Business, Legal & Accounting Glossary
Action to prevent business failure, usually financial, but based on the nature of the business or collaboration. A bailout can also refer to a public relations “rescue” of a company or organization that has a bad reputation.
A bailout is a situation where a white knight or other angel investor comes to the assistance of an institution under severe financial distress. Often they provide financing to allow the operation to continue for a period while they otherwise work out the difficulty.
In late 2008, there were numerous bailouts of financial institutions.
Recent examples include Bear Stearns, American International Group (AIG), Fannie Mae (Federal National Mortgage Association or FNMA), and Freddie Mac (Federal Home Loan Mortgage Corporation or FHLMC). Lockheed was bailed out in the ’70s as was Chrysler in 1979. Long-Term Capital Management (LTCM) was bailed out in 1998.
Usually, a bailout is given to a savings institution or insured bank that is struggling from difficult market conditions or loan losses. When a bailout from a federal agency like the Bank Insurance Fund (BIF) is made, the commercial depositors are bailed out. (BIF insures commercial deposits.) The agency can either provide bank assistance or organize for the bank to be acquired by another financial institution. Both of these solutions offer enough aid (generally as promissory notes) to bridge the gap between the value of the struggling bank’s assets and its liabilities. This recapitalizes the bank.
In September 2008, the Bush Administration proposed a $700 billion bailout. In this massive bailout, the Treasury Department is supposed to buy up bad mortgage securities from financial institutions in order to get them to lend again. Additionally, this is done with a view to restoring consumer confidence in the US (and worldwide). The bailout was voted on by the US House on the 29 September 2008 and it was defeated despite support from the President and leaders of both the Democrats and Republicans. Approximately two-thirds of Republican and forty percent of Democrat lawmakers voted against the bill.
In 2008 Bear Stearns, Freddie Mac, Fannie Mae, and AIG were bailed out by the US Treasury.
The initial bill had been modified to include oversight measures, limits to home foreclosures, and restrictions on executive compensation. They also divided the $700 billion figure into tranches, with a limit of $350 billion for the initial allocation, and included a provision that if any losses had been incurred by the Treasury after five years, there would be efforts made to recoup it.
This wasn’t enough, however, to overcome the public hostility to the bill and the fear that instilled in many representatives who are up for re-election.
Bailouts can be controversial because many believe those that fail or lose vast sums of investments should not be saved with impunity. Many US citizens are opposed to the bailout, which would effectively mean each American pays $2,300 to rescue these large institutions.
On the other hand, the injection of liquidity to these massive firms that make the financial markets run worldwide is necessary in order to return the markets to the status quo. Without a bailout, investors will pull out of markets, and consumer confidence will plummet, resulting in further losses.
Supporters of the bill say that intervention is necessary to freeze up credit markets. As the crisis intensifies in Sept-Oct 2008, banks have stopped lending to each other, and rates such as the Libor interbank rate have had their highest rates ever.
This is impacting both consumer lending rates including credit card and mortgage interest rates, and the cost at which companies can borrow working capital. The former means consumer spending might drop, the latter means that companies may have trouble meeting payroll payment needs and pay for other bills, leading to investment cuts and layoffs.
The combined impact will lead to a deepening recession.
Initially, there was widespread public opposition to the bill in the US.
The right-wing of the Republican party believes that market forces should be allowed to play out without government intervention. They are opposed to an increase in government spending and government ownership of private institutions, calling this bill a form of ‘socialism’.
The left-wing of the Democratic party believes that taxpayers are bailing out the rich on Wall St while doing nothing for Main St. They would like to see more measures to get returns for taxpayers, limit Wall St profits, and do more to restructure mortgage payments and stop foreclosures.
Many economists are also doubtful of the economic benefits of the bill. On the 24 Sept 2008, over 200 economists sent an open letter to the House and Senate, stating that the bill was flawed because it was unfair, ambiguous, and would weaken the markets in the long run.
On 1st Oct 2008, an amended bill was passed by the Senate by 74 votes to 25, with support from both parties.
The amended bill included a number of new provisions that made it more palatable to lawmakers, including extending $150 billion in tax breaks for individuals and companies, an increase in the amounts of bank deposits insured by the Federal Deposit Insurance Corporation from $100,000 to $250,000 per account, and legislation to treat mental health conditions in the same way as general health problems in insurance policies.
The bill was passed by the House on the 3 Oct 2008 with a 92 vote majority. Democrats backed it 172 votes to 63, Republicans opposed it 108 to 81.
Governments around the world frequently step in to provide bailouts for large financial institutions in times of global economic crisis
Once a bank has received a large bailout from the government, they should be responsible with that money and put it into supporting their clients instead of their CEO’s pay packages.
The government bailout of that corporation is going to cost the taxpayers a hundred billion dollars.
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This glossary post was last updated: 4th August, 2021 | 4 Views.