Bankruptcy, Not Bailouts
By the time you read this, Congress may be putting the finishing touches on a $1 trillion bailout to help America cope with the economic fallout from the COVID-19 pandemic.
As is customary in such matters, the “winners” in the bailout sweepstakes will be the best-connected corporations, who maintain the largest lobbying staffs in Washington, D.C. At the front of the line this time are domestic airlines and airline manufacturers, which are hemorrhaging billions of dollars each month the pandemic lasts.
But corporate bailouts aren’t the answer. Bankruptcy is.
Several types of bankruptcy exist. The one that’s most appropriate in this situation is Chapter 11, in which a company is reorganized in exchange for debt relief. It’s used for businesses that want to keep operating but need to restructure so they can pay their debts. Once a company files a Chapter 11 bankruptcy petition, creditors can’t sue to enforce their claims against it.
Instead, the company has four months to come up with a reorganization plan, which must be completed within 18 months.
Once the bankrupt company files its reorganization plan, creditors must approve it. Generally, creditors get ownership of some or all of the bankrupt company’s shares in exchange for some degree of debt relief.
For instance, American Airlines declared bankruptcy in 2011. Throughout the process, it promised to:
Fly normal schedules
Honor reservations, tickets, gift cards and vouchers, and make exchanges and refunds as usual
Fully maintain frequent flyer and other customer service programs
Provide employee wages, healthcare coverage, vacation and other benefits, without interruption
Pay suppliers for goods and services received during the reorganization process.
By and large, American did exactly that during its reorganization. The airline’s biggest casualty was its pension plans, which were frozen for some categories of employees, including pilots. And existing shareholders: when the company emerged from bankruptcy, the old shares became worthless.
The American bankruptcy filing came on the heels of bankruptcy reorganizations of its competitors, including United (2002); Delta (2005); and Northwest (2005). Each of these airlines continued to operate more or less normally, although again, employee pension plans were in some cases terminated and the responsibility for paying them transferred to the Pension Benefit Guarantee Corp (PBGC).
Admittedly, it won’t be as easy for airlines to maintain normal operations as COVID-19 sweeps the globe. Demand for airline travel has collapsed as countries rapidly close off their airspace. There’s also a possibility that in the next few days, all domestic commercial air travel will be suspended. Many if not most of the nearly 750,000 employees of domestic airlines will face joblessness as the crisis deepens.
This is why critics of a Chapter 11 filing say a direct bailout is necessary, since otherwise, it would be in the best interests of airlines to lay off as many employees as possible to reduce costs. As well, it’s true (as President Trump has pointed out), that domestic airlines couldn’t have possibly predicted a pandemic in 2020, when they were enjoying record profits.
Still, a bailout is a failed strategy because of the “moral hazard” issue. When the government steps in to save management and stockholders from the consequences of their bad decisions, it encourages similar behavior by other companies.
We can see that phenomenon at work in the case of the post-bankruptcy behavior of domestic airlines. Since 2012, when the last major domestic airline (American) emerged from bankruptcy, they’ve enjoyed record profits. But instead of using those monies to strengthen their balance sheets or improve customer service, the four largest domestic carriers (American, Delta, Southwest, and United) collectively spent a staggering $43.7 billion to buy back their own shares. That’s within spitting distance of the $50 billion bailout they’re demanding.
The goal of using profits to buy back shares is obviously to enrich shareholders. And while I have no problem with enriching shareholders, I do have an issue when the companies engaging in this risky and once-illegal practice ask for a taxpayer-funded handout.
Yes, it will be painful if all domestic air carriers – and possibly airline manufacturers like Boeing – are forced into bankruptcy. Hundreds of thousands of employees will be thrown out of work, at least temporarily.
For that reason, it’s probably inevitable that Congress will approve a bailout package for domestic airlines and airline manufacturers. But it should come with strings attached, including wiping out existing shareholders and prohibiting share buybacks once the companies return to profitability.
After all, when companies can shift the cost of their reckless behavior to taxpayers without adverse consequences, we shouldn’t be surprised when they do it. The bottom line is that when markets react negatively to a shock like the COVID-19 epidemic, we shouldn’t reward that behavior.
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