What Is a "Bail-Out"?

September 22, 2008, Revised August 18, 2009

Whenever Government is involved in a program to assist a private firm in trouble, much of the press reports it as a "bail-out". Back in the 80s when the savings and loan industry was in trouble, the operations of the Resolution Trust Corporation (RTC), which the Federal Government chartered to manage and liquidate the assets of failed associations, were frequently yet erroneously, described in this way, and they still are.

For readers who don’t bother absorbing the details, the term "bail-out" suggests that everybody connected to the troubled enterprise is being rescued, including those who were responsible for its plight. For this reason, it often generates a hostile public response – "one more example of how government protects the big guys."

In fact, a core if unstated principle of Federal Government intervention since the 80s has been that the shareholders of the firms involved lose all or most of their investment, and that some or all of the top executives lose their jobs. This was the case in the savings and loan episode, and it has been true of the recent interventions involving the investment bank Bear-Stearns, the Government Sponsored Enterprises Fannie Mae and Freddie Mac, and the insurance conglomerate AIG. Those protected by the intervention have been the creditors of the firm, and the employees if the firm continues as a going concern.

The erroneous inferences hasty readers draw when they see the term "bail-out" used in connection with a Government intervention derives from the other common uses of the term. The most familiar one is bailing-out a leaking boat, which protects everybody in the boat. It is not possible to bail for one but not for another. Similarly, only one pilot bails-out of a damaged airplane, and one accused felon is bailed-out of jail, In describing Government interventions in connection with individual firms in trouble, we need another term that does not carry this baggage.

Ironically, as I was writing this piece in 2008, the news broke about the Treasury’s planned program to provide general support to the market. The new program would buy distressed assets for more than they are worth, gifting the selling firms and receiving nothing in return. Describing this program as a bail-out is accurate, but the program never got off the ground.

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