The Case against Bailing Out the Airline Industry

By Veronique de Rugy and Gary D. Leff of Mercatus.  Excerpts:

"While the airline industry is always fast to request a bailout, such a bailout is rarely appropriate. As far as bailouts go, it is preferable to extend loans to firms than outright grants. Nevertheless, before the government considers any sort of bailout for the airlines, airlines should always first go through the bankruptcy process.

As the United States has seen in the past, airline bankruptcy does not present any significant contagion risk to the economy. Airlines have often flown through bankruptcy successfully—American, Delta, and United have all done it—and airlines that each has merged with have done it as well, in some cases more than once, without jeopardizing airline operation or safety. And any help for workers should address the needs they face independently of which industry they work for.

It is unwise to impose, and especially to rush, many of the Democrats’ proposed operational reforms in exchange for the bailout funds. A hasty legislative package, pushed through in an emergency when the industry is weak and voters are panicked, should be kept as limited as possible. The risk is that operational reforms imposed under these circumstances will make the industry worse off once the crisis passes.

No Systemic Risk or Spillover Effect 

During the Great Recession of 2008, the arguments for a government bailout of banks were that it would prevent a contagion of failure from spreading from bank to bank and to other financial institutions, that businesses wouldn’t be able to access capital markets without banks, and that assets would become “frozen” when they were needed most. The tight interconnection between banks, so the argument went, meant that failure of one of them would trigger the failure of many other financial institutions. This consequent collapse of the entire industry would significantly damage the whole economy because the payments system and supply of credit to worthy borrowers (so that businesses could make payroll, entrepreneurs could launch companies, and so forth) would be severely constrained; the economy could possibly collapse.

The probability of this worst-case scenario is debatable, as is whether the method of the bank bailout was appropriate or resulted in even more fragility for the system. But none of these arguments in support of a bailout can be made for the airline industry.

The industry does have its own chain of supply, and some spillover can be expected to hit suppliers if the airlines fail. If, for example, Delta and United stop flying, suppliers of aviation fuel must not only lay off workers, but the reduced demand for fuel will mean fewer jobs in oil refineries. Likewise, failed airlines mean less demand for the output of companies that supply food and beverages for flights. These problems are not unique to airlines. The failure of any industry entails such effects.

A bailout is unlikely to prevent such spillover effects in any case. Compass Airlines and Trans States Airlines, which have provided contract flying for American, Delta, and United Airlines, have already announced they are shutting down permanently. Airport workers and contract aircraft cleaners are already being laid off—and are unlikely to see any benefit of a bailout. Until passenger demand returns, airlines will defer capital spending on aircraft and airport lounge projects even if they are bailed out.

Meanwhile, airlines may come back for more funding, and quickly. A letter to Senate and House leadership from industry trade association Airlines for America dated March 21, 2020, under the signatures of CEOs of 10 US airlines (including 3 cargo airlines), indicated that “payroll protection grants . . . equaling at least $29 billion” for “750,000 airline professionals” would only prevent layoffs through August 31, 2020. Taking United Airlines’s order-of-magnitude suggestion that approximately 60 percent of employees could be furloughed, 450,000 jobs would be saved at a cost of nearly $13,000 per job per month. Airline demand is unlikely to fully return this year, so furloughs may still occur once these funds are exhausted, unless airlines receive an additional bailout.

There is no risk of an airline run, as there is with banks, and spillover effects of an airline bankruptcy on other businesses can be expected even if airlines receive a bailout. A bailout of airlines does not protect a linchpin to the economy when demand is already severely depressed, and there is no systemic risk to the economy from an airline failure.

Bankruptcy, Not Bailout

Bankruptcy is a more effective way than a bailout to resolve the airline industry’s financial problems. Airlines still have access to capital markets and have many durable assets that they can sell or use as collateral to get additional financing, even during a crisis. In the past two weeks, major airlines have raised substantial additional capital: $1 billion for American, $2 billion for United, and $2.6 billion for Delta, giving each carrier approximately $8 billion in liquidity. Each of these three airlines reported between $10 billion and $20 billion in unencumbered assets (the market value of which could be somewhat lower today than when last marked to market). They also earn billions of dollars from the sale of frequent-flyer miles to banks.

Even without selling these lucrative assets, airlines have turned to their co-brand credit-card-issuing partners for liquidity during past challenges. American, United, and Delta have each presold between $500 million and $1 billion worth of frequent-flyer miles, including during the financial crisis of 2008.

Airlines should be expected to use their substantial assets, which include their multibillion-dollar credit card deals with banks that include JPMorgan Chase, American Express, and Citibank, before entering bankruptcy. These assets also position them well for success should bankruptcy be required.
Unlike the banks before 2008, there is in place an orderly bankruptcy process for airlines—one that has been used successfully many times before. This process allows bankrupt airlines to keep their lights on and fly without jeopardizing the safety of their passengers. The three largest US airlines have all flown successfully through bankruptcy. Yet they still have the planes, the spare parts, the gates, the workforce, and everything else that’s needed for them to fly, and they have assets with which to secure additional working capital."

When the federal government bails out an industry, it shifts resources away from nonsubsidized industries to the subsidized one. Because politics drives the bailout decision, this shifting of resources is done largely independently of the merit of the industry or of its claims of special distress. If it were not for the government action, the resources used in bailouts would be directed naturally by the market to other, more productive uses. So while it is easy to see the companies and the jobs that are today saved by bailing out the airlines, we don’t know what goods and services are thereby notproduced and consumed because of the bailout, what non-airline companies don’t survive because of the bailout, and what jobs aren’t created and sustained in nonsubsidized industries.

The history of bailouts also suggests that they prop up weak firms long enough to make their dysfunctions worse, thus requiring further intervention in the long run. Economist Bill Shughart, for instance, looked at the history of bank bailouts in the United States and found that

"the record of government bailouts of private financial institutions in the 1930s, of Continental Illinois Bank in 1984 (which cost $8 billion) and of the entire U.S. savings & loan industry in the late 1980s and early 1990s (which cost $125 billion) teaches that emergency loans keep weak institutions alive just long enough for their problems to increase. Bailouts encourage more risk-taking and eliminate the freedom to fail that is just as essential to a free-market economy as the freedom to succeed."

This is true, in part, because bailouts change expectations about this industry and other industries being bailed out again in the future. From the 1971 bailout of Lockheed Aircraft Corporation to the record-setting financial institutions bailouts of the Great Recession, big American companies have built-in expectations about being helped in times of trouble. Unfortunately, the expectation of future bailouts creates incentives for executives of large firms to be less careful about their decision-making and to take more risks. The negative consequences of this behavior likely include higher costs of production, malinvestments, poor managerial decisions—and a further shifting of executives’ attention away from meeting the demands of consumers spending their own money and toward lobbying for favors dispensed by politicians spending taxpayers’ money."

"Commentators from Robert Reich to Mark Cuban have criticized airlines for buying back stock rather than setting aside funds for a rainy day and have called for permanent restrictions on airline stock buybacks as part of a bailout package. If airlines have been insufficiently risk averse, that stems in part from past bailouts themselves, rather than the option to buy back stock. However, with significant profits over the past decade, air travel demand growing only modestly, and capacity restricted at government-owned airports in major cities and in government-managed airspace, additional investment appears to be of lower value than opportunities for investors elsewhere. Buybacks are a tax-efficient alternative to dividends. Banning buybacks restricts capital from flowing to more valuable uses in the economy. Currently, that capital might be put to better use producing medical equipment and vaccines, for instance."