Preventing Bailouts Is Simple, but It Isn’t Easy

The Fed could simply stop blocking run-proof banks from emerging. But that would take political will.

By John H. Cochrane and Amit Seru. Excerpts:

"Silicon Valley Bank and a few others suffered runs in early 2023. SVB took large uninsured deposits and invested them in long-term Treasury securities. No subprime mortgages, no collateralized loan obligations, no toxic derivatives, no special-purpose vehicles. SVB’s only risk was that higher interest rates would reduce the market value of its assets. When that happened, depositors ran. The army of regulators missed this simplest interest-rate risk. The Federal Deposit Insurance Corp. quickly guaranteed all deposits, of any size. Markets now expect that guarantee.

In March 2023, Credit Suisse was teetering. Its troubles were clearly isolated, with no “contagion” to worry about. Finally, here was a chance to use the big-bank reforms. Instead, the Swiss government orchestrated a weekend sale to UBS with an infusion of government money.

Our basic financial regulatory architecture allows a fragile and highly leveraged financial system but counts on regulators and complex rules to spot and contain risk. That basic architecture has suffered an institutional failure. And nobody has the decency to apologize, to investigate, to talk about constraining incentives, or even to promise “never again.” The institutions pat themselves on the back for saving the world. They want to expand the complex rule book with the “Basel 3 endgame” having nothing to do with recent failures, regulate a fanciful “climate risk to the financial system,” and bail out even more next time."

"The solution is straightforward. Risky bank investments must be financed by equity and long-term debt, as they are in the private credit market. Deposits must be funneled narrowly to reserves or short-term Treasurys. Then banks can’t fail or suffer runs. All of this can be done without government regulation to assess asset risk. We’ve understood this system for a century. The standard objections have been answered. The Fed could simply stop blocking run-proof institutions from emerging, as it did with its recent denial of the Narrow Bank’s request for a master account."

The 2020 Bailouts Left Airlines, the Economy, and the Federal Budget in Worse Shape Than Before

By Veronique de Rugy and George Gibbs.

"The arguments for bailing out the airlines during the COVID-19 pandemic included the claim that without the subsidies, airlines would fail and that subsidies were needed to keep the industry’s labor force at the ready for when the pandemic ended. Bailouts were paid to the tune of $54 billion, and airlines received other benefits, employees were paid to stay home, and financial aid was dispensed to airports.

Nevertheless, travel by air became a nightmare for many in summer 2022 as passenger demand returned. Mass cancellations and delays occurred with regularity, and each instance cascaded into further delays as crew and planes were caught out of position. The major carriers have canceled a significant portion of their flights in the past few months, creating chaos at major airports, especially during high-traffic periods. The problem is not unique to domestic travel; it affects also international flights and airlines around the world.

Numerous factors have been blamed for the current wave of delays and cancelations, including pandemic recovery, COVID-19 deaths, early retirement, and the heavy burden of occupational licensing for pilots. Each of these explanations makes some sense. Yet stakeholders have also used each to distract from the question of whether government should have bailed out airlines in the first place.

This brief is the third installment of the series that looks at airline bailouts. The first makes the case that there were no valid reasons to bail out airlines, at least before they used all the means at their disposal to address the challenges of the pandemic. These means included tapping into private capital markets (which were flush with cash from the Federal Reserve), using as collateral the significant amounts of durable assets (planes, spare parts, gates, slots, and real estate) the airlines have at their disposal. In addition, if private financing failed, some airlines could and should have done what they did in the past in such a predicament: declare chapter 11 bankruptcy. History shows that airlines can continue flying safely, even during bankruptcy, so there is no systemic risk posed to the economy at large by doing so.

The second brief examines the labor argument made to justify further bailouts. Even if airlines would have had to furlough 35,000 workers during the pandemic and the resulting period of drastically low demand, the bailouts were grossly oversized. In fact, the bailouts were large enough to cover a substantial share of airlines’ other expenses in addition to the cost of retaining furloughed workers.

In this brief we consider the reasons advanced to bail out the airlines and how well the bailouts have delivered on the promises made. Although the bailouts are not the reasons for the mess in 2022, the arguments used to get the bailouts were proved to be flimsy. No major US airline has gone bankrupt during the pandemic (though later we discuss the case of ExpressJet Airlines, 49 percent of which had been owned by United Airlines, and which just declared bankruptcy), but that is not much of an accomplishment, considering that bankruptcy is not a death warrant for an airline and provides an opportunity to restructure and recover. Therefore, these bailouts may have left airlines more fragile by creating a false sense of financial safety for their management teams and, thus, muting airlines’ incentives to be as good as possible. If that is the case, bailouts will have only postponed bankruptcy rather than prevent it. Also, to the extent that the bailouts were intended to keep airlines ready to fly when passengers returned, they have failed.

How Big Were the Bailouts?

Throughout the pandemic, via three separate statutes, the 10 major US passenger airlines together received more than $54 billion in direct payments ($25 billion, $15 billion, and $14 billion). Congress also appropriated another $25 billion in subsidized loans from the US Department of the Treasury (only a fraction of which airlines have used) and suspended the 7.5 percent excise tax on domestic air travel as well as payments to airports and contractors.

In exchange, the airlines had relatively few requirements. They had to use the funds for payroll and had to maintain a minimum level of air service along existing routes. In addition, they could not furlough workers involuntarily or reduce pay or benefits, and they could not buy back shares of their stock or pay shareholder dividends. They also had to limit executive compensation. And the airlines will be required to repay—years down the road—only a small portion of the money they have received.

These bailouts were significantly larger than anything the airlines had received in the past. In the wake of the 9/11 terrorist attacks, Congress quickly passed the bipartisan Air Transportation Safety and System Stabilization Act. Airlines were bailed out to the tune of $5 billion in cash and $10 billion in loan guarantees.

The Results of the 2020 Airline Bailouts

The results of the bailout are mixed. On the one hand, no major US airline so far has gone into bankruptcy or been forced to close shop (though some of them are facing real financial headwinds). In addition, disruptions to travel during and after the pandemic would have likely been much worse than they have been so far without the first bailout (though the second and third bailouts accomplished little). On the other hand, the main arguments for the bailouts were not that airlines would avoid bankruptcy in the short term or that travels would be less disrupted than otherwise; they were that without bailouts, airlines would disappear and would not be travel ready once the economy reopened.

Were the Airlines Able to Avoid Bankruptcy?

On March 21, 2020, the chief executives of the nation’s top carriers wrote a letter to congressional leaders urging them “to swiftly pass a bipartisan bill with worker payroll protections to ensure that we can save the jobs of our 750,000 airline professionals who are coming to work every day to serve the traveling and shipping public.” According to this letter, this first COVID-19-era bailout of the US airlines was meant to keep the nation’s aviation system alive through the coronavirus pandemic, given that all employees in the industry were at risk of losing their job owing to the reduction in demand.

Testifying before Senate Committee on Commerce, Science, and Transportation in December 2021, American Airlines CEO Doug Parker said that “it’s not an exaggeration to say the program saved the airline industry.”

Parker’s claim is groundless. Although American Airlines and potentially United Airlines were at risk of chapter 11 restructuring (on the basis of the price of credit default swaps at the time, one can infer that an American Airlines bankruptcy was highly likely), the airline industry was never at risk of disappearing. If some airlines were forced to cease or suspend operations indefinitely, they would be quickly replaced by new ones. In fact, few people realize that every year, many airlines around the world stop flying. Most of them are small, but there are also many examples of major airlines going under, such as Pan American World Airways or Eastern Airlines.

Also, many observers equate bankruptcy with going out of business, but that perspective is far from accurate. The most common path is chapter 11 reorganization. Chapter 11 “ordinarily is used by commercial enterprises that desire to continue operating . . . and repay creditors concurrently through a court-approved plan of reorganization.” Under more extreme circumstances, companies engage in chapter 7 liquidation proceedings, which entail “an orderly, court-supervised procedure by which a trustee takes over the assets of the debtor’s estate, reduces them to cash, and makes distributions to creditors, subject to the debtor’s right to retain certain exempt property and the rights of secured creditors.”

In other words, the principal goal of chapter 11 commercial bankruptcy, which the airlines would have likely filed for, is precisely the survival of the company. And in fact, any airline that files for bankruptcy can stage a comeback, as Delta Air Lines, United Airlines, and American Airlines have all done. Some may even come back stronger. However, if they do not come back, the supply of flights is not likely to waver. Because the aircraft, hangars, workers, landing slots, and other assets do not simply vanish when an airline goes out of business, another airline will quickly replace the defunct one.

Bailouts may have prevented the bankruptcy of major airlines so far, but the net outcome is unlikely to be positive in the long run. These bailouts cost taxpayers and add to the country’s already outsized public debt. In addition, bailouts create all sorts of perverse incentives. They also prevent airlines from getting a shot at a restructuring—shareholders may not like the idea of bankruptcy, but it would be healthier in the longer term. In fact, whereas bailouts may have prevented bankruptcy during the pandemic, it may have simply postponed the inevitable for some of the airlines. For instance, ExpressJet Airlines, an airline that had been 49 percent owned by United Airlines, has filed for chapter 11 bankruptcy and ceased all flight operations. The company was in trouble already, and the bailout may have given it a lease on life for a while. Now that reprieve is over.

Moreover, bailouts are unfair. Why one industry gets bailouts while others do not is mostly determined by political connections and the perception of saliency rather than by real systemic risks to the economy or other economic factors. There are no systemic risks to the economy from airline failures. However, airlines have long benefited from a preferred status with the political class, which explains why they almost always get bailed out.

This situation creates moral hazard, meaning that airlines, their creditors, and their shareholders soon learn that they need not plan for emergencies, because in times of crises their political friends will not let them fail. Indeed, when the pandemic hit, airlines were coming off a remarkable 10-year run. For instance, in 2019, Delta Air Lines CEO Ed Bastian noted that “2019 was a truly outstanding year on all fronts—the best in Delta’s history operationally, financially and for our customers.” Airlines were doing so well that American Airlines CEO Doug Parker told investors in 2017, “I don’t think we’re ever going to lose money again.” And yet, as soon as demand for their services dropped, the airlines ran to Congress for help as common paupers, instead of letting their shareholders take a hit, selling any of their assets, or fully take advantage of their access to capital and various lines of credit.

Unfortunately, that pattern will continue, as evidenced by the message that Bastian gave his investors during a speech at the Alliance Bernstein 37th Annual Strategic Decisions Conference. Bastian said, “my hope is that we’ve tested at Delta at least the proposition ‘are airlines investable’ and I think the strong answer is ‘yes they are investable.’ And even in the worst crisis imaginable we’ve proven ourselves. We’ve proven the value of what we bring to society. We’ve proven that governments will be there for us if ever needed again, hopefully never again.”

Were the Airlines Ready for the End of the Pandemic?

Another prominent argument for bailing out airlines was that the money was needed to keep airline workers on the job so they would be ready to fly when passengers returned. As Americans now know, this plan has not worked out, in large part because the airlines—contrary to their promise—did not keep their workers. However, this failure does not mean the bailouts induced the current mess.

In large part—and unacknowledged by legislators—although a condition for the bailouts was that airlines could not fire workers, airlines induced many of their employees to leave. To understand what happened, one must break the three bailouts apart.

First was $25 billion in cash plus $25 billion in loans to airlines distributed as part of 2020’s Coronavirus Aid, Relief, and Economic Recovery Act. At the time, airline travel had collapsed. Under these conditions, there is little doubt that without the bailout money airlines would have had to shut down and furlough most of their employees. That would have meant a longer time to build back up. Instead, legislators extended $50 billion to the airlines, required them to keep their staff and continue flying to all destinations. Although reduced ridership was permitted, about 90,000 people per day (down from 2 million per day) managed to travel by air during the pandemic’s height, many of whom probably would not have been able to do so otherwise.

Was this outcome worth billions? No. Airlines had enjoyed profits for the better part of the previous decade. They were not at risk of disappearing and, owning lots of valuable assets, had tremendous access to capital markets for needed liquidity (bolstered further by the Fed). Even in the worst-case scenario, airlines could go through the bankruptcy process, continue to fly safely while doing so, and emerge healthier. Either way, the airlines’ pleas for handouts were unjustified. There was, contrary to their insistence, no systemic risk associated with closing or going bankrupt. Bailouts meant that taxpayers took a haircut rather than shareholders and creditors.

If airlines had needed more time to restart their business, passengers would have expected a reduced number of flights and a greater number of delays. Indeed, Americans were told that everything would be just like before in no time, and airlines tried to behave as if the fiction were true that airlines can go through such an economic shock with no disruption to travel whatsoever.

The second and third bailouts were also a waste of taxpayer money; they were at least 10 times larger than what was needed to cover the payroll of the workers at risk of being furloughed. One knows this because, during the time between the first and second payroll support programs, some airlines furloughed workers. By the time the second program was passed, demand for travel was growing, and airlines were planning increased schedules. As a result, most of the funds were used to pay workers whose jobs were never at risk, and shareholders and creditors pocketed any excess while the airlines downsized anyway. Also, although airlines continued to pay pilots, pilot training was not kept up to date, thus preventing some pilots from returning to the skies when passenger demand returned.

In addition, airlines used a brief gap in government payroll-support funding between the first and second bailouts—that gap created the specter of layoffs—to induce employees to leave voluntarily. These employees were offered buyouts—potentially with bailout money!—with termination as a possible alternative and the promise of better benefits for making their termination voluntary.

Once the second bailout passed, requiring airlines to continue employing existing workers, departed employees were discouraged from coming back to their jobs. American Airlines, for instance, emphasized that employees who had taken other jobs could not simply return to the airline’s payroll. That’s the opposite of keeping employees attached to the company.

As a result, Delta Air Lines shrunk its staff by 31 percent and American Airlines shed $500 million a year in annualized payroll by reducing its nonunionized workforce by 30 percent. American Airlines did continue paying pilots, as required, but did not keep them eligible to fly; they were paid to sit home and did not do recurrent training. The consequence was that when passengers returned, the airline lacked sufficient pilot staff to operate its published schedule.

Airlines also retired aircraft fleets, necessitating pilots to be retrained on new aircraft. Union contracts amplify the problem of pilot shortages because the determination of which pilots fly which planes is based on seniority, so the retirement of one aircraft type bumps younger pilots off of the planes they are currently flying to make room for senior pilots who previously flew the now-retired aircraft. The younger pilots then need to get retrained.

In addition, as airlines restaffed, employees lacked the experience that they used to have in running an airline. Many of the more experienced managers had left during the pandemic. These were the people who determined when to schedule maintenance on planes, built flight schedules, and had years of experience handling irregular operations. Flight attendants and reservations agents cannot simply start working with customers on their date of hire; they must go through training. These circumstances contribute to poor operational performance.

Labor shortages affect not only airlines; airports received bailouts too, which gave them the flexibility to relax requirements for concessions operators. They are now having a hard time restaffing. A small portion of delays is also due to inadequate staffing at the Federal Aviation Administration and Transportation Security Administration. This inadequate staffing can be explained in part by the disincentives to return to work created by overly generous pieces of government spending such as stimulus checks, enhanced unemployment benefits, and more.

Conclusion

Airline bailouts did not cause the current problems faced by airline passengers; the pandemic and the airlines’ need to adjust to the collapse in travel demand did. However, the current airline troubles should make legislators think twice next time they are asked to bail out airlines’ shareholders, even if the airlines claim the bailouts will allow them to keep their employees. The airlines were not ready when passengers came back, because in spite of the bailouts, which made it a priority for airlines to keep their workers (in part to keep airlines travel ready), airlines got rid of many employees, dissuaded those employees from coming back when the economy reopened, encouraged retirements, and did not keep the pilots they retained ready to fly. In addition, airlines were never in danger of disappearing. United Airlines and American Airlines would likely have entered chapter 11 bankruptcy. But Congress instead decided to bail out their shareholders and creditors, inducing many unintended consequences for years to come while leaving the skies very unfriendly."

COVID Paycheck Protection Program: Promises Not Kept

By Veronique de Rugy.

"One of the U.S. government’s most popular recent programs is the Paycheck Protection Program, or PPP. Congress authorized $800 billion for PPP to provide loans to companies to help pay wages, rent, interest on mortgages, and utilities during the COVID pandemic. If a firm kept enough workers on payroll, then its loan would eventually be forgiven. Yet as I predicted, the program has been a mess in both its implementation and its results.

As is always the case, a certain number of ineligible companies— many of them publicly traded — got large loans approved before many other firms could even get access to a bank in order to apply. Meanwhile, a fair number of self-employed workers — who constitute 81% of all small businesses — could not get a PPP loan because, in the eyes of the federal government, they don’t exist as businesses.

Also unsurprisingly, PPP payments mostly benefited those least in need. For example, the study titled “Did The Paycheck Protection Program Hit the Target?” found that the funds didn’t flow to where the economic shock was greatest, as measured by declines in hours worked or by the number of business closures. Another piece of research – this one by MIT’s Lawrence Schmidt and Northwestern University’s Dimitris Papanikolaou – found that the professional and technical services sector received the largest number of PPP loans- around $65 billion in total. This sector also has the highest fraction of workers who are remote and, hence, least exposed to pandemic-related disruptions. These researchers also reported that nonremote, lower-paid workers were 15 percentage points more likely to be unemployed compared with workers in sectors where working remotely is an option.

A recent paper by economist David Autor and nine co-authors – a paper titled “The $800 Billion Paycheck Protection Program: Where Did The Money Go And Why Did It Go There?” – presents yet further and fresh evidence that PPP is problematic. Here are the main findings (highlights are mine):

“PPP had measurable impacts. It meaningfully blunted pandemic job losses, preserving somewhere between 1.98 and 3.0 million job-years of employment during and after the pandemic at a substantial cost of $69K to $258K per job-year saved. PPP also reduced the rate of temporary closures among small firms, though it is less clear whether it reduced permanent closures. The majority of PPP loan dollars issued in 2020—66 to 77 percent—did not go to paychecks, however, but instead accrued to business owners and shareholders. And because business ownership and share-holding are concentrated among high-income households, the incidence of the program across the household income distribution was highly regressive. We estimate that about three-quarters of PPP benefits accrued to the top quintile of household income. By comparison, the incidence of federal pandemic unemployment insurance and household stimulus payments was far more equally distributed.”

That’s a sample of the academic work. Reporters pretty much came to the same conclusion once they looked at the program’s beneficiaries. For instance, here was the PPP news headline equivalent of “water still wet”: “Small Business Loans Helped the Well-Heeled and Connected, Too.”

Now, because PPP was intentionally untargeted, none of this should surprise anyone. The only restriction in the legislation was that the benefits shouldn’t flow to firms with more than 500 employees. But even this rule was later relaxed for some sectors.

However, benefits going to big firms and higher income individuals, with plenty of access to capital in the first place, as well and going to less affected areas, are common findings even in the case of more targeted business handouts. Bailouts notoriously benefit shareholders and creditors rather than workers. Also, the high cost of a “job saved or created” is a common feature of most business handouts. Adam Millsap makes that same point about state and local economic development programs for instance. He writes:

“A recent paper from economist Timothy Bartik notes that the cost per job created by state and local economic development programs often exceeds $150,000. Other research finds that in addition to being expensive, economic development programs typically fail to generate widespread economic growth.”

 

But I remember finding similar high costs when looking at the 1705 green energy program and a few others like it. Cost is no object when you are spending other people’s money!

And, of course, the bigger companies are the biggest beneficiaries even though most of them have no problem accessing capital. A few examples: 65 percent of the ExIm Bank’s activities benefit 10 major companies, 70 percent of sugar subsidies benefit 3 large companies, most farm subsidies benefit large mega farms, 90 percent of the 1705 green energy loan program went to energy giants, and so on and so forth.

The fact that PPP was poorly thought through, recklessly implemented and administered, and ended up benefiting those who are least likely to need it is, for politicians and bureaucrats, a feature, not a bug, and has little to do with the fact that the program was rushed through at the start of the pandemic. This is why I would get rid of all business handouts during good times. During bad times, especially when the government shutdown the economy, I would design a government rescue plan that targets mostly individuals, not businesses. Getting the incentives right is also important. Arnold Kling and I wrote a piece explaining what such a plan might could have look like.

And yet, who wants to bet that next time around, Congress will again rush to design a rescue plan that sends billions of dollars to unneedy businesses and bailout shareholders? I am."

$75 Billion in Band-Aids Won't Cure Ailing Airlines

Airlines keep claiming they need a second bailout to bring back 35,000 furloughed employees. Don't buy their argument.

By Veronique de Rugy.

"Regal Cinemas announced in early October that it will temporarily close all 536 of its U.S. locations as the COVID-19 pandemic continues to keep customers away. This move affects about 40,000 employees across the country. Yet nobody in Congress is talking about a bailout for theaters.

Now compare that with the airline industry.

In April, Congress passed a $50 billion bailout for the airlines, including $25 billion in subsidized loans and another $25 billion meant to keep most airline workers employed until the end of September. As predicted, since consumers were not yet ready to fly, this taxpayer-funded band-aid only postponed the inevitable.

American Airlines and United Airlines furloughed 32,000 employees in the fall, claiming they had no choice without another $25 billion. So House Speaker Nancy Pelosi (D–Calif.), President Donald Trump, and many Senate Republicans drew the obvious conclusion: The bailout should be bigger.

Advocates of the additional $25 billion bailout say a new injection of funding will be used to restore 35,000 jobs. But as my colleague Gary Leff and I show in new research published by George Mason University's Mercatus Center, the math doesn't add up.

 

Assuming an average annual salary of $100,000, supporting 35,000 airline employees for six months—the time covered under the new proposed bailout—should cost a total of $1.7 billion. Yet airlines are asking for $25 billion, which works out to $715,000 per job temporarily saved. A more plausible explanation is that—as with the first bailout—airlines are planning on using taxpayers' money, rather than their own, to cover the salaries of those who are at risk of furlough and the salaries of employees they have no intention of furloughing.

Airline representatives have argued that another bailout would not only help them bring back furloughed workers but also protect workers who went on leave back in April to avoid termination. Don't buy it. First, there is no indication that airlines plan to furlough those people. If they did, they would have had to notify them 60 days in advance, which they have not done. Second, the concern that airlines will make additional, yet-to-be-announced furloughs strengthens the argument against payroll support. If airlines feel a need to furlough on-leave workers who aren't currently costing them a dime, that suggests the industry is not expecting to do better anytime soon.

Some companies are taking a different approach to retaining their employees. Southwest Airlines, for example, is asking its labor unions to accept pay cuts through the end of 2021 to prevent furloughs and layoffs. Singapore Airlines has done the same.

Airlines also have access to capital markets and have many durable assets they can sell or use as collateral to secure additional financing, even during a crisis. And even without sacrificing these lucrative assets, airlines can turn to their credit-card-issuing partners for liquidity, as they have in response to past financial challenges.

Sadly, as long as demand for air travel remains deflated, there will be no way for airlines to avoid slimming down their payrolls. Subsidies provided under the cover of payroll programs are not necessary to protect an industry that can, and perhaps should, pursue restructuring through bankruptcy. Airlines can continue to fly safely during this process as a judge imposes a stay on creditors' claims and gives the carriers breathing room until consumers are ready to come back.

Unlike special favors granted by Congress, the bankruptcy process is equitable. It shifts the cost of the crisis onto airline investors, who make good returns during good times in exchange for shouldering the decreased value of their investments during bad times, instead of taxpayers. Without another bailout, the skies that the airlines fly will be fair as well as friendly."

Bailouts benefit mostly shareholders and creditors rather than workers

What Was Pelosi’s Taxpayer Ransom’s Goal? by Veronique de Rugy. Letter to The WSJ.

"In your otherwise excellent editorial “Pelosi’s Taxpayer Ransom Demand” (Oct. 7), you write that “aside from money for beleaguered industries like airlines, there was very little stimulus at all.” This is a terrible mistake. You assume that the airline bailout would be stimulative. Yet, as you have noted in the past, and as academic research also shows, bailouts benefit mostly shareholders and creditors rather than workers. If this bailout were about workers, it would cost less than $2 billion—$50,000 (for six months of payroll) times 32,000 furloughed employees—not $25 billion. Bailouts create disincentives to restructure industries efficiently, and they create many moral hazards.

In short, bailouts spend taxpayers’ money not merely wastefully, but also destructively.

Veronique de Rugy

Mercatus Center

Arlington, Va."

The Federal Government Is Spending $60 Billion To Keep Mostly Empty Commercial Planes Flying Over the U.S.

Pending minimum service rules would require airlines to keep operating a certain number of flights, regardless of how little demand there is for air travel.

By Christian Britschgi of Reason.

"It's no secret that the coronavirus pandemic has been particularly devastating for the airline industry, with the number of passengers paying to fly falling by as much as 95 percent compared to this time last year.

Air carriers' financial pain proved enough of a justification for Congress to include $60 billion in financial assistance to the industry as part of the $2.3 trillion economic relief package it passed last week.

This aid isn't without strings, however. Airlines are being asked to maintain a minimum level of service to qualify for emergency government funding. The result has been companies running nearly-empty, money-losing flights just so they can avail themselves of taxpayer support.

When Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act, it included $50 billion evenly divided into loans and grants for passenger air carriers. The law also empowered the Secretary of Transportation to require airlines to continue flying to locations they were servicing before March 1, 2020.

On Tuesday, the U.S. Department of Transportation (DOT) issued proposed guidance that specifies the minimum levels of service passenger airlines have to maintain to qualify for CARES Act assistance.

If an airline flew into a city at least five times a week prior to March 1, it will have to continue to offer at least five flights a week to the same city. If an airline flew into a city less than five times a week, it will have to offer only one flight per week.

This guidance allows the biggest air carriers, who flew lots of flights into lots of cities, to substantially reduce their service levels. "You can literally go from that 25 or 30 flights a day to Albuquerque down to one," one airline industry consultant told NPR.

Low-cost budget carriers who offered fewer flights are required to maintain a higher percentage of their existing service. For that reason, these low-cost carriers have been some of the biggest critics of the new DOT guidance.

Frontier Airlines, in a public comment on the new guidance, noted that it flew a total of five flights a week into four airports prior to March 1. That means the proposed DOT rules will require it to maintain 100 percent of its service at those locations. In another 10 cities, said Frontier, the DOT rules only allow it to reduce service by less than 50 percent, despite demand dropping off by more than 90 percent.

DOT's "minimum service requirement bears no realistic relationship to current reduced passenger demand," wrote the airline, adding that the order "amounts to a government edict to operate more flights with the attendant costs and burdens regardless of whether those flights are empty or have load factors in the single digits or teens. That does not make sense."

The National Air Carrier Association (NACA), a trade association representing budget carriers, argues that the new rules also do not take into account the seasonality of many low-cost airlines' services.

"By not taking into account the seasonality of air service provided by a large number of air carriers," wrote NACA, DOT's proposed minimum service requirements "would require carriers to maintain a schedule developed for the peak winter travel season into the spring travel season and beyond."

"As a result, a significant number of carriers would be placed at a competitive disadvantage vis-à-vis U.S. legacy air carriers" whose service is less affected by seasonal peaks and troughs, wrote NACA.
The proposed DOT guidelines would allow airlines to apply for exemptions, but approving those could take time, and there's no guarantee that every carrier that wants one would receive one.
NACA and the budget carriers they represent are asking that lower minimum service requirements be incorporated into any final rule.

A DOT spokesperson tells Reason that comments on the department's proposed rules are still being considered, so there's still a possibility that the budget airlines will get their proposed changes included in the final rule.

At the same time, however, members of Congress, as well as smaller regional airports, are demanding that airlines be required to maintain service at each airport they regularly fly into, not just each city. That request, if adopted by DOT, would have the effect of increasing the minimum number of flights airlines would have to fly.

While DOT hashes out a final rule, NPR reports that the U.S. Treasury Department is encouraging airlines to apply for financial aid by today, otherwise it could get delayed. The confusion over conditions for receiving financial assistance, reported The Air Current on Tuesday, is causing airlines to backtrack planned reductions in service.

The result, as countless news articles have pointed out, is airlines running ghost flights that have more airline staff than paying customers on them.

We are left in the worst possible world of businesses getting a bunch of taxpayer money on the condition that they waste it. This is central planning at its most illogical, and it's making all of us poorer."

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."

U.S. government says it lost $11.2 billion on GM bailout

By Eric Beech of Reuters. Excerpt:

"The U.S. government lost $11.2 billion on its bailout of General Motors Co (GM.N), more than the $10.3 billion the Treasury Department estimated when it sold its remaining GM shares in December, according to a government report released on Wednesday.

The $11.2 billion loss includes a write-off in March of the government’s remaining $826 million investment in “old” GM, the quarterly report by a Treasury watchdog said.

The U.S. government spent about $50 billion to bail out GM. As a result of the company’s 2009 bankruptcy, the government’s investment was converted to a 61 percent equity stake in the Detroit-based automaker, plus preferred shares and a loan.

Treasury whittled down its GM stake through a series of stock sales starting in November 2010, with the remaining shares sold on December 9, 2013.

At the time of the December sale, Treasury put the total loss at $10.3 billion but said it did not expect any significant proceeds from its remaining $826 million investment in “old” GM, the report by the Office of the Special Inspector General for the Troubled Asset Relief Program said."

Out of the $50.7 billion that GM received in federal bailout funds, $11.4 billion was never paid back.

See GM discovers that government bailouts come with golden chains attached by Matthew D. Mitchell and Tad DeHaven of Mercatus. Excerpt:

"Yet it’s hard to feel sympathy for GM. For decades, the industrial behemoth has benefited from a host of government-granted privileges. As Trump correctly noted, taxpayers rescued the company in 2009. And out of the $50.7 billion that GM received in federal bailout funds, $11.4 billion was never paid back. The company also benefited from the infamous “Cash for Clunkers” program, which offered a government handout to those who traded in perfectly good older cars for destruction, as long as they used the windfall to purchase a new car. While that program provided a short-term taxpayer-funded boost to companies like GM, there’s no evidence that it had any long-term benefit for the economy as a whole.

And GM’s government gravy train didn’t come to a stop in 2009. According to a subsidy database constructed by the advocacy group Good Jobs First, GM has since received another $700 million in federal grants and loans. While most of that figure comes from programs administered by the Department of Energy, the company received money from the U.S. Export-Import Bank and the National Science Foundation as well.

It’s also worth mentioning that GM’s ongoing employee pension woes could conceivably lead to another taxpayer bailout down the road. GM’s pension obligations are underfunded by approximately $30 billion, far beyond even the $18 billion insured by the federal Pension Benefits Guarantee Corporation (PBGC). Were the PBGC compelled to take on GM’s pension obligations at some point, the taxpayers could be on the hook for a bailout if the agency doesn’t have the resources to cover its own obligations.

General Motors also benefits from privileges in the tax code, though it would prefer to benefit more. The $7,500 tax credit that Trump mentioned in his tweet is limited to the first 200,000 electric vehicles an automaker sells. GM is already close to meeting this cap, so the company has actually been lobbying to have it lifted, so as to stay competitive with the other brands that haven't yet.

GM benefits from the so-called “ Chicken Tax,” too — a 25 percent tariff imposed on light trucks in 1964 as a response to European tariffs on U.S. chicken exports. The tariff has survived because it helps insulate politically powerful U.S. automakers from foreign competition.

The lesson here is that with government dollars come government shackles. Though lucrative in the short run, bailouts, subsidies, and protections are no guarantee of perpetual profitability. In fact, by insulating a firm from the realities of the market, they likely encourage poor decision making."

Don Boudreaux on the bailouts of General Motors and Chrysler

See There’s Much More to the Matter.

"Here’s a letter to the Washington Post:

E.J. Dionne insists that the Obama administration’s bailouts of General Motors and Chrysler are evidence that “government works” (“Don’t buy the spin. Government works.” Jan. 22).  Forget that, as Mr. Dionne admits, taxpayers got back only seven out of every eight of the 80 billion dollars of the bailout money, for a return of negative (!) twelve-and-a-half percent.

Instead, recognize that the most serious arguments against bailouts are not the superficial claims that Mr. Dionne quotes from the likes of Mitt Romney and Rush Limbaugh.  The correct economic arguments against bailouts all point more deeply to what is not seen.  Yes, we all see that resources directed to G.M. and Chrysler by the bailouts ensured that these companies survived intact.  No serious person ever doubted this outcome.  But what Mr. Dionne and too many others don’t see are real costs and hidden consequences – costs and consequences that are revealed by asking probing questions.

For example: What would G.M. and Chrysler look like today without the bailouts?  Contrary to Mr. Dionne’s assumption, failure to bail out these companies was not destined to lead to their total demise.  Instead, they would have gotten private funding likely on the condition that they scale down their operations.  Might such reductions in size mean that today these companies would be better able to withstand future financial crises – and, hence, be less likely to ‘need’ bailouts in the future?

Another question: how would the resources commandeered by Uncle Sam for G.M. and Chrysler otherwise have been used?  Mr. Dionne assumes that these resources were and would have remained idle.  But that’s incorrect.  If not directed artificially by government to G.M. and Chrysler, these resources would have been directed naturally by the market to other productive uses.  What goods and services are we Americans today not producing and consuming because of the bailouts?  What jobs do Americans today not have because of the bailouts?

And finally: what expectations did those bailouts create, and what are the consequences of those expectations?  Because large and highly visible firms are now more likely to be bailed out, executives of such firms can be more careless in their decision-making.  The future consequences of such carelessness almost surely include higher costs of production, lower real wages, and a further shifting of executives’ attention away from meeting the demands of consumers spending their own money and toward gratifying the whims of politicians spending other people’s money.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

…..
When it comes to economics, E.J. Dionne is like far too many pundits: he mistakes that which is visibly and vividly in front of his nose for all of economic reality."

GM Might Still Be Cost The Tax Payers Money

See GM's Profits are Still a Huge Net Loss For Taxpayers by Megan McArdle. Excerpt:

"About $40 billion of the money that the government gave GM was converted to GM common stock. In the November IPO, the government made about $20 billion selling 478 million shares, leaving us with around $20 billion more to recoup on our remaining 26.5% stake in the company. That means we need to sell the approximately 365 million shares we have left at about $55 per share, net of underwriting and legal costs. At the current share price of $31, we'd be left with a loss somewhere north of $9 billion--plus the $1 billion we gave the "old GM" to wind things up, and the $2.1 billion worth of GM preferred stock we own. Since I don't know the details of the preferred transaction, I'll leave that out, which gives us a loss after expenses of $10 to $11 billion on our investment in GM.

But of course, that assumes that the current share price holds. It could well fall over the next few months--or when the government dumps an enormous new supply of GM stock on a market that isn't showing all that much enthusiasm for the product.

It also leaves out a very important extra: the $14 billion gift that the government seems to have handed the company, in the form of a special tax break (quoting a Chris Isidore story at CNN):

"That break will reduce GM's U.S. tax bill by an estimated $14 billion in the coming years, and its global taxes by close to $19 billion, according to a company filing.

Companies typically get a break on future taxes because of past losses. But in most cases they lose that tax break during bankruptcy, because the losses are offset by the "income" the company receives from shedding its debt.

Since the company shed $30 billion in debt during bankruptcy, it should have wiped out most of the tax break. GM even warned it expected to lose those tax breaks shortly before filing for Chapter 11 protection.

But somehow, that never happened, and the automaker was able to keep most of its tax breaks, essentially receiving a $14 billion "gift" from the government.

While it's unclear why GM was allowed to carry over its losses, some experts insist that GM got preferential treatment."

"What lesson, exactly, are we supposed to learn from this "success"? What question did it answer? "Can the government keep companies operating if it is willing to give them a virtually interest free loan of $50 billion, and a tax-free gift of $20 billion or so?" I don't think that this was really in dispute. When all is said and done, we will probably have given them a sum equal to its 2007 market cap and roughly four times GM's 2008 market capitalization.

No, the question was not whether GM could make a profit after a bankruptcy that stiffed most of its creditors and shed the most grotesque burdens of its legacy costs, nor whether giving companies money will make them more profitable. The question is whether it was worth it to the taxpayer to burn $10-20 billion in order to give the company another shot at life. To put that in perspective, GM had about 75,000 hourly workers before the bankruptcy. We could have given each of them a cool $250,000 and still come out well ahead compared to the ultimate cost of the bailout including the tax breaks--and over $100,000 a piece if we just wanted to break even against our losses on the common stock.

And if we'd done that, we'd have saved ourselves in other ways. We would have reduced some of the overcapacity that plagues the global industry. We would not have seen the government throwing its weight into a bankruptcy proceeding in order to redistribute money from creditors to pensioners, which isn't a good precedent."