was participation in the Temporary Liquidity Guarantee Program. This is the program under which the FDIC guarantees the debt of the issuing financial institution. It was heavily used by the banks at the height of the crisis to raise new debt as a means of shoring up their capital ratios.

The FDIC isn’t turning out to be quite so generous with its guarantees as the Treasury was with its TARP grants. So far, they haven’t seen fit to agree to guarantee any debt under the TLGP on the understandable grounds that they’re concerned about CIT’s ability to pay back the money. I know it’s hard to believe someone’s actually thinking about piddling details like that! So for the time being CIT is having to content itself with ramping up pressure through back channels in order to get the FDIC to play ball.

Oh, I forgot to add one little detail or actually two. CIT lost $500 million in the first quarter and they have a cool $10 billion of debt maturing through 2010. Those are pretty good reasons to be worried about the credit risk.

So, that brings us to the point. Should CIT be saved? It’s not systemically important, commercial finance companies have historically failed fairly regularly with no substantial adverse effects on the economy and there aren’t a substantial number of insured deposits at risk. Where is the logic of putting more money at risk? True we’re already on the hook for $2.3 billion but does that justify throwing more money at the company.

We can’t save everybody, nor should we. Failure is difficult but it’s also a means of culling out the weakest players. It seems as if CIT fits that bill. Truth be told, it should probably never have been granted bank holding company status and in calmer times with cooler heads prevailing probably wouldn’t have had its application approved. The Treasury should have exercised more due diligence in handing out the money but that’s water under the bridge now. Guaranteeing CIT’s debt looks like a case of throwing good money after bad. Hopefully, the FDIC will pass on this opportunity.

more: here and here