The move marked a defining moment for the Obama administration and showed it's drawing a line in the sand on federal rescues for troubled financial firms.
The early reaction to the collapse of the talks was subdued.
Futures on the Dow Jones industrial average and the Standard and Poor's 500 index dipped on the announcement. But after a stronger than expected earnings report from JPMorgan Chase on Thursday morning, the Dow Jones industrials and S&P 500 futures edged higher.
The muted response to CIT's woes suggests investors are more focused on signs that the economic slump may be easing, said Paul Baiocchi, senior market strategist at Delta Global Advisors in San Francisco.
"The market may simply scoff at this news," Baiocchi said. "We're seeing more optimism with the earnings outlook this quarter, so that could outweigh CIT's problems."
CIT's small size relative to other big commercial banks may also ease worries of a ripple effect. Though a major lender to small and midsize U.S. business with about a million clients, CIT is one-eighth of the size of Lehman Brothers when massive credit losses forced the investment bank into bankruptcy last fall.
CIT had also begun cutting back on lending in recent months, diminishing the risk a possible bankruptcy could cause significant damage to the broader economy. The lender had $5.3 billion in credit lines to customers as of March, down from $6.1 billion at the end of 2008.
"That shows they were pulling back and should lessen the immediate blow of this," said Kathleen Shanley, an analyst at corporate bond research firm Gimme Credit. "I don't see a real contagion effect here."
And neither, it seems, does the Obama administration's financial rescue program, headed by Treasury Secretary Timothy Geithner. By withholding aid, the administration is betting that CIT's likely failure won't pose a critical risk to an economy weighed down by rising unemployment.
CIT, which got $2.3 billion of bailout money in December, has warned that depriving it of more federal aid could imperil about a million corporate borrowers—from Dunkin' Donuts franchisees to retailer Dillards .
The Bush administration paid a price for its decision not to save Lehman Brothers, whose collapse helped spark the financial crisis last fall.
Asked about CIT, a Treasury Department spokeswoman said in an e-mail that "even during periods of financial stress, we believe that there is a very high threshold for exceptional government assistance to individual companies."
With its assets deteriorating and dangerously little cash on hand, the news left CIT with few options outside of bankruptcy.
A bankruptcy filing would wipe out CIT's shareholders and the government's $2.3 billion stake. But CIT's clients would not automatically lose their lines of credit, longtime banking analyst Bert Ely said.
Still, with other lenders to retailers already under financial strain, many CIT clients may lose their financing options.
"The industry just won't be able to absorb the amount of volume," said Michael Cipriani, executive vice president of Rosenthal & Rosenthal, a competitor of CIT that's considered healthy.