Bailout - Themes

Themes

From the many bailouts over the course of the 20th century, certain principles and lessons have emerged that are consistent:

• Central banks provide loans to help the system cope with liquidity concerns, where banks are unable or unwilling to provide loans to businesses or individuals. Lending into illiquidity, but not insolvency, was articulated at least as early as 1873, in Lombard Street, A Description of the Money Market, by Walter Bagehot.
• Let insolvent institutions (those with insufficient funds to pay their short-term obligations or those with more debt than assets) fail in an orderly way.
• Understand the true financial position of key financial institutions, through audits or other means. Ensure the extent of losses and quality of assets are known and reported by the institutions.
• Banks that are deemed healthy enough (or important enough) to survive require recapitalization, which involves the government providing funds to the bank in exchange for preferred stock, which receives a cash dividend over time.
• If taking over an institution due to insolvency, take effective control through the board or new management, cancel the common stock equity (existing shareholders lose their investment) but protect the debt holders and suppliers.
• Government should take an ownership (equity or stock) interest to the extent taxpayer assistance is provided, so that taxpayers can benefit later. In other words, the government becomes the owner and can later obtain funds by issuing new common stock shares to the public when the nationalized institution is later privatized.
• A special government entity is created to administer the program, such as the Resolution Trust Corporation.
• Prohibit dividend payments to ensure taxpayer money are used for loans and strengthening the bank, rather than payments to investors.
• Interest rate cuts to lower lending rates and stimulate the economy.