What Is a Bailout?
A bailout is when a business, individual, or government provides money and/or resources (also known as a capital injection) to a struggling company. These actions help prevent the company’s potential downfall, which may include bankruptcy and default on its financial obligations.
Businesses and governments may receive a bailout in the form of loans, purchasing of bonds, stocks, or cash infusions, often under terms that require the rescued party to pay back the support, with or without interest.
Key Takeaways
- A bailout is the injection of money into a business or organization that would otherwise face imminent collapse.
- Bailouts can come in the form of loans, bonds, stocks, or cash.
- Some loans require reimbursement—either with or without interest.
- Bailouts typically focus on companies or industries that directly impact the strength of the overall economy rather than just one particular sector.
Bailout Explained
Bailouts are usually extended to companies or industries whose failures could have severe adverse effects on the overall economy, not just a specific market sector.
For example, companies with a significant workforce may receive a bailout to prevent a drastic rise in unemployment that would negatively impact the economy. In some cases, other firms step in and acquire the failing business, a process known as a bailout takeover.
Allowing a company to fail can have severe consequences both for the company and the wider economy, exemplified by contagion. Here are additional reasons why letting a company fail may not always be the best option and why bailouts might be necessary:
- Job Losses: Significant job losses can result in reduced consumer spending and increased dependence on social safety net programs.
- Economic Instability: The collapse of a large company can lead to economic instability, potentially triggering a domino effect of further corporate failures.
- Loss of Investor Confidence: Failure and bankruptcy can erode investor confidence, making it harder for other companies to raise capital.
- Legal Complications: Allowing a company to fail can lead to lengthy and costly legal proceedings due to the company’s debts and legal obligations.
In some cases, allowing a company to fail may be unavoidable, but bailouts are generally seen as a beneficial measure to support economic stability.
Examples of Bailouts
The U.S. government has a history of bailouts dating back to the Panic of 1792. Some notable examples include the 1989 savings and loan bailout and the 2008 bailout of financial institutions, officially known as the Emergency Economic Stabilization Act of 2008 (EESA). Other recipients include insurance giant AIG, government-sponsored home lenders Freddie Mac and Fannie Mae, as well as industries such as aviation and automotive.
Outside the U.S., there are also examples like Ireland’s 2010 bailout of Anglo-Irish Bank Corporation and multiple European Union bailouts for Greece, which totaled around €326 billion.
It’s notable that many recipients of bailout funds often go on to repay their obligations, as seen with Chrysler, GM, and AIG.
Financial Industry Bailout
In 2008, the U.S. government launched one of the largest bailouts in history in response to the global financial crisis. This targeted the banking sector heavily impacted by the subprime mortgage meltdown. The Troubled Asset Relief Program (TARP) enabled the Treasury to spend up to $700 billion buying toxic assets, ultimately disbursing over $443 billion to financial institutions.
Auto Industry Bailout
Automakers like Chrysler and General Motors were also supported during the 2008 financial crisis as they sought taxpayer bailouts to remain solvent. Facing slumping sales and challenging financing conditions, both companies emerged from bankruptcy in 2009 after drawing on TARP funds.
Why Bail Out a Company?
Bailouts are necessary to prevent potential economic fallout from the failure of significant companies. These measures help preserve jobs, stabilize markets, and ensure continued economic functioning, especially if a company’s collapse would cause ripple effects.
What Are the Risks of Bailouts?
Risks include moral hazard, where firms may engage in risky behaviors since they expect future bailouts. Additionally, the cost of bailouts can be significant for taxpayers and may not always guarantee successful recovery.
What Are the Terms of a Bailout?
Terms vary widely but often include conditions such as restructuring plans, changes in management, limitations on executive compensation, and other measures to ensure financial stability and prevent future bailouts.
The Bottom Line
A bailout occurs when an external party, typically a government entity, steps in to provide support to companies facing failure, thus preventing broader economic repercussions. While they offer a lifeline to struggling businesses, bailouts often come with stringent conditions and may result in notable changes in corporate structure and management.
Related Terms: capital injection, bankruptcy, financial institutions, credit crisis, moral hazard
References
- U.S. Congress. “Public Law 110-343, Emergency Economic Stabilization Act of 2008”.
- Irish Office of the Comptroller and Auditor General. “2010 Report of the Comptroller and Auditor General Volume 1”, Page 36.
- Council on Foreign Relations. “Greece’s Debt, 1974 - 2018”.
- National Bureau of Economic Research. “The U.S. Panic of 1792: Financial Crisis Management and the Lender of Last Resort”, Page 5.
- Congressional Budget Office. “Report on the Troubled Asset Relief Program—July 2021”.
- U.S. Securities and Exchange Commission. “JPMorgan Chase and Bear Stearns Announce Amended Merger Agreement and Agreement for JPMorgan Chase to Purchase 39.5% of Bear Stearns”.
- U.S. Department of the Treasury. “Auto Industry Program Review”.
