Tags

Should our Kenyan government bailout failing Companies?

What is a Bailout? This is a situation in which the government offers money to a failing business or a company in order to prevent the consequences that arise from a business’s downfall. Bailouts can take the form of loans, bonds, stocks or cash. They may or may not require reimbursement.

Bailouts have traditionally occurred in industries or businesses that may be perceived as no longer being viable, or are just sustaining huge losses. Typically, these companies employ a large number of people, leading some people to believe that the economy would be unable to sustain such a huge jump in unemployment if the business folded.

Normally government bailout plans are meant for very large corporations or big players in industry. The way it works is that the financial planners calculate the impact if such a big industry goes out of business then thousands of people will lose their jobs and the implications of that will be huge on the economy. So if they think that by helping the business with some liquid cash can make it come out of the situation then may be its better for the government to support it as otherwise if they go out it will be even bigger burden than the bailout itself.

For example, Chrysler, a large U.S. automaker was in need of a bailout in the early 1980s. The U.S. government stepped in and offered roughly $1.2 billion to the failing company. Chrysler was able to pay the entire bailout back, and is currently a profitable firm.

 

BAILOUTS

Kenya Airways Chairman Evanson Mwaniki, Senator Anyang’ Nyong’

As kenyans we have been down this road before. You will recall Uchumi Supermarkets, Pan African Paper Mills (Pan Paper) and more recently Mumias Sugar.

Uchumi, Mumias and KQ are listed on the stock exchange and the government is a minority shareholder, generally holding less than 33%. Pan Paper was more closely held, with the Birla Group of India as majority shareholder. Have we learned from previous bailouts?

My back of envelope calculation and hunch is that ksh 20 billion equity injection and ksh 30 billion subordinated loan would be a reasonable bailout package for KQ. The National Treasury should be prepared to go that route.

Here are my reasons.

 Commercial reason

If the government did not bail out KQ, we would certainly have suffered about 4,000 job losses worth ksh 10 billion per year; other purchases of ksh 50 billion, annual forex earnings of about ksh 50 billion (50% of KQ revenue), and massive disruption of floriculture export trade (approximately 50% of this trade is worth ksh 50 billion).

BAILOUTS2

This would constitute direct losses in the first year of bankruptcy and a fire sale scenario. Further losses would occur for any year that this scenario subsists. For example, if it takes two years to resolve, we are clearly faced with a cumulative loss of over ksh 300 billion.

   Bankruptcy or rescue?

Although bankruptcy may not always be the answer, rescues create a moral hazard that encourages risky behavior. For instance uchumi and mumias went burst after rapid expansion primarily funded by short-term debt financing. First year MBAs are cautioned never to finance long term assets with short term capital. Kenya airways is struggling over the exact issue.

In the words of Trevor Manuel, former South African Finance Minister, singling out companies for state support sends the wrong signal and undermines the government’s ability to support the broader economy. He says it destroys the incentive to create sound businesses. Socializing the losses of shareholders and managers is the only thing worse than nationalizing firms outright.

 A case for bailouts

World over governments have been faced with this dilemma. In the US for example, there is a long history of corporate bailouts going back to 1970. Big companies like Chrysler, General Motors, Citi Group have all received public support at one time or another.

The case for bailouts is generally based on the idea of systemic risk – that a corporate failure will undermine the economy to a far greater extent, and could lead to a meltdown. In all instances, bailouts are expected to be transitional.

 

It is was a good idea to bail out KQ but the National Treasury and KQ must sit down and come up with a thorough restructuring and recovery strategy.

   Reasons against bailouts

  • Signals lower business standards for giant companies by incentivizing risk
  • Create moral hazard through the assurance of safety nets
  • Promotes centralized bureaucracy by allowing government powers to choose the terms of the bailout.

 

Ref http://www.afarber.com/definition-of-bailout

1.James Ott and Raymond Neidl,Airline Odyssey: The Airline Industry’s Turbulent Flight into the Future(New York: McGraw-Hill,
1995), pp. 72–83.
2. Thomas Hemphill, “Can a Libertarian Accept the ATSB?” Regulation, Spring 2003, pp.10–11.
3. Ibid., p. 10.
4. Susanna Dokupil, “Rethinking the Airline Bailout,” National Security White Papers, Federalist Society, http://www.fed-soc.org/Publications/Terrorism/airlinebailout.htm.
5. Ibid.
6. John Samples,“Against Politics as Usual,” Cato Institute, Center
for Representative Government, September 26, 2001, http://www.cato.
org/current/terrorism/pubs/samples-010926.html.
7. Laurence Phillips,“A Crisis of Security and Economics,” Regulation, Winter 2001, pp. 53–54, and Hemphill, p. 10.

 

(THIS IS MY OWN WORK, REFERENCED   I HOPE IT CHANGES YOUR THINKING 😉

Advertisements