CIT goes into a pre-packaged bankruptcy.

The WSJ has a story up (HT to Calculated Risk) about the impending bankruptcy at CIT.

The company plans to file for bankruptcy in New York as soon as Sunday night or early Monday, said people familiar with the matter. CIT is poised to enter bankruptcy with enough creditor support to approve its reorganization plan and shorten its stay in Chapter 11 ...

... CIT asked bondholders to vote on a prepackaged bankruptcy plan, which would give most bondholders new debt it values at 70 cents on the dollar, and all the equity in a restructured company.

On the up side, it great that this thing is going into a prepackaged bankruptcy. We've seen this at GM and Chrysler. It allows them to emerge stronger. So in the long term the economy will be better off for this, but.....

As Keynes said, in the long term we are all dead.

Last summer, I wrote about the dangers inherent in a CIT bankruptcy.

Something like 70% of our economy is based in consumer spending. One of the things that keeps this running smoothly is a process called factoring.

Basically factoring works like this. Let's say that I am a shoe store. I buy shoes from the factory and sell them to customers. When I buy shoes I have a period of time (let's say 60-90 days) to pay shoe factory.

If you are the shoe factory, you don't really want to wait 60-90 days for payment. But you have an option, rather than waiting 60-90 days for me to give you cash, you can sell that obligation to a third party. So you get cash from the factoring company, and I pay that factoring company the money instead of you. You are going to get less than the full amount of money that I owe you, but you are going to get that money now. This means you can buy supplies to buy more shoes now with money in hand instead of having to take out a loan. This is the factoring process.

This is what CIT Group does for thousands of small retailers, including franchisees (like Dunkin' Donuts). CIT Group has a serious problem, they are on the verge of bankruptcy.

What would this mean?

In an environment where there is little credit available to retailers, it would mean that they would be unable to get product into stores. So basically empty shelves, potentially into the holiday season. And, of course empty shelves will mean that many businesses will be forced to close. That means more people out of work in the retail industry.

Look, it's great that CIT is entering a prepackaged bankruptcy. It will likely mean that this process will be resolved in a little over a month instead of a year. The problem is the timing. Which sucks...... seriously.

We know from what happened at GM and Chrysler that even prepackaged bankruptcies involve shutting down parts of the business while the books are sorted out, and the reorganization plan is put into place. At GM the process from start to finish took 40 days, but the shutdown at factories ran just under twice that.

If CIT is forced to cut volume on their factoring business, that is going to make Christmas this year interesting. It would be interesting to know if retail stores have their inventories for Christmas in. I can't say for certain, but I doubt it. Also GE Capital could pick up some of this business. The bottom line is that total collapse is unlikely, however it is likely that this will create difficulties for smaller retailers. And that ripples out.

We are nearly through the worst of the collapse in residential real estate, but a second bubble in commercial real estate is just beginning to burst.

Just today, guidance came out from the FED, FDIC, and other agencies that commercial real estate is a problem for smaller banks that were less laden with crap mortgages in the residential sector.

Now if we have a situation were retail sales are already weak, and small stores start going out of business. That will put pressure on the owners of these properties who rent them out. If they find that they can't keep paying the mortgage, then they default, and it becomes the banks problem.

Load the banks down with that, and suddenly they're insolvent. So it becomes the FDIC's problem. And the FDIC is bankrupt, and wants to up rates for solvent banks.

There's a whole load of problems here, and we are about to see how far things ripple out from CIT, into commercial real estate markets, and the smaller banks that are loaded down with them.



$2.3 billion down the drain

Why are we giving equity holders the benefit of the doubt and allowing this zombies to continue?

The longer we wait in ignoring the insolvency problem the longer we will linger in purgatory and risk losing billions and billions of taxpayer money. - Financial Information for the Rest of Us.

how bad can this get?

To me this is more the real economy too. Just when I go out driving, I see rows and rows of commercial real estate "for lease", all sorts of Mom&Pops, no more.

So, just how badly will CRE affect the overall economy is what I want to know, how bad is this tsunami, a 10 footer or a 100 footer?

CRE Market was valued at $6.2 trillion

According to this WSJ article:

* $1.7 trillion in commercial mortgage loans.

* $100 billion in CMBS in jeopardy.

Today, there were 2 very big investors that warned about CRE: Wilbur Ross and George Soros.

All the fundmentals are heading in the wrong direction with no sign of slowing down: occupancy rates, rent and cap rates.

Is there some sort of accumulative effect to these crisis and the question is whether the Fed and Treasury have spent their last bullets on the subprime mortgage crisis? - Financial Information for the Rest of Us.

Residential market

vs. residential and the business implied there, i.e. construction, contractors, finance people all lost their jobs when it imploded...

but intuitively it would seem that CRE would imply many more jobs due to the customers leasing/owning CRE would be employers themselves.

There are all kinds of multipliers in the opposite direction

does that make sense? The other thing is municipal and state governments that rely heavily on real estate property taxes. The reduction of property values reduces assessed values used to calculate property taxes. - Financial Information for the Rest of Us.

Geithner says not to worry about CRE

There you have it. Treasury Secretary Geithner says not to worry there is nothing to see here:

“I don’t think so,” Geithner said, when asked whether commercial real estate could set off another banking meltdown. “That’s a problem the economy can manage through even though it’s going to be still exceptionally difficult.”


“You can say now with confidence that the financial system is stable, the economy is stabilized,” Geithner said. “You can see the first signs of growth here and around the world.” - Financial Information for the Rest of Us.

It's hard to say

Sadly, economists have held on to a physics based understanding of the economy, equilibrium and all, when in fact much of the time a biological view is better.

For example of we think of the economy like a gas, we can figure out the new equilibrium that will be established if we heat it or cool it off. (Charle's law) A molecule of gas is a molecule of gas, etc. The units are homogenous.

The economy isn't that way. It's organic. If a small firm making cakes goes out of business, it's unlikely to have a huge downstream impact.

If a firm making specialized components for transmissions does, it can lead to the short term shutdown of auto plants downstream. Even if the economic value of production of this firm and the cake firm is the same, the multiplier effect is likely to be higher in the latter case.

The economy is less like molecules of gas, and more like a living thing. Cut out the kidney, and the patient dies without constant external intervention. Cut off a finger and the impact is less drastic. Firms are not homogenous.

The problem with the bankruptcy of CIT isn't the damage it has alone, it's the absence of another firm able to provide the same specialized service on the same scale in the short to medium term.