Bailouts: Necessary Evil Or Economically Foolish

Wall Street, located in the lower Manhattan section of New York City, is popularly known as the ‘home of the US financial market’ with the headquarters of the New York Stock Exchange located here. It was here that the seeds of the Financial Crisis of 2008, commonly known as the Great recession, were laid. This recession shook the entire world and still continues to impact the world we live in.



Lack of confidence in bank solvency, low credibility, lack of investor confidence, and bursting of the housing bubble, had led to a massive down-turn. Stock values plummeted, unemployment soared, businesses failed, people were evicted from their homes and as a result, economies suffered.


Where did the money come from to take the world out of this recession? Was it the right decision? We will be discussing all that and more today in this article.


The unanticipated recession militated a conducive environment for growth and prosperity and the only way out of this perplexing situation seemed to be a 'bailout'.


A bailout simply means an act of giving financial assistance to a failing business or economy, to save it from collapsing. But, why are bailouts important?


The Case for Bailouts


Bailouts are important to ensure the continued survival of the business in question. With each business, there are people, jobs, and resources associated. In order to avoid layoffs, wastage of resources, and crumbling of the entire financial system, bailouts are essential.


The businesses that need bailouts are often on the brink of failure or bankruptcy, therefore bailouts usually include grants-money that is not likely to be paid back. To ensure the smooth functioning of the overall markets, governments often step in to avoid insolvency of intuitions.


Coming back to Wall Street that was mentioned in the first paragraph, it was the hub of the financial sector of the USA, and therefore, one of the hardest-hit divisions of the economy.


In order to protect the financial stability of the country and the government, the central bank had to provide unprecedented trillions of dollars in bailouts and come up with comprehensive stimulus packages, including expansive fiscal and monetary policy to avoid further collapse and boost consumer confidence in banks and thereby encouraging lending.


What would have happened if the bailout wasn’t provided? From banks to small businesses to Fortune 100 companies, hundreds would have gone bankrupt. Mass layoffs would have taken place depriving numerous families of income, causing a huge spike in unemployment and millions of people would have lost their insurance.


In short, the entire system would have been crippled.


Whether good or bad, there is no denying that bailouts have played a crucial role in recognizing the need for financial assistance by saving the key industries of the economy from falling apart. So, why were people upset about the bailout?


The Case Against Bailouts


The main point of criticism for bailouts was that the government had used the hard-earned money of the taxpayers and corporates to bail out Wall Street. People believed that those who took the risk and benefited during the boom period, were rightful to own the losses when the bubble burst – the taxpayers were not responsible. People considered it to be economically foolish and morally wrong.


It is fair to say that bailouts have their own disadvantages. Anticipated bailouts encourage risky business models who take higher-than-recommended risks in financial transactions. This happens because they start counting on a bailout when things go wrong. Bailouts positively encourage future debt crises.


A Different Kind of Bailout?


So, are bailouts good or bad? Well, it is a complex problem and there is no specific answer to this question. Even though bailouts are considered morally wrong and seem to encourage risky business models, they are not inevitable. People are not usually in the favour of simply bailing out a business, and therefore opt for 'bailout takeover'.


Under this, the government or the institution providing financial assistance takes over the control of the financially weak company by purchasing a significant amount of the company’s stock shares or assets. The goal of the bailout is to turn around the operations of the company without liquidating its assets.


A key bailout takeover that took place during the financial crisis of 2008 was the US government bailout of two automakers, Chrysler and General Motors. The two companies needed a bailout to stay afloat due to the decreasing sales of SUVs and large vehicles.


Under the takeover deal, the government loaned $17.4 billion to the two companies on conditions that they reduce wages and salaries, cut debts and create a restructuring plan for them to survive.


The US government believed the bailout was important for two reasons:

  1. To avoid a much deeper crisis

  2. To make General Motors and Chrysler more competitive in the future.

Post the bailout takeover, the US government ended up saving 1.5 million jobs and the two companies reported significant profits quarter after quarter.


Today, Chrysler is one of the “Big Three” automobile manufacturers in the United States, and General Motors’ timely bailout and modernization strategies have led them to a path of success.


Conclusion


Even though bailouts have had a long history of debate and conflict, the fact remains that they have played a crucial role in shaping our history. If major economic institutions were allowed to fail, it would lead to a complete meltdown of the economy. Abolishing bailouts altogether would invite even more problems and ultimately lead to economic destruction.


Even though bailouts are considered to be unfair and seem to encourage risky business models, they are important to uphold the financial and economic stability of the country or business.

by Smriti Vohra


Reference


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