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The Bailout
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Bailout in economics and finance is a term used to describe a situation where a bankrupt or nearly bankrupt entity, such as a corporation or a bank, is given a fresh injection of liquidity, in order to meet its short-term obligations. Often bailouts are by governments, or by consortia of investors who demand control over the entity as the price for injecting funds.
Often a bailout is in response to a short-term cash flow crunch, where an entity with illiquid, but sufficient, assets is given funds to "tide it over" until short term problems are resolved.
The bailing out of a corporation by government is controversial because bankruptcy can be seen as being caused by the failure to satisfy consumer demand; the bailing out is thus an instance of government intervention on the market overruling the will of consumers. "All this talk: the state should do this or that, ultimately means: the police should force consumers to behave otherwise than they would behave spontaneously." According to the Austrian School of Economics the appearance of monopolies can often be blamed on such acts of government intervention that preserve overstretched and badly managed corporations which market forces would have broken into smaller and more specialized companies.
Government bailouts of corporations are usually reserved for cases when a corporation is considered "too big to fail" — justified by the argument that failure of certain corporations would cause unacceptable short-term economic repercussions throughout the economy.
A financial bailout may also describe an external intervention into the economic affairs of a nation, industry, corporation or citizen, typically for the purpose of enhancing their financial circumstances for public benefit. Bailouts have occurred globally and with some frequency since the early 20th century. In general, the needs of the entity/entities bailed out are subordinate to the needs of the state. Further, a bailout presents the challenge of moral hazard, by rewarding excessive risk-taking.
Themes from Bailouts
From the many bailouts over the course of the 20th century, certain principles and lessons have emerged that are consistent:
Act quickly and decisively.
Let insolvent institutions (i.e., those with insufficient funds to pay their short-term obligations) fail in an orderly way.
Loans help the system cope with liquidity concerns, but bank solvency issues require recapitalization (i.e., new equity investments and debt forgiveness/elimination).
If taking over an institution due to insolvency take effective control through the board or new management, cancel the common equity (i.e., existing shareholders lose their investment), but protect the debt holders and suppliers.
Government should take an ownership (equity or stock) interest to the extent taxpayer assistance is provided, so that taxpayers can benefit later. In other words, the government becomes the owner and can later obtain funds by issuing new common stock shares to the public when the nationalized institution is later privatized.
A special government entity is created to administer the program, such as the Resolution Trust Corporation.
Prohibit dividend payments, to ensure taxpayer dollars are used for loans and strengthening the bank, rather than payments to investors.
Strong oversight.
Bailout Costs
A 2002 World Bank report indicated that bailout costs average approximately 13% of GDP.
Other Bailouts
1930s Great Depression
1984 Continental Illinois
1990 Japan
1991 Executive Life Insurance Company, by states assessing other insurers
1998 Long-Term Capital Management, by banks and investment houses, not government (see LTCM page).
2003 Parmalat
2008 Bear Stearns
2008 Fannie Mae and Freddie Mac
2008 American International Group
2008 Emergency Economic Stabilization Act of 2008
2008 - 2008 United Kingdom bank rescue package
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Get more info on The Bailout now
en.wikipedia.org/wiki/Bailout_bill
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