LeoGlossary: Bailout
A bailout is financial help given to a corporation that, without it, would be in bankruptcy. This is often done by governments with companies or industries they deem essential. The "too big to fail" model comes from this concept.
Bailouts are not limited to governments. They can be done by other corporations or individuals. Of course, the motive will differ from that of politicians.
Motive
Players in bailouts have different motives.
Governments - prevent financial contagion while also protecting industries deemed necessary. This is often related to transportation.
Profit - companies or individuals will often jump on a company in need of a bailout because they see the potential to generate a terrific return. When assets are essentially being sold at distressed prices, investors often see the opportunity to turn things around.
Philanthropy - if a company is failing, a wealthy investor might step in because the business is deemed a benefit to certain individuals who have few options. For example, a food company might be bailed out since its product is vital for the community.
Controversy
Bailouts are extremely controversial, especially in emergency situations.
Proponents feel there are times when the only one large enough to step in is the government (or central bank). If there are too big to fail entities, only something bigger can keep them afloat. If there is systemic risk, so say the advocates, it is vital to keep things going.
Detractors argue this is just a form of corporate welfare. The idea is that companies will privatize their profits while socializing losses. When governments step in, obviously the company is enhanced. This ends up benefitting a select few as compared to others.
The thought process continues in saying that corporations will take unnecessary risk knowing there is a backstop if their actions fail. Also, like with zombie corporations, resource allocation can go awry. When companies are artificially supported, entrepreneurs are unable to pick up the asset on the open market, something that could enhance productivity through better allocation.
To counter, the belief that the mismanagement of a company(s) should not cause widespread pain throughout the economy. There are many firms and individuals, so the thinking goes, that are affected due to no fault of their own. Hence, the only option is for governments to step in with bailouts.
Examples
There are a lot of bailout examples in the United States along with other countries.
Some notable:
1970 – Penn Central Railroad 1971 – Lockheed Corporation 1980 – Chrysler Corporation 1984 – Continental Illinois 1991 – Executive Life Insurance Company by states assessing other insurers 1995 – Mexico Bailout 1997 – South Korea Bailout 1997 – Indonesia Bailout 1998 – Long-Term Capital Management by banks and investment houses, not government 1998 – Brazil Bailout 2000 – Argentina Bailout 2001 – Brazil Bailout 2002 – Brazil Bailout 2003 – Parmalat 2008 – The Bear Stearns Companies, Inc. 2008 – Fannie Mae and Freddie Mac 2008 – The Goldman Sachs Group, Inc. by the US federal government and Berkshire Hathaway 2008 – Morgan Stanley bailed out by The Bank of Tokyo-Mitsubishi UFJ 2008–2009 – American International Group, Inc. multiple times 2008 – Emergency Economic Stabilization Act of 2008 2008 – 2008 United Kingdom bank rescue package 2008 – Citigroup Inc. 2008 – Royal Bank of Scotland 2008 – Halifax Bank of Scotland 2008 – General Motors Corporation and Chrysler LLC: though technically not a bailout, a bridge loan was given to the auto manufacturers by the US government; it is referred to by most as a bailout. 2009 – Bank of America to help it absorb known losses that were much greater than revealed to shareholders incurred by its buyout of Merrill Lynch 2009 – CIT Group $3 billion by its bondholders in an attempt to avoid a bankruptcy, which was only delayed 2009 – Dubai and Dubai World bailed out by Abu Dhabi
Banks tend to be the entities that get bailed out most often.
After the Great Financial Crisis, the Irish had to bail out their banking industry. The same was true in the early 1990s in Sweden.
General:
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