Government Bailouts for companies during crisis
November 9, 2020 0

Bailing out troubled businesses during an economic crisis: with or against?

Economic crises are among the phenomena that occur repeatedly throughout history with varying shapes and sizes. Some happen to specific countries, some sweep across several countries while others affect most world countries, depending on the differences in the causes of crises.

In many cases, economic crises are similar in their impact, especially on profitable companies. We can see the downfall of a group of companies, the tragic losses of some of them and the success of others depending on market needs and the conditions of the crisis. An example of this is the unexpected profits achieved by medical companies during the crisis.

With regard to government companies, governments usually offer bailout by providing financial support to profitable companies to avoid bankruptcy or downfall. Government support includes various forms, such as loans, securities, buying bonds and stocks, or even direct financial support.

Opinions differ on the benefits and risks of bailing out companies, and here we ask:

Do the benefits of rescuing troubled businesses outweigh the risks, or not?

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Arguments supporting the bailout of companies during economic crisis:

Proponents of saving profitable companies during crises rely on some basic arguments from an economic and social standpoint.

  1. Protecting the state’s economy from collapse

Economically speaking, every change that occurs in any economic sector has a major impact on the country’s economy because of the domino effect between different elements that move the economic wheels.

The fall of a number of companies producing the basic needs of citizens necessarily leads to the loss of the products that complement them, followed by the loss of job opportunities, and then the loss of investor confidence and inability to pay debts. Continuation of this situation leads to deterioration of the state’s economy and social chaos. For example, the fall of automobile companies will negatively affect spare parts and raw materials such as iron, plastic, glass, gas and gasoline, including of course banks that offer loans.

On the other hand, there will be instability in the stock market when investors withdraw from auto companies in addition to a complete withdrawal of investors. If the state exports cars to other countries, the fall of this industry will lead to inability of the state to cover foreign demands. Thus, it must pay the affected parties abroad, which exposes the value of the country’s currencies to decline. This example is only related to cars, and the impact would be greater and more comprehensive if the crisis affected banks, insurance companies and other financial institutions.

American economist David Weiss said that if Chrysler and General Motors fell in 2008, the United States would have relied on adding 1 million imported cars and allocated an additional 25 billion USD annually[1], but with government support, the two companies managed to emerge from the crises without these frightening effects.

  1. Ensuring sustainability of important sectors in the country
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Some national companies are more important than others because they are considered the pillars of the sector that they represent in the country. If these companies failed, the state would lose its presence in this sector. Among the most crucial sectors that confirm this importance are management of national resources and wealth, public transportation, airlines and utilities (water, gas, electricity) sector. The state must take care of these companies and protect them from collapse, because reestablishing them again will cost the state exorbitant sums. For example, the national airlines, where there is no alternatives, in the event of its bankruptcy, it must be rescued with financial support, and the bailout process is justified, especially if the airlines are stable and make good profits. Therefore, the State of Singapore provided an exorbitant financial support of 13.27 billion USD to Singapore Airlines when the Coronavirus pandemic 2019 spread[2].

As for road transport, it is more important compared to air transport because it is considered a basic need for many citizens. In November 2020, the United Kingdom provided 2.3 billion USD in financial support to the Transport Authority of London (TfL), which operates public transport from London’s trains and buses, to ensure continuity of services and avoid skyrocketing ticket prices[3].

  1. Financial assistance to citizens

It is known that one of the most important priorities of companies is to achieve profits and avoid losses. Therefore, it is expected that these companies will reduce the number of employees as a first measure to confront crises, and this increases the size of unemployment and its impact on social life.

Whoever cannot find work cannot provide for the basic needs of their family or pay off debts, and here comes the role of the government as the best way to intervene and provide financial support to companies on the condition that the employees remain for a certain period. These economic burdens, albeit large in size, are more beneficial compared to the expected damages from high unemployment.

The Center for Automotive Research (CAR) conducted a specific study on the consequences of the crisis in 2008 and charted the expected consequences of the complete downfall of the three largest automakers in the United States. According to the results, 3 million people would lose work, and the income of citizens will decrease by 150.7 billion USD. All of this was expected to happen in 2009[4]. The amount provided by the US government to support auto companies under the Troubled Asset Relief Program (TARP) in 2008 was 80.7 billion[5]. Incidentally, the government has succeeded in returning 70.43 billion USD from the sale of the shares of these companies within 10 years, with a loss of only 9 billion USD. So, the real price the US government paid to secure employment and income for 3 million citizens was just 9 billion USD[6].

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  1. Financial benefits to the government

Bailing out companies does not necessarily imply benefits for companies and losses for the government as this process may lead to double benefits for both parties. When the government provides loans to troubled companies, it can get the interest in addition to the amount it provided to the companies. It is also possible to achieve the government’s benefit from the companies’ private shares when they are sold at a higher price after the crisis ends and economic conditions improve. In this case, using state funds to save companies is a kind of investment in times of crisis and it benefits them more than leaving the money in the state fund without its returns.

The clearest example of this was when the Indian government paid approximately 1.8 billion USD in 2002 to UTI trust units in order to protect them from falling, and after 15 years the government made a profit of approximately 30% in addition to the amount it provided to UTI.

Likewise, when providing material assistance to companies on the condition that employees not be furloughed for a certain period, the government’s responsibility towards citizens will be reduced if the matter worsens in the future.

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Arguments against bailing out failing companies during a crisis:
  1. There are other better ways to utilize state funds in times of crisis

Without exception, all sectors are affected when the state falls into economic crises. Many citizens are affected by them, regardless of their standard of living and fields of work. During this period, the importance of relying on correct methods of utilizing state funds to achieve the desired benefit has emerged. Because bailing out companies may benefit employees, yet the most benefit from government money is received by company owners, senior employees and investors. It is advisable for the government to provide direct support to the needy, as the amount paid by the government to save one national company is sufficient to provide for the basic needs of a large number of employees of that company.

As a result, many developed countries paid attention to assisting those directly hit by the Coronavirus pandemic 2019, because saving companies alone does not guarantee that funds will reach the needy. Some of those countries were Australia, Canada, Denmark, Iceland, and the Netherlands[7].

  1. Attempting to rescue companies does not guarantee their success in keeping pace with crises

Often, the root cause that exposes companies or sectors to bankruptcy is present throughout the period of crises and does not disappear until the end of the crises. When the government provides financial support to companies and the cause of their loss is still there, the government cannot guarantee that the companies will be rescued out of the tragedy. If the crises continue, the effects of government support will end and companies will resort to help again. So, saving companies in times of crisis has become a dangerous step for the state. At the end of the process, companies may collapse, many lose their jobs, and government resources go in vain.

  1. Discrimination against companies

Oftentimes, the government is not able to aid every company that suffers an economic crisis, but rather help some companies and neglect others due to the government’s limited resources.

Thus, bailing out some companies and neglecting others will lead to the bankruptcy of those neglected companies or expose them to great losses. This effect continues for a long time, even many years after the crises have ended. The government’s decision is, in principle, unfair to companies.

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When the economic crises of 2008, the US government left Lehman Brothers for bankruptcy without any assistance, and the government tried to save Bear Stearns and saved AIG afterwards, which are two companies similar to Lehman Brothers. Bear Stearns filed for bankruptcy shortly after receiving government support[8]. Here comes the question: was this decision right and fair for Lehman Brothers?

  1. Dangerous decisions taken by profit-making companies

Government bailouts of corporations brings confidence in their rescued owners; consequently, other players in the same field would hope for government support when their companies go under. This mentality will drive the owners of companies to take dangerous decisions and not prepare the resources and cadres to face crises, believing that the government is always there to lend them a hand.

Setting strict conditions regarding resources, and the existence of an administration that does not allow dangerous decisions and investments to be made, is a clear message that the government would not support them during crises. Thus, shareholders will play an effective role in monitoring the actions taken by companies.

When the Coronavirus pandemic spread, air transport sector was the worst sector hit by tragic losses and bankruptcy. Besides the inability to transport passengers from 2019 to 2020, there is another reason behind this suffering. The period between 2015-2018 witnessed progressive increase in airlines’ profits. Profits of air transportation sector has never been below 25 billion USD annually since 2015[9]. This phenomenon led to great competition among airlines to control the global market, which led to a lack of interest in financial reserves in the hope of expected profits. These airlines were all confident that governments will save them when they are on the brink of bankruptcy. When the 2019-2020 crisis occurred, the only way out was through government bailouts.

  1. Opening the door to corruption or exploitation for individual interest

The implementation of the corporate bailout policy by the government in times of crisis may shift to the policy of helping selected persons of status. In many democratic countries, those with influence participate in trade, directly or indirectly. It is natural for the owners of companies to work for the interests of their companies when applying the policy of rescuing companies in times of crisis. This is particularly true with the presence of politicians and high-ranking officials in high positions in profitable companies while managing financial bodies at the same time.

The exploitation of the bailout for the individual benefit not only occurs in developing countries, but also in the major industrialized countries. As for the phenomenon of exploitation in developing countries, it is influencing the state’s decisions to obtain financial support in times of crisis or the financial return of the government party by companies that were rescued. In developed countries, there is prior knowledge before the rescue, which has benefited the owners of companies and major investors. A study conducted by four professors at Stanford University has proven that profits made from the stock exchange by owners and managers of companies who have close relationships with decision makers in bank management organizations in the United States outperform others by 8.89% during the implementation of the Troubled Asset Relief Program (TARP) to save profitable companies during the economic crisis of 2008-2009[10].

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By: Mohammed Salman – Debate Instructor at QatarDebate

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