BailOut - A Focus

Bailout in economics and finance is a term used to describe a situation where a bankrupt or nearly bankrupt entity, such as a corporation or a bank, is given a fresh injection of liquidity, in order to meet its short term obligations. Often bailouts are by governments, or by consortia of investors who demand control over the entity as the price for injecting funds.

Often a bailout is in response to a short term cash flow crunch, where an entity with illiquid, but sufficient, assets is given funds to "tide it over" until short term problems are resolved.

Some of the Bailouts of Past.

Swedish banking rescue:

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:

• Sweden's government assumed bad bank debts, but banks had to write down losses and issue an ownership interest (common stock) to the government. Shareholders were typically wiped out, but bondholders were protected.
• When distressed assets were later sold, the profits flowed to taxpayers, and the government was able to recoup more money later by selling its shares in the companies in public offerings.
• The government announced the state would guarantee all bank deposits and creditors of the nation’s 114 banks.
• Sweden formed a new agency to supervise institutions that needed recapitalization, and another that sold off the assets, mainly real estate, that the banks held as collateral.

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.

Later on there were few more bialouts in the recent past for Bearstearns , AIG and the list is on...

Proposed Bailout of US financial System

From the Last week, leaders of the U.S. Treasury and the Congress proposed a three-page bill called Troubled Asset Relief Program, which was much modified, expanded to 110 pages, and renamed the Emergency Economic Stabilization Act of 2008, an act intended to bailout the U.S. financial system. This measure, which involved the federal government's acquiring or insuring as much as $700 billion of troubled mortgage-backed securities, was intended to reduce uncertainty regarding these assets and restore confidence in the credit markets. This bill was rejected by the United States House of Representatives on September 29 by a vote of 228 to 205.

Following a series of financial crises that affected several major U.S. financial institutions, including Fannie Mae and Freddie Mac, Lehman Brothers, American International Group, Countrywide Financial and Merrill Lynch, U.S. Treasury Secretary Henry Paulson proposed a plan under which the U.S. Treasury would acquire up to $700 billion worth of mortgage-backed securities.

Alternatives sugested by few

A number of alternatives to the current proposal have been suggested. These include:

• A ten-point plan by New York University economist Nouriel Roubini which would involve a recreating a combination of a Resolution Trust Corporation, a Home Owners' Loan Corporation and a Reconstruction Finance Corporation.He also said, "It is pathetic that Congress did not consult any of the many professional economists that have presented – many on the Monitor Finance blog forum – alternative plans that were more fair and efficient. This is again a case of privatising the gains and socialising the losses; a bail-out and socialism for the rich, the well-connected and Wall Street. And it is a scandal that even Congressional Democrats have fallen for this treasury scam that does little to help millions of distressed, debt-saddled home-owners."
• Christopher Ricciardi, former Merrill Lynch banker, wrote a letter to Treasury Secretary Henry M. Paulson Jr. proposing alternatively that the government should be backing some troubled assets to encourage private investors to purchase them — as opposed to the direct purchase of troubled assets from financial institutions.
• Conservative Republican Representatives have offered a mortgage insurance plan as an alternative to the bailout.There has been speculation that U.S. Senator John McCain may support this plan but this has not been confirmed.
• Some other less-risky plans have also been suggested by other sources, such as letters published in Denver Post some of which suggested taking steps similar to Warren Buffett's to reduce the taxpayers' risk and commitment.
• Luis Zingales, Professor of Entrepreneurship and Finance at the University of Chicago, has proposed a special chapter of the bankruptcy code to convert bank's debt to equity which would improve capital adequacy ratios and enable a return to lending Zingales Plan

Bailout rejected

The House vote caused the Dow to drop over 777 points in a single day, its largest point drop ever.[104] The loss, which wiped out approximately $1.2 trillion in market value, the first $1 trillion plus loss in Dow history, still does not rank among its 10 biggest drops in percentage terms. The S & P lost 8.8%, its seventh worst day in percentage terms and its worst day since Black Monday in 1987. The NASDAQ composite also had its worst day since Black Monday, losing 9.1% in its third worst day ever. The TED spread, the difference between what banks charge each other for a three-month loan and what the Treasury charges, hit a 26-year high of 3.58%; a higher rate for inter bank loans than Treasury loans is a sign that banks fear that their fellow banks won't be able to pay off their debts. Meanwhile, the price of U.S. light crude oil for November delivery fell $10.52 to $96.37 a barrel, its second largest one-day drop ever, on expectations of an economic slowdown reducing oil consumption and demand.

      Markets, which had expected the bill to pass and had moved on to debating whether it would be sufficient, were already skittish after news that Wachovia Bank was being bought out by Citigroup to avoid collapse. To add to the bad news for the day, in Europe Dutch-Belgian Fortis Bank was given a $16.4 bil lifeline to avoid collapse, failing British bank Bradford & Bingley was nationalized, and Germany extended banking and real estate giant Hypo Real Estate Holding AG billions to ensure its survival.