Airlines: Bail or Let Them Fail?

That's the question the government may soon face as the financial situation at some of the nation's largest air carriers grows more dire. Houston-based Continental Airlines (CAL), for example, posted a $213 million loss today as revenue plunged 23 percent. The airline also said it would cut 1,700 jobs.

Continental, though, remains in better shape than most of its rivals. American (AMR), United (UAL) and US Airways (LCC) all may need additional capital to keep flying, JP Morgan analyst Jamie Baker wrote earlier this week.

... We believe the point of no return has already passed. Even a seemingly miraculous surge in demand wouldn't negate the necessity for significant incremental capital at [American, US Airways and United].

Bond investors are unlikely to pump more cash into the troubled carriers. Rates for credit-default swaps - which offer protection against debt defaults - for both American and United's parent companies have been rising sharply since May, Bloomberg reported yesterday. (No link available.)

Typically, at this stage in the airline cycle of despair, carriers return to bankruptcy court like the swallows to Capistrano. But perhaps not this time.

Most of the troubled airlines have been through Chapter 11 recently enough that the cost-cutting benefits would be miniscule. United left bankruptcy in early 2006 and US Airways a few months before that. Their costs remain competitive with rivals. American, which is the only major carrier that's never filed, may be the exception, but even then, Baker notes that bankruptcy financing may be hard to come by.

So could we finally have a major airline that simply goes out of business? That would remove capacity, allow the remaining carriers to charge more and perhaps restore some profitability to the industry.

Don't get your hopes up. Given the tenuous state of the recovery, it's unlikely the administration or Congress would allow a carrier to shut down and put tens of thousands of workers on the street. As Baker notes:

Washington may ultimately prove the lender of last resort and push for job-saving consolidation in return. Unfortunately, this does less to reshape the industry than outright liquidation....

In fact, it repeats the problems of the past by keeping weak carriers flying. Once again, they'll slash fares to drive traffic, forcing financially stronger competitors to follow suit.

In the meantime, expect renewed clamoring from Wall Street for a merger of the damned. United and US Airways already talked about combining last year, and despite the abysmal record of airline mergers, you can almost hear investment bankers salivating over the potential fees from putting such a deal together. Indeed, Baker concludes by saying that he continues "to find merit" in a merger of the merger idea.

So here we are, in the final phase of the airline cycle - losses mount, bankruptcies loom, mergers get proposed and the carriers ultimately go to Washington to beg for a bailout.

It's time to stop the insanity. Failure isn't an option in the airline industry, it's a necessity. It's way past time to let competition work, to let some of the weaker carriers die and put them out of our misery.

Disclosures: no positions

Comments

[aadriver:]

Failure is a necessity? Is that the capitalist answer to the worst global recession since the Great Depression? I guess success is something the employees of United, US Airways, or American need not strive for. It's all about "our misery." My misery? Does United Airlines/US Airways/American Airlines very existance make me absolutely so miserable that I will cheer when they go out of business and thousands of hard-working, decent people lose their jobs? Articles like this show there is absolutely no limit what people will wish for in order to line their pockets. Shame on you!

Jul 21 06:22 PM

[Don't Belie...:]

I think your commentary is short sighted and trite. Your entire premise for "the necessity of failure" is that reduced capacity leads to higher ticket prices. Yes, in my freshman economics class (25 years ago) that worked, but alas, it is just as cheap to fly home from college (chicago to LA) now as it was 25 years ago! The problem is more complex than the simple supply-demand issue, and ironically as easy as the ticket price staying the same for 25 years! As for supply/demand, when one airline reduces seat supply, another simply increases it and keeps the price the same in the name of "market share." In the past few quarters, capacity was reduced by everyone and the revenue decline simply outpaced it. The industry probably still has to much capacity due to the RECESSION, not the need to rid a company.
The bigger issue is the value placed on travel by people. We hand our lives to someone, who in some cases makes more working at Starbucks, and do it in exchange for our excess of purchases with our "special credit card," (frequent flyer). Our lives are now in the hands of someone who flew all night to get to work because they have to live with their parents, and who may not know what to do, or be fast enough to react to a situation of peril brought upon by our foreign, subcontracted, poorly regulated mainentance. Yes, you say, you'd pay more for the "experienced guy," and the better maintenance, but, you won't. So, the airlines nickel and dime you and place a value on all the stuff that used to be free. They can't shove squeeze their employees any more to subsidize the travel of the American public anymore, as the employees, (less CEO and upper management), are making the same hourly wage as 10 years ago. And as AA UA or US go away, some poor company of cheap employees, bad management, subcontracted maintenance, but shiny new leased airplanes will take their place in the spirit of competition. Unless as the traveling public, we see some value in this travel, slowly our metaphorical Volvo of the skies will magically transform itself into a Yugo. And just like our regulators approved the car as "meeting standards," they will approve the airline.
The question of the airlines may short term be a one of simple supply and demand, but longer term is one of value. Effective oversight and regulatory control is needed, especially in light of the traveling public's inability to see value. Otherwise, our simple capitalist notions, those same ones which allowed our children to eat the lead paint off toys and our dogs to have their food poisoned, will unknowingly take us into very dangerous territory that only a few "smoking holes" may cause us to pause and think: "should my ticket from Chicago to LA cost less than my montly bill for texting?"

Jul 21 07:20 PM

[User 272317:]

I'd have to agree, mostly, with the first 2 comments. Yet foreign carriers find themselves in much the same pickle -- even without the fierce domestic competition that you see in the US. First and foremost this is a recession driven problem, and like all large companies airlines are not very nimble. And even the newest carriers, without legacy costs (airline employees stick around forever, same as auto and steel before them) are finding it hard to come by a profit when everyone shops online to save a nickel. but you can't blame the consumer -- these carriers all have roughly the same safety record and all have passed FAA inspections. Its grim and something has to give. The current model is unsustainable, even with oil at 40$ a barrel. Mergers seem to be the only way to bring some rationality (ironically: less competion, higher fares) Yet, at present most dont deliver the efficiencies they promise. In fact, what you get at mergers like Delta and USair is more like twice the management and half the workers. Not a winning formula -- mainly because the executives in charge of bringing about such mergers are more concerned with the bonuses they recieve in the process than the actual results (sound familiar?).

Jul 22 12:19 AM

[Snitzer:]

Capitalism is the system, and if the company can't stay solvent then it should liquidate. I see no reason for me, as a taxpayer, to subsidize the jobs of people who failed, in whatever degree, to make their company profitable. Having said that, I'm thinking that perhaps we should return to some level of government regulation in industries that are more utilities than just a mass of companies. Included in this list would be transports (air, land, sea and rail), power generators and the grid, health care providers, communications, etc. There should be some entry barriers, and a realistic assessments of costs and some government control over pricing. I say this as a veteran of the trucking industry who has managed to survive the '80's deregulation, but think that we went just a little too far.

Jul 22 01:01 AM

[hokieincane...:]

Loren, you say that if a major would liquidate, it would eliminate industry capacity, and the remaining carriers could raise prices. Your presumption is just wrong!

Pricing in the domestic market is now (and has been for some time) controlled by the low cost carriers (Southwest, AirTran, JetBlue, Spirit, etc.). The low cost carriers have been steadily gaining domestic market share for years. Add to that the current downturn in business and international traffic, and the legacy carriers' business models stopped working, at least during the current economic downturn.

If a major were to liquidate, the low cost carriers would soon grow capacity to absorb this traffic.

The legacies are now facing low cost carriers that are also competing to take a bigger share of domestic business travel. Southwest has changed some policies recently directed toward the business traveler, and AirTran earlier this month completed the addition of WiFi to every single flight--a first in the industry.

It's just a matter of time before Southwest adds international destinations, while Spirit, JetBlue and AirTran have already begun this process. If you are a legacy carrier, it's time to face the hard, cold facts!!

Jul 23 08:41 AM

[David White:]

Airlines got a little more bad news today when Chevy announced its mpg figure of 230mpg for the Volt. Chevy called this figure conservative. With this kind of gas mileage, a few more people will elect to drive to "closer" airline destinations.

Aug 11 09:28 AM