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Red Ink in the Skies

Why the airline industry is losing money, filing for bankruptcy, and still not going out of business.

12:00 AM, Sep 21, 2004 • By IRWIN M. STELZER
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BUSINESS IS BOOMING. Most airplanes are full, or almost so, including--so British Airways's staff tell me--the pricey first- and business-class cabins on most transatlantic flights. As September 11 recedes from memory, and as the business recovery takes hold, carriers are putting more buns on seats, to use the industry vernacular. And the industry's safety record is improving.

The result: United Airlines remains in bankruptcy and is planning to lay off 6,000 more workers (10 percent of its work force); US Airways has filed for bankruptcy (for the second time); and Delta, which has lost close to $6 billion in less than four years, is teetering on the brink of bankruptcy. All in all, Merrill Lynch estimates that by year-end the industry will add over $4 billion to the $27 billion it lost between 2001 and 2003.

Nothing new here. Some analysts put the airlines' problems down to soaring oil prices. They're wrong. True, the increase in fuel costs has hurt, but several carriers have protected themselves by hedging, and most were chalking up big losses long before oil prices took off. Others blame bloody-minded unions. They have a point: BA, an island of relative prosperity in the industry's sea of red ink thanks to the tough cost-cutting strategy of its CEO, Rod Eddington, is afflicted by ground staff that claim to be too sickly to turn up for work in sufficient numbers to ticket and board the airlines' customers. US Air's pilots drove it back into bankruptcy by refusing even to consider the carrier's plan to cut $800 million from its costs to enable it to compete with low-cost carriers such as profitable Southwest and non-union JetBlue. And Delta's pilots have refused to offer enough concessions to deter the airlines' auditors from telling regulators that they doubt the debt-ridden carrier's viability.

Until now, all of this turmoil could be dismissed as of little consequence: wealth was being transferred from overpaid pilots, and from shareholders who freely decided to put their money into airline shares, to travelers, as the final effects of deregulation are working their way through the system. Good news for consumers, bad news for unions and investors.

And, it turns out, bad news for taxpayers. For one thing, the loans that the government imprudently made available to the likes of US Air, which still owes $717 million of the $900 million in guaranteed loans it received in the aftermath of September 11, may never be repaid. For another, taxpayers may have to cough up billions as the airlines walk away from their pension obligations.

Last week, US Air, which terminated the pension plan covering its pilots when it filed for its first bankruptcy two years ago, failed to make the $110 million contribution due to its remaining pension plan, and told the bankruptcy court that it doubted its ability to contribute $531 million needed to meet its minimum obligations for the two defined-benefits plans that cover 25,000 current and former mechanics and flight attendants. US Air was following the lead of United, which last month announced that it would not make the $500 million contribution due to its four pension plans this year.

THIS IS WHERE the taxpayer comes in. The quasi-government Pension Benefit Guarantee Corporation (PBGC) insures defined benefit plans. Due to the decline in share prices from their peak, and low interest rates, the assets of the PBGC haven't earned enough to cope with the obligations left by the 7,500 plans that have been terminated since 2000. So it already has a deficit of over $11 billion, and would pick up over $6.4 billion in new liabilities if United does walk away from its pension plans, and an additional $2.1 billion if US Air does the same.

Then there is the domino effect. If United and US Air are relieved of the burden of paying into their pension plans, Delta would surely have to follow suit in order to order to remain competitive. And if US Air is finally forced to discontinue operations after two bankruptcies in two years, its valuable slots would be auctioned off by its creditors. Since only Southwest and other low-cost carriers are in a position to bid for these scarce slots, the result would be a major extension of the networks and increase in market share of these bargain-offering airlines, which would put further pressure on United, Delta, and American Airlines. A downward spiral is not a happy circumstance for an airline.

The problem for the traditional carriers is the so-called "legacy" of high costs inherited from the days when regulators allowed the costs of generous settlements with trade unions, to be passed on to customers. Even after shedding one-in-four workers since 2000, the six largest legacy carriers have costs far above their newer competitors.

And even more labor-shedding will not be enough to enable these carriers to fly through the financial storm that has weakened their balance sheets and profit-and-loss statements (well, loss statements). Nor will cuts in distribution costs achieved by by-passing travel agents, reductions in the quality of food service (hard to imagine), and charging for lunch ($10 for a salad in the "main cabin" of the flight on which this was written), bring costs in line with those of the low-fare airlines.

More radical steps, such as Delta's proposed elimination of its Dallas hub, and American's decision to increase interconnection times for passengers connecting in Chicago's O'Hare airport are required. Add to that a ground staff that is willing to check passengers in and also clean airplanes and handle baggage, pilots who recognize that the world has changed since the good old days of regulated monopolies, managements that know how to do more than file for bankruptcy, and governments that are willing to let bankrupt carriers exit the market, and the survivors might just possibly discover that ink also comes in black.

Irwin M. Stelzer is director of economic policy studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.