California and CIT

In my blog entitled "The Fourth Turning Point", I mentioned that California was the bad boy of US municipals. Here is the update.

California, the most populous US state has started to issue IOUs to its creditors as payment for goods and services as it ran out of cash. This was the consequence of lawmakers' failure to agree on the USD 26 billion funding gap. This step has been taken only once before, since the Great Depression. Rating agencies warned that if weeks go by without a resolution to the cash crisis, California would risk further downgrades. Presently, California is rated Baa1/A/BBB by Moodys/S&P/Fitch respectively.

Meanwhile, California Controller, John Chiang, said there was little risk of default as the IOUs carry the highest priority of payment under the state constitution. In his mind, the state should have the funds to meet these obligations from September. Nonetheless, California bonds have traded lower, reflecting the elevated risks.

Over at Wall Street, another financial institution is battling for its life. CIT Group, a hundred years old finance company turned bank, is pleading with the Fed to save them and lend them funds via the FDIC Government-guaranteed program. Regulators at the Treasury, Fed and FDIC are now debating whether to risk more tax-payers money on top of the USD 2.3 billion granted in December, to keep the lender afloat.

CIT problems stemmed from the mismatch of fundings and an increased risks from its borrowers. Essentially, CIT borrows from the capital markets and lends the funds to SME in the US. At one time, CIT was the largest independent commercial lender in the US. Now, with CIT battling cash shortages, and facing a USD 1 billion bond redemption next month, it risk bankruptcy without Federal aid.

As I write, regulators are rushing to craft a rescue package. In their minds, regulators are working out the impact on markets, should CIT fail... and there is no room for mis-judgment. On paper, CIT is not that big, only USD 70 billion. But they are lenders to over 1 million businesses.

So how will it go? Judging by its latest stock price, market believes a bailout will happen.