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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.
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.
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