CIT is perhaps the most important lender to small businesses in the US. Discussion about its impending demise started in earnest with the WSJ article Major Lender Faces Crunch (via front pages). Today it is being discussed everywhere. Bloomberg has the article CIT Group Says Its Failure Risks Demise of Customers:

CIT Group Inc., the century-old lender that hasn’t been able to persuade the government to back its debt sales, says its demise would put 760 manufacturing clients at risk of failure and “precipitate a crisis” for as many as 300,000 retailers.

Here’s the situation in a nutshell: CIT has a million small businesses as customers. There is some speculation that they may fail as early as August if they cannot get the FDIC to guarantee their loans. Thus far, the FDIC, Treasury, and the Fed have stated that CIT does not pose a systemic risk. CIT has a billion dollars of financing they need by August (hence the first demise prediction), but they need ten times that amount in April of next year. I think they’ll be alive after August. I also think that they will fail in April with anything short of a bailout. And speaking of bailouts, CIT has already received $2.33 billion from TARP.

Amex has cut their lending to small business, shutting down entire departments. The market for small business credit has been drying up. I’d guess that CIT’s failure would result in a much larger number of small business failures than just the 300,000 retailers it says are at risk, perhaps as many as 600,000 small businesses. Large companies are exiting this line of business, not entering. Yet the powers that be hold the position that someone else will step in to pick up the slack. Regardless of which side you took on the bank bailouts, you should find it amusing that the reason for TARP was that if the big banks failed, small businesses on Main Street would fail from the lack of credit. That same logic has not been applied to perhaps the most important lender to small businesses. Instead, it appears that “Systemic Risk” means “Hurts Goldman Sachs.”

This weekend I found myself sitting on a patio, overlooking a lake, drinking a beer (my weekend also involved a motorcycle ride through three national forests, so it was better than yours), while having a conversation with an owner of a small retailer (women’s clothing). While it was distinctly not the appropriate venue, I asked her about the topic. The first thing she pointed out was that she actually has no debt for her business. I found that interesting, and probably not representative of most retailers. I know the holiday season is important to retailers, so I asked her about that. She’s already made the inventory selections for the holiday shopping season. I asked about the impact CIT would have on her business, and even in her position, the impact would be huge. Most designers are fairly small, and the turnover in that line of business is quite high. Many go out of business in their first year. The manufacturers get a guarantee on the inventory from CIT. The designers are then able to sell inventory knowing that it will be produced. The manufacturers make the inventory, and CIT makes the loan to the designers, who pay the manufacturers as they ship to the retailers. CIT then bills the retailers. The retailers have 30 days to pay the bill once it arrives (the bill may arrive as much as 30 days after the inventory, so this is very nice for the retailer). The retailers sell the inventory and pay CIT directly. So, even if a retailer doesn’t actually need credit themselves, there is a very good chance that someone on their supply chain does. For women’s clothing, apparently all designers need credit. If CIT goes bankrupt, selection will suffer greatly.

I suppose an alternative is that the retailer pay the designer up front for the inventory (which would be used to pay the manufacturing). There are a few problems with this. First, I don’t believe that most retailers actually have the cash to do this, despite my sample size of 1 providing evidence to the contrary. Second, I just don’t believe the business practices will shift rapidly enough in that industry. There’s a huge difference between paying after you receive something and paying six months prior.

CIT doesn’t just provide the credit necessary to support the cash flow, they also provide the trust, in the forms of their guarantees, needed for the gears to spin properly. Especially in retail, the industry turnover just doesn’t create an atmosphere of trust. Everybody wants to get paid. Is this the necessary structure to the system? Absolutely not. But it is the system we have in place, and CIT appears to be systemically important.

There’s more about the CIT impacts in the Bloomberg article:

CIT, which says it was the first to offer credit to help consumers nationwide buy Studebaker cars, funds about 1 million businesses from Dunkin’ Brands Inc. in Canton, Massachusetts, to Eddie Bauer Holdings Inc., the bankrupt clothing chain in Bellevue, Washington. CIT says it’s the third-largest U.S. railcar-leasing firm and the world’s third-biggest aircraft financier.

All industries are going to take a hit.

Now for the crazynutjob disclaimer: There was a recent study that showed that the number of retailers in the US could be cut in half without impacting consumer choice. That is a serious indicator that we over-invested in stores. Everyone agrees that the old spending pattern of Americans was unsustainable. The system is falling apart, it is just an issue of when and how. I actually oppose bailouts of all sorts, but I realize that I am in the minority. The consequence of a CIT failure will be large, but the system that grows out of the fallout will be stronger and necessarily less dependent on credit. It is going to be a bumpy ride. Also, I do think a bailout of CIT is going to happen, they’re just going to get jerked around a bit first.

FYI: Apparently it is common practice to point out that CIT is a completely different entity from Citigroup. I have now done so.