A bailout is a colloquial term for giving financial support to a company or country which faces serious financial difficulty or bankruptcy. It may also be used to allow a failing entity to fail gracefully without spreading contagion. A bailout can, but does not necessarily, avoid an insolvency process.
The term is maritime in origin being the act of removing water from a sinking vessel using a smaller bucket. A bailout differs from the term bail-in (coined in the 2010s) under which the bondholders and/or depositors of global systemically important financial institutions (G-SIFIs) are forced to participate in the process, but taxpayers supposedly are not. Some governments have the power to participate in the insolvency process: for instance, the U.S. government intervened in the General Motors bailout of 2009–2013.
A bailout could be completed for mere profit, as when a predatory investor resurrects a floundering company by buying its shares at fire-sale prices; for social improvement, as when, hypothetically speaking, a wealthy philanthropist reinvents an unprofitable fast food company into a non-profit food distribution network; or the bailout of a company might be seen as a necessity in order to prevent greater, socioeconomic failures: For example, the U.S. government assumes transportation to be the backbone of America's general economic fluency, which maintains the nation's geopolitical power. As such, it is the policy of the U.S. government to protect the biggest American companies responsible for transportation (airliners, petrol companies, etc.) from failure through subsidies and low-interest loans. These companies, among others, are deemed "too big to fail" because their goods and services are considered by the government to be constant universal necessities in maintaining the nation's welfare and often, indirectly, its security.
Emergency-type government bailouts can be controversial. Debates raged in 2008 over if and how to bail out the failing auto industry in the United States. Those against it, like pro-free market radio personality Hugh Hewitt, saw this bailout as an unacceptable buck passing to taxpayers. He denounced any bailout for the Big Three, arguing that mismanagement caused the companies to fail, and they now deserve to be dismantled organically by the free-market forces so that entrepreneurs may arise from the ashes; that the bailout signals lower business standards for giant companies by incentivizing risk, creating moral hazard through the assurance of safety nets (that others will pay for) that ought not be, but unfortunately are, considered in business equations; and that a bailout promotes centralized bureaucracy by allowing government powers to choose the terms of the bailout.
Others, such as economist Jeffrey Sachs have characterized this particular bailout as a necessary evil and have argued that the probable incompetence in management of the car companies is an insufficient reason to let them fail completely and risk disturbing the (current) delicate economic state of the United States, since up to three million jobs rest on the solvency of the Big Three and things are bleak enough as it is.
Governments around the world have bailed out their nations' businesses 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.
Basically, a bail-in forces the borrower's creditors to bear some of the burden by having part of the debt they are owed written off. (In the case of Cyprus, the creditors in question were bondholders, and depositors with more than €100,000 in their accounts.) ( Source : The Economist )
This bail-in tool was first brought to global attention in Cyprus, as discussed below, but had been discussed theoretically since at least 2010. The resolution of globally significant banking institutions (GSIFIs) was a topic of a joint paper by the Federal Reserve and the Bank of England in 2012.
The Financial Stability Board (FSB) published in October 2011 a guideline document entitled "Key Attributes of Effective Resolution Regimes for Financial Institutions" which deals with the current bailout regime. The scope of this planned bail-in regime for participating countries is not just limited to large domestic banks. In addition to these "systemically significant or critical" financial institutions, the scope also applies to two further categories of institutions, a) Global SIFIs, in other words, cross-border banks which happen to be incorporated domestically in a country that is implementing the bail-in regime, and b) "Financial Market Infrastructures (FMIs)", such as clearing houses. The inclusion of FMIs in potential bail-ins is in itself a major departure. The FSB defines these market infrastructures to include multilateral securities and derivatives clearing and settlement systems, and a whole host of exchange and transaction systems, such as payment systems, central securities depositories, and trade depositories. This would mean that an unsecured creditor claim to, for example, a clearing house institution, or to a stock exchange, could in theory be affected if such an institution needed to be bailed-in. The inclusion of FMIs means that large parts of the global financial system is susceptible to bail-in and could potentially be bailed-in.
Outgoing Deputy Director of the Bank of England Paul Tucker chose to open his academic career at Harvard with an October 2013 address in Washington to the Institute of International Finance in which he suggested that U.S. banks and other institutions were now no longer to be deemed too big to fail and henceforward would be bailed-in. The EU financial community symposium on the "Future of Banking in Europe" (December 2013) was attended by Irish Finance Minister Michael Noonan, who proposed a bail-in scheme in light of the banking union that was under discussion at the event. Deputy BoE Director Jon Cunliffe suggested in a March 2014 speech at Chatham House that the domestic banks were too big to fail (TBTF), and instead of the nationalisation process used in the case of HBOS, RBS and threatened for Barclays (all in late 2008), could henceforth be bailed-in.
Economist Graeme Archer noticed in March 2014 that no personal punishment (such as dismissal or incarceration) is required under the latest regulations, and that therefore corrective action is unlikely.
The Dodd-Frank Act Title II now legislates bailout procedures for the United States. A January 2012 the Federal Deposit Insurance Corporation Office of Complex Financial Institutions slide presentation covers the resolution strategy. The FDIC has drawn attention to the problem of post-bailout governance, and did suggest that a new CEO and Board of Directors were to be installed under FDIC receivership guidance, but as of January 2012 had yet to resolve the issues. In any case, U.S. legislation only applies to domestic organisations. Title II is aimed at protecting the financial stability of the American economy, forcing shareholders and creditors to bear the losses of the failed financial company, "removing management that was responsible for the financial condition of the company", and ensuring that payout to claimants is at least as much as the claimants would have received under a bankruptcy liquidation. Claims are paid in the following order:
The Eurogroup proposed on 27 June 2013 that after 2018 bank shareholders will be first in line for assuming the losses of a failed bank before bondholders and certain large depositors. Insured deposits under £85,000 (€100,000) are exempt and, with specific exemptions, uninsured deposits of individuals and small companies are given preferred status in the bail-in pecking order for taking losses. This agreement formalised the practice seen earlier in Cyprus. Under this proposal, all unsecured bondholders must be hit for losses before a bank can eligible to receive capital injections directly from the European Stability Mechanism. A tool known as the Single Resolution Mechanism, which was agreed amongst Eurogroup members on 20 March 2014, is part of an EU effort to prevent future financial crises by pooling responsibility for euro-area banks, a project known as banking union. In a first step, the ECB will fully assume supervision of the 18-nation currency bloc's lenders in November 2014. The deal needed formal approval by the European Parliament and by national governments. The resolution fund was to be paid for by the banks themselves, and will gradually merge national resolution funds into a common European one until it hits its €55 billion target funding level. See the EC FAQ on the SRM. The legislative item was split into three initiatives by Internal Market and Services Commissioner Michel Barnier: BRRD, DGS and SRM.
The difference between a bailout and a bail-in was first realised by the events of the 2012-2013 Cypriot financial crisis. Two Cypriot banks were exposed to a haircut of upwards of 50% in 2011 during the Greek government-debt crisis, leading to fears of a collapse of the Cypriot banks. Rumours circulated for a time, then in early 2013 matters came to a head. On 25 March 2013, a €10 billion bailout was announced by the Troika — a loose coalition of the European Union, European Central Bank and International Monetary Fund — in return for Cyprus agreeing to close its second largest bank, the Cyprus Popular Bank (also known as Laiki Bank). The Cypriots had to agree to levy all uninsured deposits there, and possibly around 40% of uninsured deposits in the Bank of Cyprus (the island's largest commercial bank). No insured deposit of €100k or less was to be affected. The levy of deposits that exceeded €100k was termed a "bail-in", to differentiate it from a bailout because of the depositor fund levy. The Bank of Cyprus executed the depositor bail-in on 28 April 2013.
Paul Volcker, chairman of Barack Obama's White House Economic Recovery Advisory Board, said that bailouts create moral hazard: they signal to the firms that they can take reckless risks, and if the risks are realized, taxpayers pay the losses, also in the future. "The danger is the spread of moral hazard could make the next crisis much bigger".
On November 24, 2008, American Republican Congressman Ron Paul (R–TX) wrote, "In bailing out failing companies, they are confiscating money from productive members of the economy and giving it to failing ones. By sustaining companies with obsolete or unsustainable business models, the government prevents their resources from being liquidated and made available to other companies that can put them to better, more productive use. An essential element of a healthy free market, is that both success and failure must be permitted to happen when they are earned. But instead with a bailout, the rewards are reversed – the proceeds from successful entities are given to failing ones. How this is supposed to be good for our economy is beyond me.... It won’t work. It can’t work.... It is obvious to most Americans that we need to reject corporate cronyism, and allow the natural regulations and incentives of the free market to pick the winners and losers in our economy, not the whims of bureaucrats and politicians."
Governments and, thus ultimately taxpayers, have largely shouldered the direct costs of banking system collapses. These costs have been large: in our sample of 40 countries governments spent on average 12.8 percent of national GDP to clean up their financial systems.
While the Irish banking crisis of 2008 isn’t much different from other banking crisis, it was unique in that it was the first banking crisis in a country that was a member of the Eurozone. Because of this the Irish government and central bank faced unique constraints when the crisis struck.
Irish banks suffered substantial share price falls due to a lack of liquidity in finance available to them on the international financial markets. Currently, solvency is being revealed as the most serious concern as doubtful loans to property developers, still undeclared in bad debt provisions, come into focus.
During 1991–1992, a housing bubble in Sweden deflated, resulting in a severe credit crunch and widespread bank insolvency. The causes were similar to those of the subprime mortgage crisis of 2007–2008. In response, the government took the following actions:
This bailout initially cost about 4% of Sweden's GDP, later lowered to between 0–2% of GDP depending on various assumptions due to the value of stock later sold when the nationalized banks were privatized.
In 2008–09 the U.S. Treasury and the Federal Reserve System bailed out numerous very large banks and insurance companies, as well as General Motors and Chrysler. Congress at the urgent request of President George W. Bush passed the Troubled Asset Relief Program (TARP), funded at $700 billion. The banks have largely repaid the money and the net cost of TARP may eventually be in the range of $30 billion. The bailout of Fannie Mae and Freddie Mac, which insure mortgages, totals $135 billion by October 2010, and could be much higher, depending on the future of the housing and mortgage markets.