What Is a Government Bailout?

A government bailout occurs when a government body directly or indirectly contributes funds to a business or industry to prevent it from failing. Government bailouts have a long and often troubled history throughout the world, but can provide vital relief for short-term economic crises. Understanding the risks and possible rewards of a government bailout is important to determining if they are the correct strategical response to a given economic crisis.

A bailout by a government infuses an organization with a supply of money. This may either be done through a direct transfer of funds, known as “direct funding,” or by “indirect funding,” which entails purchasing bad assets from the business at high prices. In both cases, the desired outcome is to give the business liquid assets that can be used to continue operations during an economic crisis or re-organization period.

A government bailout may be considered necessary if the business in question represents a significant investment or mainstay of the national economy. During the banking crisis beginning in the United States in 2007, for instance, proponents of bailout plans highlighted the risk to millions of American investors and account holders should large banking institutions be permitted to fail. In Japan during the 1990s, it became government policy to keep banking and other large industries afloat through repeated bailouts, in order to curb unemployment and economic downturn. An organization that is of significant value to the national economy may be a likely candidate for a bailout, since the consequences of the business' insolvency may pose a greater economic threat.

Another reason a government bailout may be considered is if the industry in question provides a service available nowhere else. In the mid-20th century, the US government bailed out railroad companies in the wake of massively falling revenues due to the popularity of flying for long-distance transportation. In order to keep railroads running at all, the government felt it necessary to step in with emergency funding, which many American railroad services still rely on in the 21st century.

Though a government bailout can help a necessary company through a short-term crisis, they entail many risks. First, they can disrupt the natural order of a market economy, which dictates that poorly performing companies need to be allowed to fail. Secondly, they can artificially inflate the value of a business, which in turn may drive up stock prices incorrectly. Third, they may create an ethically dangerous situation, where executives and managers at large companies can continue to do bad business because they are aware that the government will bail them out. Fourth, it may create an open-ended situation with no stop date, meaning that bailouts using taxpayer money may continue to prop up poorly performing but large corporations in perpetuity.