Bailout Takeover

A scenario where the government or a financially stable company assumes control of a weak company

What is a Bailout Takeover?

Bailout takeover refers to a scenario where the government or a financially stable company takes over control of a weak company with the goal of helping it regain its financial strength. The acquiring entity takes over the weak company by purchasing a substantial number of shares, exchanging shares, or both. The goal of the bailout takeover is to help turn around the operations of the company without liquidating its assets. The acquiring entity achieves this by developing a rescue plan, appointing a manager to spearhead the recovery while protecting the interests of the investors and shareholders.

 

Bailout Takeover

 

Companies considered for bailout takeover are those whose collapse, or bankruptcy would be detrimental to the industry and the country’s economy as well. Such companies employ a large number of individuals and allowing them to go into bankruptcy would lead to a large number of unemployed people that the economy would be unable to accommodate. The bailout comes in the form of stock, bonds, loans, and cash that may require reimbursement in the future. In the case of stocks, the struggling company would need to re-purchase the shares from the acquiring company once it regains its financial strength.

 

Legislative and executive efforts on bailout takeover

The Dodd-Frank Act promotes the financial stability of the United States financial system by requiring accountability and transparency among US companies and protecting the American consumers. Title II of the Dodd-Frank Act legislates bailout procedures for struggling companies. It protects the financial stability of the US economy and requires shareholders and creditors to bear the losses of a failed company.

The Dodd-Frank Act was signed into law by President Barack Obama in July 2010. The act was a response to the financial crisis of 2007/2008 when most US companies were facing collapse due to the financial crunch. While the government moved in to rescue the troubled companies, the Dodd-Frank Act also protected consumers from bearing the cost of bailouts when rescuing mismanaged companies. The law also established regulatory bodies such as the Financial Stability Oversight Council, Office of the Financial Research and Bureau of Consumer Financial Protection.

 

Financial industry bailout takeover

The 2008 bailout takeover by the United States Government was the largest in history. The government moved in to rescue financial institutions that suffered large losses from the collapse of the subprime mortgage market. At the time, financial institutions provided mortgage loans to borrowers with low credit scores, and when the mortgages went into default, these companies were unable to absorb the losses.

 

Troubled Asset Relief Program (TARP)

The Emergency Economic Stabilization Act (2008) authorized the creation of Troubled Asset Relief Program (TARP) to provide a bailout to large US companies totaling $700 billion. It was one of the measures that the government took to address the subprime mortgage crisis. Authorities used TARP to purchase toxic assets and equity from financial institutions to strengthen their financial position. The toxic assets included illiquid, difficult-to-value assets such as collateralized debt obligations that were hit by foreclosures on their underlying loans. Purchasing the assets helped regain the liquidity of the assets in question, helping stabilize the balance sheets of struggling companies. In the end, TARP disbursed more than $426.4 billion to financial institutions and recovered $441.7 billion from the disbursed amount.

 

Bailout takeover of National City Corporation

In 2008, PNC Financial Services purchased $5.2 billion in National City Corp’s stocks to acquire it. National City suffered massive losses during the financial crisis due to the subprime lending crisis. PNC used the TARP fund to bail out NPC. After the takeover, NPC became the fifth largest bank in the US, even though the bailout led to the loss of jobs at the National City’s headquarters.

Another bailout takeover that happened during the financial crisis was the US government takeover of two automakers, Chrysler and General Motors. The two companies needed a bailout to stay afloat due to the decreasing number of SUV and large vehicles sales. Consumers were unable to obtain auto loans from financial institutions during the crisis, and it worsened the two companies’ financial status. Both companies employed over one million people and allowing such large companies to fall would dent the economy. Under the takeover deal, the government loaned the two companies $17.4 billion from the TARP funds on condition that they cut their debts, reduce wages and salaries, and create a restructuring plan. As the lender, the government retained the right to call off the loans if they failed to honor the agreement.

 

Reasons against a bailout takeover

Creates a moral hazard

According to Paul Volker, former Chairman of the Federal Reserve, setting bailouts for large companies creates a moral hazard because they can take excessive risks with the expectation that they will be bailed out. During the crisis, the government bailed out large financial institutions, even those that lend out mortgages without conducting due diligence on the borrowers. If the government continues with the bailout, it will encourage companies to take on substantial risks with the expectation that the government will bail them out. This can be compared to taking money from productive taxpayers and using it to reward failing companies.

 

A bailout disadvantages competition

A government bailout for struggling large companies discourages other rival firms that have been prudently managed. The government’s intervention makes markets less efficient, and in the end, it is the consumers/taxpayers who bear the biggest burden. Bailing out companies puts them at an advantage over their competitors. It reverses the gains made by productive companies and individuals since the proceeds from these companies are given to failing companies. The government should allow the market to operate freely and allow both successes and failures to occur when they are earned. Supporting unsustainable models prevents liquidated assets from being put to better use by the competitors and other companies with sustainable models.

 

More resources

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