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They Have Bankruptcy in Common and Soon They Will be Too Big to Fail: The Coupling of CIT and OneWest

Adam Rust's picture

Posted February 25, 2015

The proposed aquisition of OneWest by CIT Group is not just another run-of-the-mill M&A story. In many ways, it represents a turning point in our response to the subprime mortgage crisis. This is a merger of a bank that walked away from TARP with a bank that crashed and burned because it made billions in bad loans. This is a merger that will enrich a team of hedge fund investors who appear to have found a way to use FDIC receivership to realize $3 billion in profits.

CIT Group declared bankruptcy in 2009. In doing so, they were able to sidestep on paying back the lion's share of the $2.9 billion in equity invested on to their balance sheet in TARP. That's right - you spent $10 to help out CIT! 

While there has been some pressure to increase the threshold that defines the term, Too Big to Fail is currently crossed when a bank reaches $50 billion in assets. CIT currently has about $45 billion in assets. With OneWest on board, their balance sheet will zoom past $70 billion. 

OneWest has its own colorful past. OneWest is the phoenix that rose from the ashes of IndyMac. Technically, IndyMac did not go bankrupt. Rather they were put in to receivership. But since its re-organization into OneWest in early 2010, OneWest has grown by acquiring the assets of other failed banks. OneWest is the poster child of moral hazard, as its reconstitution has matured through a heads-I-win, tails-you-lose relationship with the FDIC. As part of OneWest's arrangement with the FDIC, for instance, a subsidiary with OneWest (IMB HoldCo) only suffers on the first 20 percent of losses. The FDIC absorbs the great majority of the rest of the losses on the portfolios it sold to IMB HoldCo. 

IndyMac under-delivered on integrity. As it went down, its management did all it could to hide its problems. They did that because their books, if reported publicly, would have triggered enough in the way of safety and soundness concerns by regulators. It is likely that the thrift would have had to disgorge itself of billions in dollars of brokered deposits - an event that would have hastened their downward spiral toward dissolution.  

What kind of security can the public have with the creation of a new Too Big To Fail institution? Is the management at either vested with a fiscally prudent reputation?

CIT is led by John Thain. To his credit, Thain was not at CIT when it declared bankruptcy. But nonetheless, Thain has a checkered past of his own. In 2009, Thain resigned from his positions as CEO and Chairman of Merrill Lynch. While some would say that Thain deserves credit for getting B of A to pay a premium on Merrill's market value even as its own portfolio began to sour, it still remains the case that it was on his watch that things went wrong. It has been said that Ken Lewis pushed for his departure.

Thain's tenure was most notable for its huge losses and equally huge executive bonuses. Thain himself was no stranger to big pay, as he was paid $83 million in 2007, received a $15 million signing bonus when he took the job at Merrill, and asked for another $10 million when he sold the company to B of A in 2008.  His request for a parting gift was denied, but Thain went ahead and approved $4 billion in bonuses to his Merrill teammates during the last days of the firm's independence. 

Dune Capital Managements stands to be on of the big winners if the transaction does gain approval from the Fed. Dune Capital will ultimately have realized $3 billion in profits from its five year investment in the company. Dune put down $1.55 billion when the FDIC auctioned off the assets of IndyMac. To date, Dune has received almost $2 billion in dividend payments and the sale will generate the rest. If approved, the sale will allow Dune to realize a return of slightly less than 200 percent. 

John Paulson is one of the larger stakeholders in Dune. Paulson is a notable name, as he was one of the individuals who profited the most from the subprime bubble. Paulson famously bet against subprime bond portfolios through extensive investment in credit default swaps.