OCTOBER 8, 2001
Earlier this year, while federal antitrust authorities were reviewing his company's proposed merger with United, US Airways CEO Rakesh Gangwal acknowledged that "there [was] no plan B" should the deal fail. The claim was surprising given that corporate executives usually pretend to be optimistic even in the worst of times. But Gangwal could no longer pretend. Though US Airways had improved since the 1980s, when it was beset by chronic delays and lost baggage, it still faced a daunting problem. With its generous pilot salaries and posh airplanes, US Airways had the cost structure of a lucrative long-distance carrier, but competed primarily on shorter, less profitable routes. Dogged by a slowing economy and increased competition from no-frills carriers, US Airways had begun to hemorrhage money--almost $200 million in the first half of this year alone.
Well, say hello to plan B: the $15 billion airline bailout that congressional negotiators and the White House agreed to last Friday. In the days following the terrorist attacks, US Airways' dismal long-term prospects had made private fund-raising impossible, and the company had only enough cash in reserve to hold out for about two months amid the millions it was losing each day. But under the tentative bailout formula, US Airways will immediately receive about $400 million of the $5 billion the government is throwing at the industry. And it will probably also receive a sizable fraction of the $10 billion in federal loan guarantees. Taken together, the package will keep US Airways out of bankruptcy court into next year, something that was by no means assured before September 11.
And US Airways isn't the only airline that stands to benefit from the terrorist attacks. America West was in so much trouble early this year that some analysts wondered how long it could survive on its own. Under the bailout it could receive a few hundred million dollars. Northwest's large debt was rapidly undermining its financial position as well. Under the bailout it will receive at least half a billion dollars. Which raises a question: Why, under the guise of an emergency, are the feds propping up companies that might well have failed anyway?
Since deregulation in 1978, the airline industry has been one of the most volatile in the country. Carriers must fill an average of 65 percent of their seats to offset the huge costs of multi-million dollar aircraft, terminal space, and highly trained employees. But because demand for air travel is extremely cyclical--air travel is always among the first casualties of a slowing economy--it's rare that carriers can sustain that volume consistently. The result is that airlines do extremely well in times of plenty and rack up huge losses during economic downturns. Well-run airlines prepare for this. They stockpile cash reserves during boom times and run them down when consumers retrench. Poorly run airlines don't; during severe recessions they get radically overhauled or go out of business.
That's what happened during the recession and war of the early 1990s. In 1991, one of the worst years in the history of the aviation industry, American carriers lost in excess of $4 billion as domestic passenger traffic fell by 4 percent and highly profitable international traffic fell by more than 25 percent. By the time the economy rebounded, three major carriers--America West, Continental, and TWA--had declared bankruptcy. Another three--Pan Am, Eastern, and Midway--had been liquidated entirely.
And yet the industry as a whole was never in danger. The top three carriers--United, American, and Delta (they remain the top three today)--were well situated to absorb the losses and began recording steady increases in traffic and revenues by 1992, although profitability returned more slowly. America West, TWA, and Continental all reemerged from the rubble, the latter to become an industry power. And while we never heard from the likes of Pan Am and Eastern again, that wasn't necessarily a bad thing.
The same sort of shakeout probably would have happened this time. While 1991's 4 percent reduction in passenger traffic looks like a mere hiccup compared to the more than 50 percent reduction the airlines experienced immediately after the hijackings, no one expects that kind of drop-off to persist once the feds beef up airport security. Which means that, as in the early '90s, the big three should have had little trouble staying afloat. All have over a billion dollars in cash on hand and, as one source close to United told The Wall Street Journal last week, could probably "pick up the phone and raise a billion" from suppliers and international banks. Smaller carriers like Continental and Southwest--the only two profitable airlines in the first half of this year--have considerable cash reserves of their own and viable long-term business models. They would probably have weathered the next several months, even if it meant temporary bankruptcy protection. The only airlines that might have gone under for good--US Airways and America West--were already in trouble.
The only real justification for an airline bailout would be a long-term blow to passenger confidence--say, after a second serious terrorist attack or a protracted military effort--that permanently reduced demand for air travel. But last Friday's $15 billion relief package isn't even the right remedy for that. If the demand for air travel is permanently reduced, the industry will be completely transformed--with fewer airlines needed to meet the lower passenger volume. So floating money to companies the market will soon be unable to support would still be a bad use of resources. Again, consider US Airways. One of the chief arguments for propping it up is that it has suffered disproportionately from the closure of Reagan National Airport, which anchors its most profitable northeastern routes. But that argument is irrelevant. After all, if National reopens in the next few weeks, US Airways' $900 million reserves should sustain it in the meantime. And if National closes for good, the company will have lost its raison d'etre and should be allowed to fail.
None of which is to say federal intervention was altogether unnecessary. United and American, the two carriers directly affected by the terrorist attacks, faced billions in liability before Congress stepped in to shield them from property damage claims and to help them compensate victims. What's more, all the airlines faced skyrocketing costs for insurance against war and terrorism, premiums that increased more than a hundred-fold after the attacks and which would not have been affordable without Congress temporarily filling the gap. And it seems only fair that some of the burden of tighter airport security be borne by taxpayers, whether as fare increases or federal expenditures. But all of that came on top of the $15 billion Congress handed the industry.
"If we hadn't passed this package today ... a number of airlines would have had a number of their airplanes firmly on the ground," Missouri Representative Roy Blunt announced last Friday, "and they would never have gone up again." Probably so. Except that this would have been the case even if September 11 had just been a normal day.
This article originally ran in the October 8, 2001, issue of the magazine.