CIT lost in gamble to pressure FDIC

WASHINGTON (Reuters) - A key U.S. bank regulator had clearly indicated to CIT Group (CIT.N) weeks ago that it would not be eligible for a government debt guarantee program, and even gave the troubled lender the opportunity to withdraw its application, say sources familiar with the matter.

CIT, which is scrambling for a private deal after talks over government financing collapsed on Wednesday, took a gamble by launching a public campaign to pressure the Federal Deposit Insurance Corp into giving it access to the liquidity facility.

The New York-based lender even got the Treasury Department on board with the idea of it issuing government-backed debt, sources have said.

But the FDIC refused to budge, contending that CIT's plea was a last ditch effort involving too much risk exposure for the agency, said one of the sources, speaking anonymously because the discussions with CIT were private.

CIT issued a press release last Friday, saying that it "continues to be in active dialogue with the government," after reports surfaced that the FDIC was concerned about the lender's credit quality.

In the following days, trade groups issued a series of statements and press releases, arguing that CIT's failure could cause serious harm to hundreds of thousands of small businesses and that government should rescue the lender.

CIT also issued more press releases that said the government debt guarantee option was still on the table.

"I think they needed to at least calm the market and say they still had an opportunity to get government assistance," said Gil Schwartz, a former lawyer at the Federal Reserve who now works in private practice at Schwartz & Ballen in Washington D.C.

APPLIED IN JANUARY

CIT had applied in January to the debt guarantee program, also known as the Temporary Liquidity Guarantee Program, or TLGP. The facility was put in place in October and was designed as a way to shore up confidence in the banking sector and inject liquidity into the credit markets.

FDIC Chairman Sheila Bair has in the past said the TLGP is a program designed for healthy institutions hit by temporary market disruptions.

The agency is trying to wind down the program now that credit conditions have eased. And being able to raise non-guaranteed debt was included as a key condition for institutions to exit other government bailout programs.

The FDIC did not see CIT as a good candidate for the program because it thought the lender's problems went a lot deeper than short-term liquidity.

The agency did not issue a formal denial, but it made clear to CIT that its fundamental business problems compounded by escalating bad loans would make it ineligible for the TLGP, sources said.

CIT was given the opportunity to withdraw its application before the lender's recent crisis became public.

Institutions typically withdraw government applications when it becomes clear the application will not be approved, or if they no longer wish to participate in a program.

An FDIC spokesman said the agency does not comment about individual institutions' applications.

CIT did not immediately respond to a request for comment.

GUARDING THE BANK FUND

John Douglas, a former FDIC counsel, said the agency views itself primarily as stewards of its deposit insurance fund.

"The FDIC really has been very careful about the TLGP program because if there's a loss, it gets borne by the fund and the banks themselves have to pay up for it," said Douglas, who now works in private practice at Davis Polk & Wardwell.

During the past week, government officials had been in frequent talks with CIT about ways to improve its deteriorating liquidity situation so it could remain a lender to hundreds of thousands of small medium-sized businesses.

CIT's request for additional help came after it had already received a $2.3 billion capital injection in December from the government's Troubled Asset Relief Program (TARP).

Treasury had seen the FDIC's debt guarantee as a logical temporary solution for CIT, a source familiar with government thinking has said, but the FDIC would not engage in serious talks with other officials about that option.

"I don't think they respond to the public pressure stuff. That's not the FDIC. They don't respond to politics," Douglas said.

After it became clear to the Treasury and Fed that the FDIC would not relent, officials started looking for other options.

Those options included a temporary loan that would give CIT room to strengthen its balance sheet by raising additional capital through debt or equity. They also discussed giving CIT access to the Fed's discount window and asset transfers.

However, conditions at CIT rapidly worsened during the week, leading Treasury officials to conclude that a government aid package could no longer put the lender on a path to recovery.

On Wednesday night, CIT issued a statement saying "discussions with government agencies have ceased."

(Reporting by Karey Wutkowski; Editing by Tim Dobbyn)