CIT = Capitalism In Transition

Good Evening: U.S. stocks finished mixed for a second straight day on Wednesday, as positive earnings from Apple fought lingering credit concerns to a virtual draw. The NASDAQ did manage to advance, however, extending its streak of positive closes to eleven. The rest of the capital markets didn’t stray too far from unchanged, either, with bonds and the dollar modestly lower, and commodities flat. Financial stocks were initially quite heavy, but most of them staged comebacks as the day progressed. CIT was not among them, though, as word of the potentially onerous terms of a proposed private financing were leaked to the press. The media clucked quite a bit about the money bondholders stood to make on this deal, but when I last checked, that’s how capitalism is supposed to work

With another light day on the economic release calendar (mortgage purchase applications crept higher), investors once again focused on earnings. Apple announced last night that it had — surprise! — easily surpassed estimates. AAPL’s stock dutifully jumped in after hours trading. After listening to the conference call, investors then decided there wasn’t a whole lot in the company’s results that applied to the rest of the tape. U.S. stock index futures thus retreated when the bourses in Europe traded lower this morning. Morgan Stanley and Wells Fargo contributed to this sinking feeling when they reported less than stellar earnings (see below). Morgan Stanley’s results were hurt by the repayment of TARP capital and rising prices for its debt securities, while Wells Fargo was hurt by a large spike in delinquencies on mortgages and other types of loans. If the economy is truly healing, someone forgot to send the memo to WFC’s borrowers.

The net of the above news flow was a 0.5% drop in the major averages at the start of Wednesday’s trading. Stocks wasted little time, however, in vaulting back above unchanged, a level they then criss-crossed until lunchtime. Apple’s strength, as well as the aforementioned comebacks in the shares of MS and WFC, helped push the indexes higher in the early afternoon. The S&P 500, for example, was up more than 10% from its July 8 low at one point this afternoon before some late profit taking set in. The major averages eased back toward unchanged and then finished mixed. Treasurys were down ahead of the next refunding announcement, with yields rising between 2 and 7 bps. The dollar was off a few tenths of one percent, while commodities as a group treaded water. Emblematic of today’s action were the metals, since a decline in metals considered base was offset by a rally in those deemed precious. The CRB inched a fraction higher.

Earlier today, a headline on Bloomberg (since retracted) plaintively claimed that PIMCO and some other money managers stood to book an immediate, $100 million gain on their offer to help CIT through its current rough patch. A couple of other media outlets picked up on the story, also playing up the “quick buck” angle. Representative of the complaints about the terms offered to CIT by the free market — and not taxpayers — are the following two paragraphs, also courtesy of Bloomberg:

“CIT, the 101-year-old commercial lender struggling to retire $1 billion of debt maturing next month, agreed to pay a 5 percent fee to the creditors and annual interest of at least 13 percent. On top of that, the New York-based company pledged assets worth more than five times the amount of the loan as collateral.
“The terms are egregious,” said Dwayne Moyers, the chief investment officer at Fort Worth, Texas-based SMH Capital Advisors, which oversees $1.4 billion, including more than $70 million of CIT bonds. “They ripped the faces off everyone with these terms.” (source: Bloomberg article below)

Whoa, hold on there a second, Tex. Your pretense of outrage is silly. Why didn’t you, Mr. Moyers, offer to fund CIT on the same terms? Rather than disparaging private providers of capital, the media, investors, and, yes, other bond buyers, should be cheering the return of capitalism to our capital markets. This is how markets are supposed to work: Investors take risk (in this case, the bankruptcy of CIT), and they are rewarded for doing so. It’s that simple, though these lessons were forgotten during the credit bubble, when huge risks were sought without much thought — or reward. Predictably, losses and crisis ensued. It’s high time investors rediscovered the art of demanding return for the assumption of risk.

Getting the government out of the lending business should be celebrated, not scorned. Have we taxpayers been cheated out of an opportunity to make fabulous returns in CIT via yet another TARP “investment”? Of course not (the government employees at Treasury would never think of cutting such a sweet deal). This transition back to capitalism from the statism of bailouts will be bumpy, as Morgan Stanley’s earnings today will attest. Why even GE is trying to stop issuing FDIC-backed debt (see below). CIT may or may not live long enough to pay back everything it owes to its creditors, but it’s nice to see them trying to stand on their own two feet instead of settling for a TARP I.V. drip in the emergency ward at Treasury.

Ideally, the deal offered by PIMCO, Oaktree, Baupost, and others may actually act as a clarion call to other sources of capital. Reading about these terms will probably cause them to rub their eyes, and subsequently open their wallets. High prospective returns have a way of doing that to proper capitalists (as opposed to the bailout-seeking, crybaby capitalists). Again, the trip back from government sponsored finance will be neither quick nor easy. But here’s hoping that the “egregious” terms offered to CIT will some day be looked back upon as one of the turning point moments as our markets move away from their current reliance on government funding. Let CIT stand for “Capitalism In Transition”.

— Jack McHugh

U.S. Markets Wrap: Stocks Mixed; Bonds Drop Before Debt Sales
Morgan Stanley Loss Misses Estimates on Debt Costs
GE Capital Wins Approval of Plan to Exit FDIC Program
CIT Hit With Interest Rate More Than 25 Times Libor

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