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In Economics, what is a Bailout?
Mary McMahon
Mary McMahon
A bailout involves an injection of liquidity into a failing company to keep it from going under. The sources of this liquidity can vary, as can the form which the liquidity takes. Generally, a bailout is undertaken when authorities believe that allowing a business to collapse could have dire consequences. For example, if a major investment firm went under, it might cause a ripple effect in the trading of stocks and securities which could cause economic problems. Therefore, the bailout is believed to be justified, because it prevents a larger calamity.
In some cases, a government may fund a bailout, typically in the form of loans which the company is expected to repay when it becomes solvent again. In other instances, a group of investors may gather and offer a bailout. In these situations, the investors often gain control of the struggling firm by offering a bailout; since the alternative is bankruptcy, the firm generally agrees to the terms of the bailout, hoping that some staff will be able to stay on.
Loans are the common currency of a bailout, although sometimes cash will be offered, as in the instance of a buyout by investors. In other instances, a bailout may involve trades of stocks and bonds. Because large amounts of money are involved, a bailout must generally be approved by government agencies which work to prevent monopolies and which monitor the market in general, especially if the bailout funds come from the government.
There are a variety of reasons for a firm to find itself in a situation where it might need a bailout. In some instances, the firm clearly has potential to thrive, despite a short term problem with cash flow, and a bailout simply makes good economic sense. Several car manufacturers, for example, have been assisted with government bailouts, using the funds to satisfy creditors and retool their product offerings to meet market demands. In other instances, a bailout may be needed because a firm has failed to invest wisely, or has failed to note the signs of problems before it is too late.
Bailouts are not without controversy. Some people believe that struggling firms should simply be allowed to go bankrupt, as their financial problems clearly illustrate a lack of ability to cope with the market. Government bailouts can be especially acrimonious, with some people feeling that a government bailout crosses a line into interfering with the free market. Proponents of bailouts argue that they can keep markets stable during troubled times, and they can preserve valuable national resources; for example, a bailout of a national auto maker can be advantageous, because it keeps some production of cars within that country. This can be useful from a national security standpoint, because it ensures that useful skills and facilities are maintained.
Mary McMahon
Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.
Learn more...
Mary McMahon
Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a SmartCapitalMind researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.
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![Loans are the common currency of a bailout, although sometimes cash will be offered, as in the instance of a buyout by investors.]()
By: fotoatelieLoans are the common currency of a bailout, although sometimes cash will be offered, as in the instance of a buyout by investors.
Discussion Comments
Sneakers41-I know that there were banks in South Florida and I am sure all over the country that offered no doc loans. These were no documentation loans in which you did not have to offer proof of income.
It is crazy to imagine that a bank is not even verifying income. This led to a lot of mortgage fraud because people were listing all kinds of income and qualifying for upscale homes.
These people wanted to quickly flip these homes and get a substantial profit. While that was happening part of the time, when the real estate market crashed and flipping a home was no longer an option, these homeowners drowned.
Some people owned multiple homes and had to face multiple foreclosures. The homeowners got greedy and many lied in order to qualify for homes that were clearly out of their price range. So while the banks were not totally innocent, the homeowners also shares significant blame. Many of these people should not access to a bailout foreclosure.
Latte31-I think that home ownership requires a certain level of responsibility and not all people should own homes.
Many of these Fannie Mae and FHA governmental programs were established so that people with less money for a down payment could still own a home.
Fannie Mae Home Path financing programs and FHA will allow as low as a 3% down payment. Also, these programs lend to people with tainted credit.
So you combine the low lending standards with the spotty credit history and you have a recipe for disaster.
A lot of these loans should never been offered. There is a reason why they banks prefer a 20% down payment.
The reason is that it not only brings you mortgage payment down, but it offers you a certain amount of equity in the property which reduces the risk to the banks.
Loans that only require a 3% down payment run the risk of negative amortization because the house will quickly decline in value at a higher rate than the down payment causing the homeowner to owe more than the house is worth.
This is why so many people are trapped in their homes because the market value is lower than what the mortgage is. The only possible hope in this situation is to sell the home as a short sale.
Sunta12-I agree. I don’t think that GM should have gotten any kind of bailout. But I also agree that the foreclosure bailout is another program that is not a good idea.
While there are some people that went into foreclosure for legitimate reasons. They may have lost their jobs and can not longer afford their mortgage payments.
However, there are people who bought homes that they could not afford and now want a foreclosure bailout to reduce their mortgage payments.
I really think that it is unfair to the people that were responsible and bought homes that they could afford and made monthly payments on time.
The bailout news regarding the forclosure bailout has really rewarded irresponsiblity.
DeeBeez-I agree that a bailout plan for a failing company might not fix the problems with that individual company. Some companies should fail because of poor business practices.
In a capitalist system that is how companies are held accountable. It makes companies more focused on the bottom line and if a company is not then they will soon go out of business.
A bailout program should not be offered lightly. While there are institutional companies that are considered to big to fail, some people believe that they should fail and not be rewarded with a bailout program for dismal financial performance.
For example, GM was offered an auto bailout and it was taken over by the federal government and Obama even fired the CEO and had him replaced.
This is not how things are run in a capitalist country. GM should have filed for bankruptcy reorganized and eliminated as much of the union as it possibly could.
They probably could have survived and reemerged after bankruptcy, but instead were taken over by the government like they would have in a socialist nation.
In light of these historical problems, I am publishing an article that children can understand and this is the only one that came close to the explanation of 'bailout'. I, however, am not clear on what is expected of the public on this. Is it suggesting that the populace get a 'loan' to pay into the debt with the interest of jump starting and relieving the economy? Liquidity is pointing to products of said losing companies? Thanks for any specifics.
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