Don't Rescue The Airlines

The history of air travel in America has many landmark events: the Wright brothers' first flight in 1903; the introduction of the DC-3 in 1936; the start of jet travel in 1958; Congress's decision in 1978 to end government fare and route controls through "deregulation." To these dates can now be added September 11, which has virtually destroyed the airline industry as we know it. All that remains is to see how the demolition proceeds and what arises in its place.

This doesn't mean that planes will cease to fly or that mass travel has ended. (An intriguing fact: in 1971, fewer than half Americans over 18 had flown; now more than 80 percent have.) Air travel isn't dead, though some airlines may be. What looms is a Darwinian process that favors efficient carriers, because September 11 obliterated the industry's economics. Before, the airlines handled about 9 million passengers a week; now, that's recovered to about 7.5 million--still a lot, but not enough for most carriers to cover costs.

William Warlick, an analyst for the bond-rating company Fitch, reports that as of late October, Delta, United, US Airways, American, Northwest and Continental were all losing between $5 million and $15 million in cash per day. Let's do some arithmetic. A company losing $10 million a day needs $3.65 billion to stay in business a year. At the end of September, says Warlick, Delta had $2.8 billion in cash, United $2.7 billion, US Airways $1 billion, American $2.3 billion, Northwest $2.8 billion and Continental $1.2 billion.

It's no secret that the airline-hotel-tourism complex suffered hugely from September 11. Already airlines have:

Announced about 80,000 layoffs--roughly one in seven workers (airline employment had been about 570,000).

Decided to ground about 600 planes, or about 10 percent of the year-end fleet of 5,647, says industry consultant Morten Beyer.

Delayed delivery of dozens of already-ordered planes (Boeing now expects to deliver 350 to 400 planes in 2002, down from its pre-September 11 estimates of 510 to 520).

But even these steps won't fully rescue an industry that is always heavily indebted to buy planes. Airline profitability is highly sensitive to the last few passengers and average fare levels. Even before September 11, most airlines were losing money, because traffic wasn't growing and competition to fill empty seats had depressed fares. Now there are fewer passengers, and fare levels have probably fallen an additional 5 to 15 percent.

In theory, a strong traffic revival could reverse the industry's fortunes. The recession and terrorism's aftershocks make this unlikely. An AAA survey last week forecast that air travel over the Thanksgiving holiday will drop about 27 percent from last year. Cost-cutting measures so far have had mixed results. Airlines are retiring their oldest and least efficient planes (e.g., Boeing 727s) and ending money-losing routes. But layoffs often follow seniority, meaning that the remaining workers--especially pilots--are better paid than those who left. And fixed costs (terminal fees, debt payments) must be spread over less business.

Warlick of Fitch has a grim analysis of airlines' "break-even load factor," the share of seats that carriers must fill to cover all their costs. Before September 11, the break-even load factor for nine major airlines averaged about 73 percent--slightly above actual load factors. So the airlines lost money. Now Warlick figures that lower ticket prices have pushed up the average break-even point to 83 percent. For United it's 96 percent, for Delta 85 percent. Given travel's ebbs and flows, these are unattainable. In 2000 the actual load factor was 72 percent.

What loom are serial bankruptcies or frantic efforts to cut costs by renegotiating labor contracts, reducing aircraft lease and debt payments and scaling back flight schedules. Should government help? Nope--except to recognize that an obsession over airport security will worsen the industry's prospects by lengthening delays. (Nor is it clear how much new security measures add in safety. Before September 11, the last successful U.S. hijacking occurred in 1991.)

Though wrenching, a shakeout could produce hardier airlines. Patrick Murphy, an industry consultant, envisions the evolution of a two-tiered industry of "discounters" (flying Wal-Marts) and upscale carriers that cater heavily to corporate travelers. "The big winners will be the low-fare airlines like Southwest," he says. "But business travelers want lounges, frequent-flier miles and meals. You won't get those with discounters."

After September 11, Congress passed a rescue package consisting of a one-time $5 billion payment (about half has been distributed) and $10 billion in possible loan guarantees. The one-time handout can be justified as compensation for the immediate costs of September 11. But now airlines (and their creditors and workers) need to adjust to the industry's new realities without further subsidies.

Southwest's costs are about 30 percent lower than American's and United's. Some savings stem from more flexible work rules that other carriers could emulate. Some savings reflect a business model (using only secondary airports and one type of aircraft, Boeing 737s) that bigger carriers can't match. But there are other possible savings. At big airlines, senior pilots make in excess of $200,000 annually; these and other salaries aren't sacrosanct. If unions and creditors can't agree to voluntary cost cuts, bankruptcy courts might impose them. If this is impossible, insolvent airlines should be liquidated. Planes, pilots and workers would go to lower-cost carriers.

But the government shouldn't try to orchestrate this process. The best thing Congress could do with its pledge of $10 billion in loan guarantees is to repeal it. Barring that, the three-member board that would approve the guarantees ought to indicate that the conditions for receiving them would be so harsh that applicants would be better off in bankruptcy court. The last thing that a debt-ridden shaky airline needs is more debt--especially debt guaranteed by taxpayers.