CIT Execs Should Resign

I don't know who is supposed to be happy about the CIT bondholder-led financing. Certainly, not the shareholders, unsecured creditors or the non-participating bondholders. Nor the customers of CIT who are likely going to have to find alternative sources of financing when CIT does file Chapter 11 – and it will.

No, the only people who benefit from this "usurious" loan under "duress" are the participating bondholders (the "Passive-Aggressive Lenders" or "PA Lenders", for short).

And, perhaps, the Obama Administration which can now proclaim that capitalism finally exists and works in this country because it refused to provide TARP funds in addition to the $2.3 billion already provided.

Note: I use the appellation Passive-Aggressive Lenders because this is the same group of bondholders who has stood on the sidelines for the past several months, such as PIMCO, obviously waiting for a government-style bailout that wouldn't cost them a cent of principal. You know, the people like Bill Gross who presumably calls himself a capitalist even though he will gleefully promote government handouts or guarantees to serve his own agenda.

But when the government refused to play ball, the nice PA Lenders turned downright nasty and imposed "egregious terms" and what Sean Egan, president of Egan-Jones Rating Co., referred to as "Don Corleone Financing."

Let's consider the financing terms. A new lending facility of $2 billion initially. Fee for providing loan: 5% of principal amount or a quick $100 million. Interest payable at 10% over LIBOR, with a minimum LIBOR rate of 3%.

Therefore, the minimum interest charged will be 13% per annum. In exchange for the $2 billion, plus another $1 billion in less than a month (not sure if additional 5% fee applies to that sum as well, but why wouldn't it?), PA Lenders receive a security interest in previously unencumbered assets of CIT having a nominal value of at least five times the $3 billion loan amount.

Let's just say the PA Lenders received really, really good collateral coverage, or so it seems if the numbers bear any relationship to the truth. A good synopsis of the most relevant terms is set forth in a Bloomberg article entitled: CIT Rescue Group 'Ripped' Lender With 5% Fee, Collateral Demand.

Has anything been solved by CIT's new borrowing? Very little, if anything, as a bankruptcy filing is nearly inevitable. Why? Because CIT has lots of bad loans on its books and its good customers will probably jump ship as soon as they can find a more stable lender than CIT. In order words, CIT's business is kaput with or without a bankruptcy.

Who do we have to thank for this pitiful mess. Jeffrey Peak, CEO of CIT, and the Board of Wreckers, er ..., Board of Directors of CIT. By approving this financing deal, they committed one of the deadly sins of management (in addition to all their prior poor management decisions) ... believing that any alternative is better than a Chapter 11 which must be staved off at all costs no matter what. (Remember how GM sucked up TARP funds for months before it eventually had to file for bankruptcy anyway?)

While it's true that the date of bankruptcy has been temporarily delayed, the bond rating agencies and the FDIC, by their actions or inactions, don't seem convinced that CIT's problems have been adequately addressed by this pathetic stop-gap measure. On the other hand, CIT has now given up any negotiating power it may have had in a Chapter 11 with billions of dollars of unencumbered assets at stake. Hey, maybe a regular unsecured creditor/bondholder would have rather taken its chances with an unsecured claim equal in priority to the PA Lenders unsecured bondholder debt (the outstanding debt prior to the new $3 billion or secured debt).

Now, even though only the new financing is secured, the excessive fees and interest will surely more than compensate the PA Lenders for the new loan as well as a way to make back some money on the old stuff outstanding.

There was an interesting wrinkle along with the new financing. CIT has initiated an exchange offer to buy back $1 billion of bonds maturing in August for 82.5 cents on the dollar. So, while the PA Lenders loot the remaining unencumbered assets, unsecured bondholders who would have had a right to share in the proceeds of those assets until last weekend are being asked to compromise their claims.

Why should they unless shareholders are wiped out? Why should they now that the PA Lenders have extracted unreasonable loan terms from an insipid CIT? Frankly, I am surprised that the bondholders with upcoming maturities haven't filed an involuntary bankruptcy petition to stop this mismanagement of CIT's assets as they know for certain they are not going to be voluntarily paid in full.

In sum, the new financing was not commercially reasonable. It encumbered at least $15 billion or more of theretofore unencumbered assets. The fees (and there are many in addition to the initial financing fee) and interest rate on the new financing are unserviceable for any length of time. The CEO and the BOD have completely mismanaged the company to the brink of bankruptcy while begging for another government intervention as opposed to coming up with an intelligent strategy for restructuring the company months ago before it got to the brink or instituting an orderly wind-down of its assets with sufficient notice to its customers to find alternative sources of funding.

The CEO and BOD of CIT have exhibited an unforgivable level of incompetence. The only saving grace would be for the CEO to immediately resign or be terminated and then the last act of the BOD before resigning themselves would be to appoint a new CEO who knows how to liquidate a company that others have screwed up.

Disclosure: No position in CIT.

Signs Economic Recovery Not in Sight

Here is just a sampling of signs that the economic recovery is nowhere is sight:

California is issuing IOU's for billions of dollars of current obligations. State workers to be furloughed three days per month.

Unemployment rate hits 9.5%, with 467,000 jobs shed. Job losses accelerating from previous month with estimates for unemployment to exceed 10% up to 11%.

Automobile sales are still suffering despite massive incentives. Consequently, gross margins are being compressed. Sales without profits is not a recipe for long-term survival. Lear and other suppliers to file for bankruptcy relief as sales slow and margins disappear.

Once the current buyers of vehicles have bought at heavily discounted prices, sales will continue downward cycle as all who could afford and wanted to buy will have already done so.

People who are unemployed or who fear job loss are not going to buy cars or fund an economic recovery. This is a nonsensical fallacy.

The recent stock market rally is not based on improving fundamentals. It is based more on the herd mentality of Wall Street. The investment laggards must buy into the fool's rally to supposedly avoid falling further being competitors. Unfortunately for them, their clients are not going to participate in the recent rally; instead, they will suffer further losses as the market retreats.

The FDIC has already shut down more banks this year than last year in its entirety by a factor of two.

Home prices are still declining. The only increase in home sales relates to foreclosured properties or those in the midst of foreclosure.

Consumer credit is constricting at a rapid pace and banks reduce credit risk and the cost of that reduced credit is ballooning. Hardly the condition for a return to prior consumer buying habits.

The U.S. dollar is being continually devalued due to outrageous defecit spending. The value of the dollar versus other currencies will continue to decline if the profligate spending continues. It may already be too late to stave of a tidal wave of inflation once the world economic recovery returns in full force, two, three or more years from now. Don't expect an economic recovery until unemployment begins to decline for a substantial period of time and consumer credit eases.

China has already indicated its intention to rely less on the dollar as the sole global reserve currency. As that movement expands, borrowing costs for the U.S. will continue to rise.

The American taxpayers is being stressed to the max even before the cost of a new health care system and of environmental "cap" and "trade" are factored in.

Similar to California, state governments throughout the country are on the brink of collapse due to the failure to align actual current revenues with prior outdated prognostications of revenue. State legislators lack the political backbone to curtail spending even in the face of economic catastrophe AND just as every individual household must do when sources of income decline.

There are no "green shoots" of any lasting consequence. Whatever "green shoots" supposedly existed were manufactured by government manipulation of our capitalist system.

When the government no longer respects contracts or the rule of law that has governed business relationship from time immemorial (with few exceptions) in favor of general notions of the public good or socialist tendencies, we are not fomenting the conditions for economic recovery but just the opposite as entrepreneurs and businesses can not rely on the sanctity of their negotiated arrangements.

The New Rules of Government Capitalism

To My Fellow Citizens:

Please be advised that effective immediately (i) the economic system heretofore known as "Capitalism" in the United States of America shall now be known as "Government Capitalism", and (ii) the following rules, to the extent not already in effect, shall be implemented immediately.

1. Any person who purchased a home or other real property without sufficient income to afford the mortgage payments and/or without sufficient documentation of his income, and/or who was advised by a mortgage broker or lender that his mortgage could be refinanced in the future because real estate values always go up in value (and without question accepted such assumption as valid because of greed, stupidity or ignorance), shall be entitled to a modification of his mortgage to the extent necessary to ensure that the owner will not only be able to make the modified loan payments based on a reduced principal amount, but also will be entitled to realize all of the profit generated from a future sale of the property without having to repay the amount of the reduction of the mortgage. The cost of the mortgage reduction shall be absorbed by such person's neighbors and other taxpayers, who have continued to pay their mortgages without government assistance and who only purchased properties they could actually afford based on their incomes.

2. All banks and other financial institutions that failed to properly manage their risk and instead sought to increase their profits by use of excessive leverage that was based on a continued increase in the value of real estate, and whose failure would cause "systemic risk", as arbitrarily defined by the Treasury Department and the Federal Reserve (since no written definition thereof exists, or if it does nobody knows how to apply it except arbitrarily), shall be entitled to billions if not trillions of dollars of government bailouts to create the artifice of solvency. The U.S. Government will increase the deficit by up to or exceeding $2 trillion in the next fiscal year (and trillions more in subsequent fiscal years) by borrowing money from the OPEC nations, China and Japan and other countries that currently maintain massive trade surpluses with the U.S.

3. In addition to U.S. Government borrowings, the Federal Reserve will print money to the extent necessary to fund any shortfall from the aforesaid borrowings. In addition, the Federal Reserve shall continue to loan trillions of dollars to the mismanaged financial institutions to guarantee that they make profits in the future at the expense of the American taxpayers and of retirees and other individuals who prudently saved money ("Risk-Averse Investors") on which they were anticipating a reasonable rate of return to fund their ongoing living expenses without having to deplete their principal balances.

4. Any financial institution that was insolvent based on FASB mark-to-market accounting rules in effect until FASB buckled under political pressure and quickly changed them, and which received U.S. Government and Federal Reserve assistance shall remain in existence. Shareholders whose interests were actually worth nothing and were not entitled to retain an ownership stake in such insolvent institutions without infusion of additional capital from them, will nevertheless continue to own their shares in such institution on a diluted basis. Such dilution shall be as little as possible even though private investors in such institutions received or would receive a much higher percentage ownership of in exchange for the same level government assistance in such institutions, whether in the form of bailouts or continuing policies to funnel money to such institutions by the manipulation of interest rates by the Federal Reserve at the expense of, among others, the Risk-Averse Investors.

5. If a federally-chartered bank is sufficiently large so as to possibly cause said systemic risk, the FDIC will not declare the bank insolvent under any circumstances. The U.S. Government via the Treasury Department, in conjunction with the Federal Reserve and and the FDIC will devise a plan to manipulate the bond market and the stock market to benefit those parties who are the least deserving of assistance.

6. In accordance with Rule 5 above and as alluded to elsewhere above, the U.S. will never wipe out shareholders and become the 100% owner of in an insolvent bank because to do so would require the exercise of honest judgment and transparent economic policies and equal treatment amongst all banks.

7. Any secured lender of an automotive company filing for bankruptcy protection such as Chrysler or General Motors, shall not be entitled to a greater return as a result of its secured position as compared to unsecured lenders or trade unions possessing unsecured claims. In fact, such a secured creditor requesting a greater return on account of its secured interest shall be ostracized by the Federal Government and shall be treated as a scapegoat by an over-reaching Executive Branch.

8. Any automotive company filing for bankruptcy due, in part, to rising health care costs, exorbitant union benefits as compared to non-bankrupt automotive companies and excessive corporate taxes, all of which costs impede the ability of U.S. car manufacturers to compete effectively in the global market, shall be entitled to sell all of their viable assets via a government-sponsored sale, the end result of which will ensure either majority control of the reorganized entity by the U.S. Government or the United Auto Workers or some combination of both.

9. Any government-sponsored bankruptcy sale in an automotive bankruptcy case shall not be required to distribute the proceeds thereof or such other value obtained for the bankrupt's assets pursuant to the the various contracts and agreements of the subject automotive company or the priorities established by the Bankruptcy Code and longstanding legal precedent unless the government, in its sole discretion, decides to abide by the law.

10. Any Risk-Averse Investor or responsible banking institution shall be required to bear the cost of the foregoing policies along with the American taxpayers. No Wall Street executive or other highly-compensated individual of those institutions shall be required to disgorge any bonus payments made with respect to highly speculative transactions which ultimately contributed to the insolvency of those institutions absent government bailouts.

11. In addition to the recent change of the FASB mark-to-market accounting rules that required an institution to write-down the value of real estate to the best estimate of its current market value based on actual real estate transactions occurring in the marketplace, all new accounting rules and regulations by FASB shall permit irresponsible banks to reflect real estate assets on their books based upon a fantasy model of the value of such assets in the future and the assumptions underlying such fantasy valuations shall remain within the sole discretion of such financial institutions that were unable to manage their risk properly in the first place.

12. The term "Generally Accepted Accounting Principles" shall be changed to "Sometimes We Feel Like A Nut And Sometimes We Don't Accepted Accounting Principles. The organization called the Financial Accounting Standards Board or FASB, as referred to above, shall hereafter be referred to as the Insipid Financial Board of Standards or "IF-B.S.".

13. This is just a preliminary list of the rules of new Government Capitalism that will go into effect. Additional rules will be adopted and implemented if and when any of either the U.S. Government, Treasury Department, Federal Reserve or FDIC have a wild hair up their respective posterior.

We welcome suggestions for further changes to the previous system of Capitalism in order to conform more closely with the principles and philosophical foundations of Government Capitalism. We look forward to working with you to develop as many regulations as possible so as to undermine the principles of Capitalism that have led to the unprecedented and unequalled economic success of the U.S. since its formation.

Good luck on surviving the new Government Capitalism without filing for bankruptcy, losing your job or the value of a substantial portion of your net worth due to massive inflation in the coming years,

Uncle Sam