Tuesday, July 23, 2013

Bailouts need not mean losses to taxpayes

When failed banks are bailed out, these are seen as losses to tax payers. This need not be so, as an article in FT points out. The US Treasury made a profit of $5 bn on its investment in AIG and another $4.5 bn on its investments in Citigroup and Bank of America. In the UK, the government has broken even on its investment in Lloyds Bank. It also cites instances where central banks that bought securities - whether of corporates or sovereigns- stand to make profit.

In other words, intervention to save failing banks not only prevents economic collapse but also ends up as gain for the tax payer over time. The operative expression is "over time". What is seen as a "bailout cost" is a cost only at the point of intervention. The case for public intervention to save failing banks is thus overwhelming.

Where do these profits come from? Well, in a financial crisis, assets tend to be hugely undervalued. There is enormous under-shooting in prices. The moment economic calm returns, there is a good chance that prices will move up.

This is not just a foreign phenomenon. The government of India ended up making a huge profit on UTI through SUUTI. Only, the gains did not accrue to the holders of UTI units who were fobbed off with securities carrying yields of around 6% because they were not given a call option on the government investment in SUUTI. The UTI "scam" in which  managers were said to have ripped off investors through bad investments has, in fact, turned out to be a bonanza for the government. So much for the "scam" of which the media had made an enormous hullabaloo at the time.

1 comment:

Crankx said...

Government bailout means not only capital infusion, it is also the intervention by the government so that the "funny business" of looting the company cannot go on -- atleast not to the extent it was going on.

Which is what the company needed in the first place. A good CEO who needs to cleanup the business.

In any other capital infusion / bailout by a third party you don't have the stick to cleanup the company so its doomed to fail.

It does not give the right of the company to mess up in the first place and the government to gamble (it could have gone either way) with the public tax payers money.

If a company has bad governing structre, overspending, scandalous and its stake holders are looting it, why should governemnt help the company.

If I blow off all my assets in partying, would government help me to getback to the same state ?

Bailouts may not mean losses to taxpayers. -- the key word here is *may*. But it certainly means government gambles with taxpayer money and it *may* loose as well.

The Cranky observer