Bailout (Company) - Explained
What is a Financial Bailout?
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Table of ContentsWhat is a Bailout?How does a Financial Bailout Work?Real-World ExamplesFinancial Industry BailoutAuto Industry BailoutAcademic Research on Bailouts
What is a Bailout?
A bailout refers to the act of a business, person, or a government giving money, as well as, resources to a company that's failing. These actions assist to prevent the impact of the potential downfall of that business which might include bankruptcy and also default on its financial obligations. Businesses, as well as, governments might get a bailout which may be in the form of a loan, buying bonds, cash infusions or stocks, and may need the recused party to reimburse the support, depending on the terms. Bailouts initially happened in businesses or industries that are not viable anymore or that have experienced huge losses. However, even sectors that seem stable like banks are likely to fail, as seen during the financial sector bailout of 2008.
Fast Facts A bailout refers to money injection into an organization or business which would eventually experience collapse. Bailouts can take the form of bonds, cash, loans, or stocks. Some loans need reimbursement, either with or without interest payments. Bailouts usually go to industries or companies that directly affect the company's overall health, as against just one sector or industry.
How does a Financial Bailout Work?
Bailouts are usually only for industries or companies whose bankruptcies might have a severe adverse effect on the economy, not just a specific market sector. For instance, a company having a considerable workforce might get a bailout because the economy couldn't sustain the major jump in unemployment which would happen supposing the business failed. Often, other companies would intervene, acquiring the failing business, referred to as a bailout takeover. The United States government has a long history of bailouts dating back to 1792 panic. Since then, the government has helped financial institutions during the savings and loan bailout of 1989, rescued insurance giant American International Group (AIG), funded Freddie Mac and Fannie Mae, the government-sponsored home lenders, and stabilized banks during the "too big to fail" bailout of 2008, officially referred to as the Emergency Economic Stabilization Act of 2008 (EESA). Furthermore, the financial industry isn't the only one to get the rescue fund's over the years. Lockheed Aircraft Corporation (LMT), General Motors (GM), Chrysler, and the airline industry also got government, as well as, other bailout support. In 2010, Ireland bailed out the Anglo Irish Bank Corporation to the sum of about US$29 billion. Greece got the European Union (EU) bailouts toppling the scale at about US$360 billion. However, Greece isn't alone in requiring outside assistance in managing debts. Other bailouts include South Korea in 1997, Brazil in 1998, 2001, and 2002, Indonesia in 1999, and Argentina for n 2000 and 2001. Also, it's important to understand, the majority of the businesses receiving rescue funding would go on to pay back the loans eventually. GM and Chrysler repaid their Treasury obligations just as AIG did. However, AIG also got help in ways other than just financial, which is difficult tracking.
As seen, bailouts take various forms and shapes. Also, with each new bailout, there is a reopening of the record books and a new biggest recipient award updated. Observe some of the other historical financial rescues.
Financial Industry Bailout
The United States government in 2008, offered one of the largest bailouts in history in the wake of the global financial crisis. The rescue targeted the biggest financial institutions globally who experienced huge losses from the subprime mortgage market's collapse, as well as, the resulting credit crisis. Banks, that had been giving a higher number of mortgages to borrowers having low credit scores, experienced huge loan losses as tons of people defaulted on their mortgages. Financial institutions like Lehman Brothers, Countrywide, and Bear Stearns failed, and there was a huge assistance package from the government in response. On the 3rd of October, 2008, President George W. Bush signed into law the 2008 Emergency Economic Stabilization Act. This brought about the creation of the Troubled Asset Relief Program (TARP). TARP permitted the U.S. Treasury Department to spend over $700 billion to buy toxic assets from dozens of financial institutions' balance sheets. Ultimately, TARP disbursed exactly US$439 billion to financial institutions, according to an independent nonprofit newsroom, ProPublica. This figure represented the highest bailout in financial history to date.
Auto Industry Bailout
Automakers like General Motors (GM) and Chrysler were knocked down as well during the financial crisis of 2008. The automakers also sought a taxpayer bailout, arguing that, without one, they wouldn't be able to remain solvent. Automakers were pressurized as slumping sales plunged despite the dual effects of surging gas prices and the inability for various consumers to get auto loans. More vividly, the high prices at the pump made sales of the SUVs and larger vehicles of the manufacturers to plummet. Simultaneously, the public had difficulty getting financing, with the inclusion of auto loans, during the financial crisis as banks further increased their lending requirements, thus hampering auto sales. Though it was intended for financial companies, these two automakers eventually drew approximately $17 billion from TARP in order to stay afloat. In June 2009, GM and Chrysler, now Fiat-Chrysler (FCAU) emerged from bankruptcy and still remain among the major auto producers today. ProPublica posits that as of April 2018, the United States Treasury has recouped $390 billion of the $439.6 billion it dispersed, and Chrysler and GM paid back their Troubled Asset Relief Program loan Yeats ahead of schedule. The United States Treasury fully recovered the rest of what it had paid out, as it made a $66.2 billion profit by purchasing shares of the banks when prices low and then selling them as the stock rebounded.
Academic Research on Bailouts
- Balance sheet effects,bailout guarantees and financial crises, Schneider, M., & Tornell, A. (2004). Balance sheet effects, bailout guarantees and financial crises.The Review of Economic Studies,71(3), 883-913. This paper provides a model of boom-bust episodes in middle-income countries. It is based on sectoral differences in corporate finance: the nontradables sector is special in that it faces a contract enforceability problem and enjoys bailout guarantees. As a result, currency mismatch and borrowing constraints arise endogenously in that sector. This sectoral asymmetry allows the model to replicate the main features of observed boom-bust episodes. In particular, episodes begin with a lending boom and a real appreciation, peak in a self-fulfilling crisis during which a real depreciation coincides with widespread bankruptcies, and end in a recession and credit crunch. The nontradables sector accounts for most of the volatility in output and credit.
- The AIG bailout, Sjostrom Jr, W. K. (2009). The AIG bailout.Wash. & Lee L. Rev.,66, 943.Bailout and conglomeration, Kim, S. J. (2004). Bailout and conglomeration.Journal of Financial Economics,71(2), 315-347. This paper develops a model of business groups in emerging markets where banks cannot accurately distinguish between good (high productivity) and bad (low productivity) borrower firms. For stand-alone firms, banks can infer the proportion of bad firms among those that default on contracted debt repayments, and might optimally choose to liquidatealldefaulting firms in order to reduce the number of bad firms. Business groups, however, obscure the productivity of individual firms. The optimal policy might then be full bailout so as not to risk eliminating good firms. Given the bank's bailout policy, risk-averse firms might form a conglomerate to reduce the risk of liquidation.
- After the bailout: regulating systemic moral hazard, Okamoto, K. S. (2009). After the bailout: regulating systemic moral hazard.UCLA L. Rev.,57, 183.
- Corporate lobbying, political connections, and the bailout of banks, Blau, B. M., Brough, T. J., & Thomas, D. W. (2013). Corporate lobbying, political connections, and the bailout of banks.Journal of Banking & Finance,37(8), 3007-3017.