BankThink

Putting together the pieces of a free market

The pieces of a more equitable fate for troubled financial giants are beginning to come into view as evidenced by this week´s private-sector rescue of CIT. The lender´s salvation may serve as a prop for future government bailout strategies. But its ordeal is also further proof that the government needs more power to seize and resolve large companies.

Describing CIT´s $3 billion lifeline from private bondholders yesterday, American Public Media´s Marketplace argued that the Obama administration´s nudging the private sector into action was designed to provide grounds on which to refuse future bailouts-perhaps of companies larger than CIT-and force the market to step up to the plate.

The radio program quoted International Risk Analytics CEO Dennis Santiago, who said, "We could get back to the normal state of affairs where companies come and go and do their thing in the normal free market process."

In other words, the same maneuvers that before seemed foolhardy, such as letting Lehman Brothers fail, could work better now. That would be a political dream for the Obama folks.

But Chris Low, the chief economist at First Horizon National Corp.'s FTN Financial, saw the CIT incident as a risky game of chicken between bondholders and the government.

"The bondholders were clearly waiting to see what the government would do and it wasn´t until the White House made it clear that they were going to do nothing that the bondholders got together to figure out what they could do," Low said in an interview.

He disagreed with claim that the strategy could work for a larger company. In the case of CIT, he said, the administration perhaps felt it could stomach a failure because officials didn´t view it as systemic.

The choice would not be as easy for a behemoth, however.

"If `too-big-to-fail´ were a factor here, then we´d be in the same position that we found ourselves when Merrill was going down, where regulators found themselves in a position where there really wasn´t anything they could do," Low said.

He argued a new systemic resolution authority would have eased the process for both CIT and larger firms, and would still encourage private-sector bailouts. Now, in the absence of such an agency, policymakers face two drastically different scenarios: An appealing private rescue or a costly, harried government bailout.

"If they had the authority to put them into receivership," Low said, "they would have started moving towards putting them into receivership and the bondholders would have realized they stood to lose more than they had gained, and they would have put up the $3 billion."

Peter Eavis touches on this interplay today in the Wall Street Journal´s "Heard on the Street" column. But while agreeing with Low that a systemic resolution framework is needed, he warned that the process for taking over institutions should not be overly standardized, and should allow for cases like CIT´s where creditors lend a hand.

"Why don't the Treasury's overhauls provide a framework encouraging creditors to banks to take orderly haircuts in such situations?" he wrote.

So even though the government may have effectively kept the market guessing with CIT, the need for Congress to create a resolution authority is still there. Without it, Low is right: the game of chicken the public and private sectors play is just as dangerous as ever.

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