The justification for any bailout by the government is the prevention of the collapse of a financial system, where the economic consequences of collapse outweigh the cost of bailout. Thus, the Reserve Bank would be justified to come to the rescue of a private sector bank if it was felt that the collapse of this bank could trigger off a banking panic and a run on otherwise sound banks. To put it more succinctly, provided the cost of externalities arising from a financial crisis in a particular entity far exceeds the expense of preventing the crisis by instituting a bailout, then such a course of action is justified, and it should be just adequate to prevent the crisis. The maximum cost must be borne by the entity that caused the crisis by its imprudent behaviour: change in ownership, closure or the sale of all of its marketable assets. Incidentally, bailouts were never meant for bank depositors; for that there is deposit insurance.
There are many claims on the exchequer, filled by the taxes that you and I pay. The government has been reduced to borrow in order to meet its establishment expenses. Remember every rupee that goes into a bailout means denying some other use. I doubt that it would be VIP protection; more likely it will be public health or school education or such like. There is a second, even better reason for being stingy with bailouts ? and that is moral hazard. If it is known that government will bail out an agency, the latter is likely to take unwarranted risks. When in the summer of 1998, the government bailed out the Unit Trust of India (UTI), surely the agency must have become confident that an encore was most likely. We know what that conviction did to UTI management, even if we were not to take the arrest of the former chairman as evidence of sleaze, but merely an attempt to insulate the layers above from such accusation.
Had the government not performed the 1998 bailout of UTI, would the market have collapsed into inchoate hysterics? No. That there would be some payments problem on account of UTI was well known and mostly factored into a market dampened by Pokhran-II. The same question in 2002? Certainly not, how can a year-old problem in UTI cause contemporary market-wide crisis. In which case, what was the justification for the two bailouts of UTI?
The answer lies in the guilty conscience of the government, which under different leaderships has used the UTI to intervene (unwisely) in the stock market, and perhaps as part of the patronage network. It may be argued that anyone with some common sense would have stayed away from UTI after the 1998 fiasco, and that those who expected the government to perform a second bailout were mere arbitrageurs betting on the foolishness of the State, and that they surely deserved a comeuppance. Also remember that the returns that UTI was promising on its various schemes were far in excess of what, say, you could get from postal savings, provident fund or bank fixed deposits. Since when did stupidity and/or arbitrage greed become eligible for unlimited insurance provided by the government at taxpayers? cost?
Be that as it may, presumably all taxpayers bear some measure of responsibility for the governments that they elect. So a government package for UTI is not entirely indefensible, and the expressed desire to eventually privatise the agency is necessary as an expression of closure, the assurance that there will not be bailout number three. But why should ridiculously high returns, promised by the earlier UTI management, be fully protected at public cost? A stiff haircut would not only have been justified but eminently desirable.
Now to those in the queue: Is the taxpayer culpable for the bad lending decisions of IFCI, IDBI and sundry other financial institutions? I do not think so; maybe you too do not. There are state government corporations that are defaulting to provident funds. If everybody and his uncle is going to get a bailout, accountability as an organising principle in our society will be abandoned, with bleak implications for the future of this economy. One hopes that the government is alive to this.
The author is economic advisor to ICRA (Investment Information and Credit Rating Agency)