Special Report
The Plane Truth About Airline Woes
By Christopher Whalen
It is a matter of faith among conservatives that the U.S. airline industry was "deregulated" in 1978 and that the industry has benefited greatly since then. In fact, a variety of sources tell Insight, air travel remains among the most heavily regulated businesses in the United States, particularly since Sept. 11, 2001. Deregulation in the 1970s did see ticket prices, choice of routes and right-of-market entry taken out of Washington's grasp, but everything else is controlled by government one way or another, including some of the most regressive labor laws in the U.S. economy.
After 9/11, America's airlines experienced a sudden and prolonged decrease in travel volume even as ticket prices remained under downward pressure. Massive assistance from Washington since then has not helped significantly, leading one long-term observer to coin the phrase "flying bankruptcies."
It is tempting to blame airline woes on external events such as terrorism, say industry insiders, but decades-old legal and labor laws, and the U.S. bankruptcy code, are at the core of what is wrong with the airline industry. "No other private industry has the federal government controlling the basic production line - from how and when a flight can take off and land to how many airports there are and how much capacity [runways and gates] those airports can have," says an advocate who represents airlines in Washington. This veteran of previous airline collapses recalls that the last major industry "crisis," in 1991-92, saw five major carriers go through bankruptcy but did little to change the basic economics of an industry that still is run by and for pilots.
As 2004 began, US Airways and Delta Air Lines threatened to take bankruptcy to get their respective pilot unions to revise antiquated work rules. American Airlines just avoided that disaster, and United Airlines, which entered bankruptcy in 2002, still is struggling to emerge from its latest restructuring. As Mitchell Schnurman wrote in the Dallas-Fort Worth Star-Telegram: "A year ago, American Airlines went to the brink to stave off bankruptcy. But did it go far enough to turn the company around? To cut expenses? To change hearts and minds? We still don't know."
News reports say that US Air, formerly the "low-cost" carrier in the industry, now has the industry's highest labor expenses and needs a 25 percent cost reduction to be "competitive." Continental Airlines went through two bankruptcies in an effort to become a "low-cost" carrier but continues to labor under a weak financial condition and poor earnings. But the parlous state of airline finance is not due to keen competition among truly unregulated private companies. In fact, the periodic business failures that are the normal state of affairs for airlines result from the combination of government regulation, ridiculous work practices and permissive bankruptcy laws - a toxic brew that ultimately consumes billions of dollars worth of private capital each year.
In fact, industry analysts say, it is erroneous to talk about "legacy" carriers vs. the "low-fare" insurgents such as Southwest Airlines or JetBlue Airways because all airlines face the same restrictive work rules and labor agreements. Newer entrants do have lower labor costs, but it is better personnel management that gives carriers such as JetBlue and Southwest the edge, say financial analysts who recall when US Air was the new kid on the block. Several airline-industry insiders, talking on condition of anonymity, tell Insight that the airlines historically have been able to generate only modest profits when traffic and ticket sales were growing, basically earning enough to cover operating expenses such as salaries and fuel. But when you look at the industry in terms of its total cost of doing business, including building airports and purchasing aircraft, it has been unprofitable for decades.
The entire U.S. airline sector has been locked in a familiar cycle of growth and stagnation, followed by financial default and bankruptcy, all leading to curtailed service and layoffs. Indeed, the loan guarantees and other federal subsidies provided since 9/11 have failed to slow the steady deterioration in air transportation in the United States that already was evidenced before the attacks. Overcapacity exerts downward pressure on ticket prices, generating fares that don't allow the airlines to cover the cost of providing service, making the average "private" airline look more like a public utility - think of Amtrak with wings.
US Air filed bankruptcy in September 2002, followed by United Airlines two months later. The smaller carrier re-emerged in March 2003, but giant United has been struggling to complete the reorganization process. Moody's, the investment rating agency, has withdrawn all its ratings for United, including debt secured by United aircraft. The bankruptcy judge has given United until early April unilaterally to propose a plan to emerge from bankruptcy, after which the court will entertain other proposals. But the financially crippled airline is unlikely to meet that deadline because it is waiting for the latest bailout from Washington.
So shaky is United's financial health that its successful exit from bankruptcy depends in part on gaining federal relief from its pension obligations. Under the bizarre logic of postderegulation airline economics, United seeks to qualify for a $2 billion loan from the Air Transportation Stabilization Board, an appendage of the Treasury Department created after 9/11 with authority to issue up to $10 billion in federal loan guarantees. But to do this, United must have another arm of the Treasury forgive part of its pension obligations.
Early in February, the Senate passed a bill that would reduce by $80 billion the money that employers have to pay into their defined-benefit pension plans this year and next, part of Washington's election-year present to the Fortune 500. The Senate bill also would provide $16 billion in relief during the two years to airlines and others required to make catch-up payments to underfunded pension plans. Such is the degree of government involvement in the finances of the ostensibly "private" airlines that a group of senators led by Ted Kennedy (D-Mass.) wrote to United demanding that the bankrupt airline not curtail health benefits for its 72,000 employees.
Sen. Trent Lott (R-Miss.) said during the debate over the pension-fund bailout: "Some will argue that [the pension legislation] gives the major airlines an advantage over the smaller airlines. I certainly am not in a position to want to do that. I want all of our airlines to be able to meet the responsibilities and commitments of their pension plans, but also to be able to stay in business and provide service. We need the shorter routes, the ones that fly from point to point, and the hub airlines. I want a healthy airline industry. This is one step in that process."
Unfortunately, none of Washington's policy prescriptions seems to be helping the airlines - small or large - actually achieve lasting profitability. A senior Bush administration official closely involved with the post-9/11 bailout of the airlines concedes that the industry is not responding to the latest federal largesse. He reports that former Treasury secretary Paul O'Neill wanted to make outright grants to the airlines after terrorist attacks sharply reduced air travel. The official acknowledges that lending United money on the one hand while subsidizing the company's pension liabilities on the other is not an optimal policy, but argues that Congress prescribed this convoluted arrangement. "There clearly needs to be a restructuring in the airline industry," says the official, who like many others in election-year Washington is afraid to be quoted on the record.
Operatives inside the Bush administration and among Republican staffers on Capitol Hill readily concede that throwing more federal subsidies at already bankrupt airlines is not a free-market solution, but none is able to suggest an alternative. Conservatives point to the labor issue and the work practices in the airline industry as the single biggest obstacle to making airlines more profitable. They note, with some justification, that airline labor contracts never die, that unions have acquired special protection in bankruptcy, giving big labor a huge degree of leverage when an airline is restructured. Indeed, in the case of United, the unions seem to have the upper hand and are accusing management of financial fraud, among other things. But United's predicament is hardly unique.
"US Airways, which emerged from bankruptcy protection last March, continues to deal with cost and sales challenges confronting all legacy airlines, such as American Airlines and Delta Air Lines," reported Reuters in February. "Those airlines have struggled to cope with continued weakness in high-yield business travel and with the growth of low-fare carriers such as Southwest Airlines and JetBlue Airways."
Sources on Wall Street worry that US Air is now in danger of rejoining United in bankruptcy. Despite contract concessions won in bankruptcy, US Air still has the industry's second-highest cost per employee, behind only Northwest Airlines and 31 percent higher than insurgent Southwest, according to Daily Bankruptcy News. Once known as Allegheny, the nation's seventh-largest airline took advantage of the postderegulation environment and went on a merger binge, buying PSA in California, Piedmont in the Carolinas and the former Eastern Airlines/Trump Shuttle. These three airlines and their pilot contracts and work rules were merely tacked on to the Allegheny Airlines' contracts and work rules.
"US Air has never been able to create an integrated and efficient pilot workforce with compatible work rules," notes another industry observer. "The same is true of the labor agreements for US Air's mechanics, flight attendants and customer-service agents." Most observers say that without drastic additional cost cuts, US Air has little or no chance of survival - but that does not mean that the planes will stop flying. Of interest, the state of Alabama is now the controlling shareholder of US Air and may be forced either to rescue the airline or see its investment wiped out.
The Pittsburgh Post-Gazette reports that when Alabama state pension-fund chief David Bronner "jumped into US Airways' cockpit as its lead investor and chairman," he called his $240 million stake a "hell of an investment. ... It'll be the strongest airline in the world financially." Now Bronner admits that US Air is in serious trouble: "We probably should have [stayed longer in Chapter 11] if we'd known what was coming."
Unfortunately, remaining in a perpetual state of bankruptcy seems to be the preferred way of managing U.S. airlines. Republicans in and out of the Bush administration talk about free markets and competition in the air-travel industry, but in practice Washington runs the airline industry like a strange hybrid of socialist expediency and outright criminality. Private investors and banks provide the capital for these perennially unprofitable "private companies," which then use bankruptcy in effect to steal monies owed to investors, employees and lenders, critics say. The taxpayer picks up the balance through outright subsidies, tax breaks and other favors doled out from Washington.
"The one thing that has clearly changed since deregulation is that prices have become more transparent, and this has tended to benefit consumers, but it also hurt airline profitability," says Oregon Rep. Peter DeFazio, ranking Democrat on the House Transportation and Infrastructure subcommittee on Aviation. DeFazio believes that some routes in the United States can be operated profitably, as proved by the growth of Southwest, but many cities in the country do not have sufficient volume to be profitable. DeFazio believes that the effect of deregulation is to reduce or eliminate air service to many communities and ultimately weaken the financial well-being of the airlines.
"Members of the traveling public do not believe that they should pay $800 or $1,000 to fly from New York to Los Angeles," agrees a senior Senate staffer. "But that is probably what it costs, not the $200, $300 or $400 that many people actually pay. Given this reality, the only chance for this industry to survive is to cut costs and change business practices." But cutting costs is not the only problem with aviation in America. The U.S. government controls all airports - one reason why no entirely new facility has been built in this country in more than 20 years.
In December the Senate passed the Federal Aviation Administration (FAA) reauthorization bill, which included $60 billion in critically needed aviation safety, security and capacity improvements, but the performance of the FAA in managing construction and other projects is not encouraging. The FAA's Office of the Inspector General (OIG) reports that failure properly to manage air-traffic- systems (ATC) modernization programs allowed the costs of those projects to grow by more than $4.3 billion - almost double the annual FAA 2004 budget request ($2.9 billion) for ATC modernization. The FAA projects that the OIG examined were estimated originally to cost $6.8 billion; costs were actually $11.1 billion and climbing, and the FAA was only requesting about $3 billion a year in funding! The OIG says a good portion of these cost overruns can be attributed to waste, fraud and abuse at the FAA.
Antiquated labor rules and public control of airports and other facilities are important factors behind the financial problems inside the airline industry, but the key issue seems to be the perverse influence of the bankruptcy laws. Former American Airlines chairman Robert L. Crandall noted on more than one occasion that the airline industry has never generated sufficient profitability to cover its current and long-term costs, but he blames the relatively permissive U.S. bankruptcy laws, not Washington's limited experiment in deregulation, for the problem.
In a monograph published by Washington University in St. Louis in 1998, Crandall accurately predicted the industry's current state of affairs. He argued that proposals substantially to re-regulate the airline industry overlook the fact that the problems new regulations would address - such as fare structures and service requirements - are, in fact, the unintended consequences of past regulatory actions. Crandall warned at the time that the use of bankruptcy by the airlines accounts for much of the extreme ups and downs in the industry since deregulation in the late 1970s.
The former American Airlines chief argues that because an airline's assets always have a higher present value if the airline continues to operate, even at a loss, many insolvent carriers use bankruptcy to keep operating while repudiating prior obligations, negotiating reduced aircraft-lease payments, persuading lenders to exchange debt for equity, and wringing concessions from unions. As with most failed businesses that are allowed to "trade insolvent," after a carrier enters bankruptcy it typically lowers prices to sustain its traffic volume. Its competitors lower fares too, rather than allow traffic to be diverted. Thus, the U.S. bankruptcy code, by keeping bankrupt airlines aloft, actually fuels the fare wars that plagued the industry throughout the 1980s and reduced the credit standing of most U.S. carriers to noninvestment-grade or "junk" status by the mid-1990s.
Crandall argues that absent permissive bankruptcy rules, failing airlines - and the Wall Street banks that raise money to fund them - would have to be more prudent, knowing the consequences of failure would be the real losses associated with liquidation. Under the present system, U.S. bankruptcy laws weaken the competitive capacity of the more successful U.S. carriers. Crandall and others say airline regulation would work better and the U.S. airline industry would be healthier if appropriate changes were made to U.S. bankruptcy laws.
In the late 1980s U.S. bank regulators learned that keeping insolvent "zombie" banks open increased the ultimate cost to the taxpayer. Thus was born the concept of "prompt corrective action," which basically said that when the bank was insolvent it was closed immediately and its assets sold. The solution to the issue of overcapacity in the airline industry is similar - namely, to force the timely liquidation of financially troubled carriers in such a way as to cause minimal disruptions to service. But such market-driven solutions are not fashionable in the Bush administration. Many analysts argue that if US Air and another similar-size carrier were eliminated tomorrow (roughly 20 percent of total capacity), the remaining airlines would just about match demand. The problem with such solutions is that even under a Republican government, Washington lacks the political courage to follow its own free-market rhetoric.
During a conference call with analysts in February, one US Air official noted that fares are continuing to drop - this even as several of the largest carriers teeter on the brink of insolvency. For every mature "legacy" airline such as US Air or United, there is a new entrant with relatively low labor and equipment costs waiting to offer rock-bottom prices. As the larger airlines cut back service and sell assets, smaller, more recent entrants such as JetBlue pick up the slack. With a never-ending supply of investors willing to create additional airlines, and a surfeit of pilots and aircraft, the U.S. airline industry seems doomed to low or no profits.
Americans like to pretend that our economy is based on free-market discipline, when, in fact, it is a growing muddle of socialist compromises, ranging from Social Security to heavily regulated industries such as transportation. The airline industry is a case in point: a public service that masquerades as a private business, raising capital from private investors whom it often stiffs. Many socialist countries boast far less efficient means of confiscating private property. Like many of the financial disasters created by Washington, the airline industry is slowly collapsing under the weight of accumulated debt and depleted capital, and no one either in the Congress or the White House wants to deal with it.
So next time you hear a member of the Bush administration laud the benefits of airline deregulation, ask why virtually none of the "private" airlines seems to be profitable, why many of them are in or near bankruptcy, why the courts refuse to liquidate the most profoundly insolvent among them, and why the taxpayer is being asked with increasing frequency to pick up the tab. The ripening situation facing United and US Air may bring the crisis home to roost sooner rather than later, but a more likely scenario is continued muddle and gridlock in Washington as America's airline-travel system slowly disintegrates.
Christopher Whalen is a contributing writer for Insight.
--------------------------------------------------------------------------------
The Plane Truth About Airline Woes
By Christopher Whalen
It is a matter of faith among conservatives that the U.S. airline industry was "deregulated" in 1978 and that the industry has benefited greatly since then. In fact, a variety of sources tell Insight, air travel remains among the most heavily regulated businesses in the United States, particularly since Sept. 11, 2001. Deregulation in the 1970s did see ticket prices, choice of routes and right-of-market entry taken out of Washington's grasp, but everything else is controlled by government one way or another, including some of the most regressive labor laws in the U.S. economy.
After 9/11, America's airlines experienced a sudden and prolonged decrease in travel volume even as ticket prices remained under downward pressure. Massive assistance from Washington since then has not helped significantly, leading one long-term observer to coin the phrase "flying bankruptcies."
It is tempting to blame airline woes on external events such as terrorism, say industry insiders, but decades-old legal and labor laws, and the U.S. bankruptcy code, are at the core of what is wrong with the airline industry. "No other private industry has the federal government controlling the basic production line - from how and when a flight can take off and land to how many airports there are and how much capacity [runways and gates] those airports can have," says an advocate who represents airlines in Washington. This veteran of previous airline collapses recalls that the last major industry "crisis," in 1991-92, saw five major carriers go through bankruptcy but did little to change the basic economics of an industry that still is run by and for pilots.
As 2004 began, US Airways and Delta Air Lines threatened to take bankruptcy to get their respective pilot unions to revise antiquated work rules. American Airlines just avoided that disaster, and United Airlines, which entered bankruptcy in 2002, still is struggling to emerge from its latest restructuring. As Mitchell Schnurman wrote in the Dallas-Fort Worth Star-Telegram: "A year ago, American Airlines went to the brink to stave off bankruptcy. But did it go far enough to turn the company around? To cut expenses? To change hearts and minds? We still don't know."
News reports say that US Air, formerly the "low-cost" carrier in the industry, now has the industry's highest labor expenses and needs a 25 percent cost reduction to be "competitive." Continental Airlines went through two bankruptcies in an effort to become a "low-cost" carrier but continues to labor under a weak financial condition and poor earnings. But the parlous state of airline finance is not due to keen competition among truly unregulated private companies. In fact, the periodic business failures that are the normal state of affairs for airlines result from the combination of government regulation, ridiculous work practices and permissive bankruptcy laws - a toxic brew that ultimately consumes billions of dollars worth of private capital each year.
In fact, industry analysts say, it is erroneous to talk about "legacy" carriers vs. the "low-fare" insurgents such as Southwest Airlines or JetBlue Airways because all airlines face the same restrictive work rules and labor agreements. Newer entrants do have lower labor costs, but it is better personnel management that gives carriers such as JetBlue and Southwest the edge, say financial analysts who recall when US Air was the new kid on the block. Several airline-industry insiders, talking on condition of anonymity, tell Insight that the airlines historically have been able to generate only modest profits when traffic and ticket sales were growing, basically earning enough to cover operating expenses such as salaries and fuel. But when you look at the industry in terms of its total cost of doing business, including building airports and purchasing aircraft, it has been unprofitable for decades.
The entire U.S. airline sector has been locked in a familiar cycle of growth and stagnation, followed by financial default and bankruptcy, all leading to curtailed service and layoffs. Indeed, the loan guarantees and other federal subsidies provided since 9/11 have failed to slow the steady deterioration in air transportation in the United States that already was evidenced before the attacks. Overcapacity exerts downward pressure on ticket prices, generating fares that don't allow the airlines to cover the cost of providing service, making the average "private" airline look more like a public utility - think of Amtrak with wings.
US Air filed bankruptcy in September 2002, followed by United Airlines two months later. The smaller carrier re-emerged in March 2003, but giant United has been struggling to complete the reorganization process. Moody's, the investment rating agency, has withdrawn all its ratings for United, including debt secured by United aircraft. The bankruptcy judge has given United until early April unilaterally to propose a plan to emerge from bankruptcy, after which the court will entertain other proposals. But the financially crippled airline is unlikely to meet that deadline because it is waiting for the latest bailout from Washington.
So shaky is United's financial health that its successful exit from bankruptcy depends in part on gaining federal relief from its pension obligations. Under the bizarre logic of postderegulation airline economics, United seeks to qualify for a $2 billion loan from the Air Transportation Stabilization Board, an appendage of the Treasury Department created after 9/11 with authority to issue up to $10 billion in federal loan guarantees. But to do this, United must have another arm of the Treasury forgive part of its pension obligations.
Early in February, the Senate passed a bill that would reduce by $80 billion the money that employers have to pay into their defined-benefit pension plans this year and next, part of Washington's election-year present to the Fortune 500. The Senate bill also would provide $16 billion in relief during the two years to airlines and others required to make catch-up payments to underfunded pension plans. Such is the degree of government involvement in the finances of the ostensibly "private" airlines that a group of senators led by Ted Kennedy (D-Mass.) wrote to United demanding that the bankrupt airline not curtail health benefits for its 72,000 employees.
Sen. Trent Lott (R-Miss.) said during the debate over the pension-fund bailout: "Some will argue that [the pension legislation] gives the major airlines an advantage over the smaller airlines. I certainly am not in a position to want to do that. I want all of our airlines to be able to meet the responsibilities and commitments of their pension plans, but also to be able to stay in business and provide service. We need the shorter routes, the ones that fly from point to point, and the hub airlines. I want a healthy airline industry. This is one step in that process."
Unfortunately, none of Washington's policy prescriptions seems to be helping the airlines - small or large - actually achieve lasting profitability. A senior Bush administration official closely involved with the post-9/11 bailout of the airlines concedes that the industry is not responding to the latest federal largesse. He reports that former Treasury secretary Paul O'Neill wanted to make outright grants to the airlines after terrorist attacks sharply reduced air travel. The official acknowledges that lending United money on the one hand while subsidizing the company's pension liabilities on the other is not an optimal policy, but argues that Congress prescribed this convoluted arrangement. "There clearly needs to be a restructuring in the airline industry," says the official, who like many others in election-year Washington is afraid to be quoted on the record.
Operatives inside the Bush administration and among Republican staffers on Capitol Hill readily concede that throwing more federal subsidies at already bankrupt airlines is not a free-market solution, but none is able to suggest an alternative. Conservatives point to the labor issue and the work practices in the airline industry as the single biggest obstacle to making airlines more profitable. They note, with some justification, that airline labor contracts never die, that unions have acquired special protection in bankruptcy, giving big labor a huge degree of leverage when an airline is restructured. Indeed, in the case of United, the unions seem to have the upper hand and are accusing management of financial fraud, among other things. But United's predicament is hardly unique.
"US Airways, which emerged from bankruptcy protection last March, continues to deal with cost and sales challenges confronting all legacy airlines, such as American Airlines and Delta Air Lines," reported Reuters in February. "Those airlines have struggled to cope with continued weakness in high-yield business travel and with the growth of low-fare carriers such as Southwest Airlines and JetBlue Airways."
Sources on Wall Street worry that US Air is now in danger of rejoining United in bankruptcy. Despite contract concessions won in bankruptcy, US Air still has the industry's second-highest cost per employee, behind only Northwest Airlines and 31 percent higher than insurgent Southwest, according to Daily Bankruptcy News. Once known as Allegheny, the nation's seventh-largest airline took advantage of the postderegulation environment and went on a merger binge, buying PSA in California, Piedmont in the Carolinas and the former Eastern Airlines/Trump Shuttle. These three airlines and their pilot contracts and work rules were merely tacked on to the Allegheny Airlines' contracts and work rules.
"US Air has never been able to create an integrated and efficient pilot workforce with compatible work rules," notes another industry observer. "The same is true of the labor agreements for US Air's mechanics, flight attendants and customer-service agents." Most observers say that without drastic additional cost cuts, US Air has little or no chance of survival - but that does not mean that the planes will stop flying. Of interest, the state of Alabama is now the controlling shareholder of US Air and may be forced either to rescue the airline or see its investment wiped out.
The Pittsburgh Post-Gazette reports that when Alabama state pension-fund chief David Bronner "jumped into US Airways' cockpit as its lead investor and chairman," he called his $240 million stake a "hell of an investment. ... It'll be the strongest airline in the world financially." Now Bronner admits that US Air is in serious trouble: "We probably should have [stayed longer in Chapter 11] if we'd known what was coming."
Unfortunately, remaining in a perpetual state of bankruptcy seems to be the preferred way of managing U.S. airlines. Republicans in and out of the Bush administration talk about free markets and competition in the air-travel industry, but in practice Washington runs the airline industry like a strange hybrid of socialist expediency and outright criminality. Private investors and banks provide the capital for these perennially unprofitable "private companies," which then use bankruptcy in effect to steal monies owed to investors, employees and lenders, critics say. The taxpayer picks up the balance through outright subsidies, tax breaks and other favors doled out from Washington.
"The one thing that has clearly changed since deregulation is that prices have become more transparent, and this has tended to benefit consumers, but it also hurt airline profitability," says Oregon Rep. Peter DeFazio, ranking Democrat on the House Transportation and Infrastructure subcommittee on Aviation. DeFazio believes that some routes in the United States can be operated profitably, as proved by the growth of Southwest, but many cities in the country do not have sufficient volume to be profitable. DeFazio believes that the effect of deregulation is to reduce or eliminate air service to many communities and ultimately weaken the financial well-being of the airlines.
"Members of the traveling public do not believe that they should pay $800 or $1,000 to fly from New York to Los Angeles," agrees a senior Senate staffer. "But that is probably what it costs, not the $200, $300 or $400 that many people actually pay. Given this reality, the only chance for this industry to survive is to cut costs and change business practices." But cutting costs is not the only problem with aviation in America. The U.S. government controls all airports - one reason why no entirely new facility has been built in this country in more than 20 years.
In December the Senate passed the Federal Aviation Administration (FAA) reauthorization bill, which included $60 billion in critically needed aviation safety, security and capacity improvements, but the performance of the FAA in managing construction and other projects is not encouraging. The FAA's Office of the Inspector General (OIG) reports that failure properly to manage air-traffic- systems (ATC) modernization programs allowed the costs of those projects to grow by more than $4.3 billion - almost double the annual FAA 2004 budget request ($2.9 billion) for ATC modernization. The FAA projects that the OIG examined were estimated originally to cost $6.8 billion; costs were actually $11.1 billion and climbing, and the FAA was only requesting about $3 billion a year in funding! The OIG says a good portion of these cost overruns can be attributed to waste, fraud and abuse at the FAA.
Antiquated labor rules and public control of airports and other facilities are important factors behind the financial problems inside the airline industry, but the key issue seems to be the perverse influence of the bankruptcy laws. Former American Airlines chairman Robert L. Crandall noted on more than one occasion that the airline industry has never generated sufficient profitability to cover its current and long-term costs, but he blames the relatively permissive U.S. bankruptcy laws, not Washington's limited experiment in deregulation, for the problem.
In a monograph published by Washington University in St. Louis in 1998, Crandall accurately predicted the industry's current state of affairs. He argued that proposals substantially to re-regulate the airline industry overlook the fact that the problems new regulations would address - such as fare structures and service requirements - are, in fact, the unintended consequences of past regulatory actions. Crandall warned at the time that the use of bankruptcy by the airlines accounts for much of the extreme ups and downs in the industry since deregulation in the late 1970s.
The former American Airlines chief argues that because an airline's assets always have a higher present value if the airline continues to operate, even at a loss, many insolvent carriers use bankruptcy to keep operating while repudiating prior obligations, negotiating reduced aircraft-lease payments, persuading lenders to exchange debt for equity, and wringing concessions from unions. As with most failed businesses that are allowed to "trade insolvent," after a carrier enters bankruptcy it typically lowers prices to sustain its traffic volume. Its competitors lower fares too, rather than allow traffic to be diverted. Thus, the U.S. bankruptcy code, by keeping bankrupt airlines aloft, actually fuels the fare wars that plagued the industry throughout the 1980s and reduced the credit standing of most U.S. carriers to noninvestment-grade or "junk" status by the mid-1990s.
Crandall argues that absent permissive bankruptcy rules, failing airlines - and the Wall Street banks that raise money to fund them - would have to be more prudent, knowing the consequences of failure would be the real losses associated with liquidation. Under the present system, U.S. bankruptcy laws weaken the competitive capacity of the more successful U.S. carriers. Crandall and others say airline regulation would work better and the U.S. airline industry would be healthier if appropriate changes were made to U.S. bankruptcy laws.
In the late 1980s U.S. bank regulators learned that keeping insolvent "zombie" banks open increased the ultimate cost to the taxpayer. Thus was born the concept of "prompt corrective action," which basically said that when the bank was insolvent it was closed immediately and its assets sold. The solution to the issue of overcapacity in the airline industry is similar - namely, to force the timely liquidation of financially troubled carriers in such a way as to cause minimal disruptions to service. But such market-driven solutions are not fashionable in the Bush administration. Many analysts argue that if US Air and another similar-size carrier were eliminated tomorrow (roughly 20 percent of total capacity), the remaining airlines would just about match demand. The problem with such solutions is that even under a Republican government, Washington lacks the political courage to follow its own free-market rhetoric.
During a conference call with analysts in February, one US Air official noted that fares are continuing to drop - this even as several of the largest carriers teeter on the brink of insolvency. For every mature "legacy" airline such as US Air or United, there is a new entrant with relatively low labor and equipment costs waiting to offer rock-bottom prices. As the larger airlines cut back service and sell assets, smaller, more recent entrants such as JetBlue pick up the slack. With a never-ending supply of investors willing to create additional airlines, and a surfeit of pilots and aircraft, the U.S. airline industry seems doomed to low or no profits.
Americans like to pretend that our economy is based on free-market discipline, when, in fact, it is a growing muddle of socialist compromises, ranging from Social Security to heavily regulated industries such as transportation. The airline industry is a case in point: a public service that masquerades as a private business, raising capital from private investors whom it often stiffs. Many socialist countries boast far less efficient means of confiscating private property. Like many of the financial disasters created by Washington, the airline industry is slowly collapsing under the weight of accumulated debt and depleted capital, and no one either in the Congress or the White House wants to deal with it.
So next time you hear a member of the Bush administration laud the benefits of airline deregulation, ask why virtually none of the "private" airlines seems to be profitable, why many of them are in or near bankruptcy, why the courts refuse to liquidate the most profoundly insolvent among them, and why the taxpayer is being asked with increasing frequency to pick up the tab. The ripening situation facing United and US Air may bring the crisis home to roost sooner rather than later, but a more likely scenario is continued muddle and gridlock in Washington as America's airline-travel system slowly disintegrates.
Christopher Whalen is a contributing writer for Insight.
--------------------------------------------------------------------------------
