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What Is A Bailout
What Is A Bailout?
Fundamentally, the term bailout refers to the practice of injecting liquidity to a business when it is bankrupt or close to the point of bankruptcy. There are multiple ways in which this could be done. The money could be given as a loan to the company which it needs to repay on reaching solvency.
Alternatively, the bank buys the distressed assets of the company and gives it cash in return. It could also be done via the trading of stocks and bonds. It can be undertaken either by a group of investors or in certain cases by the government. A group of investors may pump in the money and get a stake in the company. However, intervention from the government generally happens in a case when it is expected that the downfall of the company could have larger repercussions on the economy.
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What is happening in the US?
The last month has seen some of the largest investment banks in the US taking a downturn or seeing a change in their status. Lehman Brothers filed for bankruptcy, Merrill Lynch was taken over by Bank of America, and AIG declared it was near bankruptcy and requests by financial big-wigs like Morgan Stanley and Goldman Sachs being given the status of depository institutions by the US Federal Reserves. Earlier in the year, Bear Stearns was acquired by JP Morgan Chase. In lieu of these events, the US Federal Reserve has devised a $700 billion bail-out package to buy the bad debts which caused the credit crisis. This is expected to revive credit markets and interbank lending.
Although the Congress initially refused this bailout plan, they reconsidered their decision and have now said that the $700 billion will be disbursed in stages over two years: initially $250 billion will be given to purchase risky assets from banks, another $100 billion could be requested by the President and the final $350 billion will need another approval from the Congress. The Congress has also introduced the Emergency Economic Stabilization Act 2008, based on which the US Treasury can get a stake in the companies involved and if the company fails, they will be amongst the last investors to incur losses.
What does it mean for investors?
The stock market has seen a bit of rough weather lately, a stark reminder to Indian investors that we are no longer insulated from what happens in global markets. The final decision regarding the bailout plan will hence, definitely be a confidence boosting mechanism on Dalal Street and could be reflected by the possibility of a slight increase in share prices.