From Pushing Tin To Going Broke
Oxford Analytica,
Thursday, October 27, 2005

The U.S. airline industry's financial position has further deteriorated over the past two months. On Sept. 14, Delta Air Lines and Northwest Airlines filed for protection from their creditors under Chapter 11 of the U.S. bankruptcy code, which left 50% of domestic air transport capacity under the operation of insolvent carriers. Such "zombie" airlines, kept alive through a combination of government subsidy and forgiving bankruptcy statutes, are retarding the reorganization and reform of an outdated business model.

The recent increase in oil prices applied a damaging blow to an already fragile industry. U.S. airlines have long struggled to control their costs, but the sudden spike in fuel prices in the aftermath of Hurricane Katrina was a particularly grievous setback. The industry's financial distress comes in the context of strong growth. Passenger traffic rebounded sharply in 2004. Moreover, rising fuel prices have allowed some carriers to pass their increased costs on to consumers, and "yields" (a measure of profitability) have improved accordingly. U.S. airlines have not managed to make money on the upturn. Moreover, recent traffic statistics suggest that growth may be tailing off as a result of higher fuel (and ticket) prices. The slowdown is affecting both "legacy" carriers and low-cost airlines.

The lack of a clear policy in Washington for dealing with the airline crisis is at the core of the issue. This policy-making dilemma, and the industry's woes, represents the unfinished legacy of the government's drive to deregulate air travel nearly 30 years ago. Until 2001, Washington's policy of eschewing direct government aid for the airline industry endured and was vigorously promoted abroad. The E.U. followed suit with a three-stage "liberalization" package. Yet while liberalization became a buzzword for international air transport policymakers, it did not change the industry as much as its framers expected.

The United States, which had led the liberalization campaign, reversed its policy after the September 11, 2001, terrorist attacks. Since the 9/11 attacks, the U.S. government has intervened to prop up its airline industry in several ways. The U.S. government has abandoned its (partly) free market industry model, without embracing a return to full regulation. Moreover, there is little political impetus in Washington for an attempt to restructure the industry through legislation. Over the medium term, many insolvent U.S. airlines will continue to operate, propped up in Chapter 11 by aircraft manufacturers and creditor financial institutions. The industry's short-term prospects depend on its ability to lobby Congress for relief on taxation and pension rules. However, federal aid will be insufficient to resolve the financial crisis.

Washington lacks the political impetus to haul the airline industry out of its current crisis, and market forces are incapable forcing a resolution. To restore the sector's viability, the least competitive airlines may need to shut down. However, given continued political resistance to liquidations and heavy job cuts, fragmentation and overcapacity are likely to persist.