Airline Industry: How Government Meddling in Marketplace Costs Taxpayers & Consumers

Good economic outcomes typically happen when the government does not directly meddle in the marketplace but, instead, acts only to ensure the existence of the rule of law and property rights so third parties can enter into viable contracts as well as count on a level playing field for all participants in the market.

Bad economic outcomes typically happen when the government meddles in the marketplace. E.g., see this posting about the impact of government meddling in the healthcare marketplace.

The meddling typically creates new (and often unforeseen) behaviorial incentives for market participants to act in economically inefficient ways. As the cost of those inefficiencies grow, the government most often then further meddles in the marketplace and only compounds the problems they helped create in the first place.

The travails of the U.S. airline industry show how one bad government meddling begets more government meddling and creates incentives for avoiding dealing with economic reality - all at a greater long-term economic cost to taxpayers and/or consumers.

For example, consider the news in this WSJ article entitled Global Airlines Rise Above Crisis As U.S. Carriers Struggle (available for a fee):

At a time when many U.S. carriers are still struggling to survive, much of the rest of the global airline industry appears to have pulled out of crisis and is entering the summer travel season in its best shape in five years.

Carriers in Asia and Europe are starting to see cost savings from several years of difficult restructuring. Passenger demand is ballooning in many markets...That means some airlines are able to stanch their losses by raising fares -- and some are even strongly profitable.

The big exception is in North America, where several giant carriers are operating either in or near bankruptcy-court protection. U.S. airlines have been filling planes to record levels recently, surpassing demand seen before the terrorist attacks of Sept. 11, 2001. Still, much of that traffic has been stoked by aggressively slashing fares.

The U.S. airline market is lagging behind the rest of the global industry for a variety of reasons. After reaching unprecedented heights in the economic boom of the 1990s, U.S. carriers were hurt worse by the Sept. 11 attacks. And the U.S. industry remains an uncomfortable mix of rabid competition and government intervention -- such as loan guarantees and pension-obligation relief -- that allows weak carriers to limp along far longer than ailing businesses do in other industries.

Outside the U.S., where Chapter 11 bankruptcy protection doesn't exist and many governments lack funds to prop up airlines, carriers have been faced since 9/11 with restructuring or going out of business -- and many have. Aiding the survivors, airlines outside the U.S. generally don't face labor unions as strong as in the U.S., and few face the sort of free-for-all competition that U.S. carriers do...

"Operating fundamentals are probably as good as they've ever been" in the U.S., thanks to deep restructuring, "although balance sheets are not," says John Heimlich, chief economist at the International Air Transport Association...

This nascent global pickup remains tenuous and could quickly disappear...

In Asia and the Middle East, airlines actually are growing, posting big profits, and appear to have shaken the crisis. The giant markets of China and India are deregulating and growing quickly. Carriers in the more mature markets of Japan, Southeast Asia and Australia-New Zealand also are expanding operations and renewing their fleets.

Airlines in the Asia-Pacific region started restructuring earlier than their peers in America and Europe...

"In Asia, we've got lower cost bases, tighter capacity and a much stronger demand recovery" than in the U.S. or Europe, says Kevin O'Connor, an analyst with investment bank CLSA Asia-Pacific Markets in Hong Kong...

In Europe, several large, traditional airlines and budget newcomers are reporting solid results...

"The results show that established carriers are able to deal with the cyclical crisis," said Ulrich Schulte-Strathaus, secretary-general of the Association of European Airlines in Brussels...

But for most airlines in the U.S., which for years had some of the world's strongest airline labor unions, slashing overhead remains a way simply to avoid insolvency. Rising jet-fuel prices have far outstripped most airlines' ability to reduce overhead expenses such as labor...

Underfunded pension plans are another big drag on airlines. US Airways and UAL Corp.'s United Airlines, both of which are operating under Chapter 11 bankruptcy-court protection, were able to escape their obligations through bankruptcy proceedings...

The two carriers' escape from their pensions has increased pressure on rivals to seek relief from their own burdens...

This attempt to help U.S. carriers is raising trade tensions within the inherently international industry, however...

"The U.S. government is subsidizing the airline industry," charged Pierre-Henri Gourgeon, chief operating officer of Air France-KLM. In Europe, "where no subsidies are possible, market strength forces the industry to adapt."

European Union officials have been strict since 2001 in limiting state money to airlines, and EU governments resisted paying for services such as airport security that politicians in the U.S. and some other countries have moved to underwrite...

Think about it: Government loan guarantees enabled inefficient airlines to survive without having to deal rigorously with their bloated, non-competitive cost structures. The problems were then only compounded by governmental policies that allowed United Airlines and USAirways to throw off their pension obligations. Which, predictably, is creating a reaction by the airlines which are still obligated to their pension liabilities as this next WSJ article entitled Delta, Northwest Seek Pension Aid; Senators Critical (available for a fee) shows:

The chief executives of two major airlines warned Congress their companies will likely seek bankruptcy protection if lawmakers don't make it easier to fund their employee-pension plans...

"Without changes in the pension-funding rules, all of our efforts to transform ourselves out of [bankruptcy] court could be to no avail," Delta Air Lines Chief Executive Gerald Grinstein told the panel, at a hearing on proposals for shoring up corporate-pension programs.

Northwest Airlines President and Chief Executive Officer Douglas Steenland said that without swift congressional action, "the defined-benefit plans at Northwest and at other carriers may very well suffer the same fate" as airlines already operating under bankruptcy-court protection...

...Mr. Grassley indicated he might be willing to add legislation to a comprehensive pension-reform bill he is working on to help the airlines catch up on pension payments. Mr. Grassley is considering "whether that broad bill includes something for airlines," an aide said.

To avert more bankruptcies, the airline executives called on Congress to quickly approve legislation offered by Sen. Johnny Isakson (R., Ga.,) and Sen. Jay Rockefeller (D., W.Va.) that would allow carriers to freeze pension plans and extend their current obligations over 25 years.

Mr. Grassley made clear he favors a more comprehensive bill covering all companies with defined-benefit plans, which pay retirees fixed benefits.

The PBGC said yesterday that companies had a record $353.7 billion shortfall in their defined-benefit pension plans at the end of 2004, a 27% jump over 2003.

The shortfall has worsened, agency officials said, because investment returns have been flat and more companies are experiencing financial difficulties and are letting pension contributions slip. Also, the officials said, pension obligations are increasing as more beneficiaries retire and interest rates used to calculate long-term pension payouts have fallen, meaning companies must put more money in their pension funds now to make up the difference.

Mr. Grassley said he hopes to approve a measure this year. But lumping other industries together in one bill could slow the process on Capitol Hill. If a broader bill gets bogged down, "then we need to do a bill tailored to the aviation industry," Sen. Isakson said.

The pension problem is acute in the aviation industry...At the end of 2004, the airlines held just $30 billion in the bank to cover $50.6 billion in potential pension payments...

Do you have any doubt that any new legislation will really fix the core economic problem? Of course it won't - which is why this next article forecasts that the Pension Agency's Gap Is Expected To Balloon to $71 Billion in Decade (available for a fee):

The Congressional Budget Office told a House panel today that the federal agency insuring private pension plans has a deficit that will likely more than triple to $71 billion in the next decade, creating more urgency for Congress to consider pension-overhaul legislation.

At a House Budget Committee hearing, CBO Director Douglas Holtz-Eakin said that under the current weak condition of many single-employer, defined-benefit plans, the Pension Benefit Guaranty Corp. will experience a deficit that would require a fivefold increase in premiums paid by companies in order to wipe it out.

Such an extreme premium boost is considered politically unfeasible, partly because it would cause many companies to seek to unload pension plans on the PBGC through bankruptcy proceedings...

Last year, the PBGC had $62.3 billion in long-term obligations to pay workers' pensions, but only $39 billion in assets taken over from failed employer plans. The $23.3 billion shortfall was double the previous year's gap.

The CBO has spent the past 18 months working on a new model to measure the funding of companies' pension plans -- and the future effect on the PBGC. Mr. Holtz-Eakin said the model shows the PBGC's deficit growing to $71 billion in 10 years and $91 billion within 20 years...

Don't you find it interesting that the very process of fixing problem via more legislation could lead to further defaults on pension obligations to the PBGC pension agency? And this next WSJ article entitled Pension Agency Faces a New Front: Multiemployer Plans Saw Deficits Jump 50% in '04; Industry, Unions Are Split (available for a fee) notes how there are even further structural problems, all of which are created by previous government meddling in the marketplace:

As the government wrestles with strategies to deal with failed pension plans sponsored by troubled companies such as UAL Corp.'s United Airlines, big problems in many multiemployer plans have been largely overlooked.

Lawmakers say they recognized only recently that Congress also must address financial turmoil in this separate segment of government-backed pension plans, which covers about 10 million workers in several industries.

Meanwhile, industry and union coalitions pushing Congress to take action are fighting among themselves over how far lawmakers should go to shore up the plans...

Of growing concern, however, are multiemployer retirement plans underfunded by $150 billion in 2004, a 50% jump in the deficit from the year before, the federal insurer reported.

Multiemployer plans were set up so that workers who tend to move from employer to employer within various unionized industries could maintain retirement-benefit plans negotiated under a common union contract. A total of 1,600 multiemployer plans are paid for by 65,000 mostly small companies with 10 million unionized workers in such industries as trucking, construction and grocery-store chains.

As old-line industries like trucking companies consolidated, many multiemployer plans have gone into the red. The reason: fewer surviving employers with a declining number of active workers are responsible for the plans' growing rolls of retirees...

If a multiemployer plan becomes insolvent both the surviving companies and PBGC share in the financial burden of paying benefits that in many cases would be cut by 66%. "Everyone gets hurt," says Michael Mathis, Teamsters' director of government affairs in Washington.

So what would help fix these problems? One step in the right direction is argued in this WSJ editorial (available for a fee) by Holman Jenkins, Jr. who says we should Send United to the Great Hangar in the Sky:

What's wrong with this picture? A federal government agency is getting stuck with United Airlines' pension obligations, and in return for this favor United is going to keep flying. By now, shouldn't the price be that United do the decent thing and disappear, vanish into the night, so the industry can begin to work off the problem of too many companies chasing too few passengers?

Federal bankruptcy law and the post 9/11 airline bailout have already done enough damage. US Airways and America West, both recipients of federal bailout loans, are merging mainly to make sure they will be "too big to fail" and thus entitled to a United-style cosseting next time they get in trouble.

Now United itself will dump its pensions on a taxpayer-backed government agency, a step that may well provoke other airlines to do the same. United even gave the government a stake in seeing this outcome come to pass -- in the form of $1.5 billion in convertible notes held by the federal Pension Benefit Guaranty Corp. The PBGC now finds itself in the weird position of cheering for United's success at the expense of carriers whose pension obligations it might have to assume next.

Let's dry our eyes. We've had two weeks for grieving over the pension plans of United Airlines; maybe we can have a few minutes of realism. What was lost, really? United's plans still hold $7 billion in assets, which could have been divvied up among retirees and employees by seniority. But this option was never considered -- it would have meant giving up the opportunity to collect, at government expense, an additional $6.6 billion in benefits promised by United but never backed by real money.

Be mindful of how these vapor benefits came into being. Until bankruptcy wiped out its vaunted experiment in worker empowerment, United was 55% owned by its employees and virtually dominated by the pilots union and machinists union.

From 1994 on, they controlled two seats on the board, held sway over a majority of others, and effectively hired and fired the CEO. To boot, labor didn't hesitate to reinforce its clout by threatening strikes and engaging in illegal work slowdowns -- a process that eventually led to the highest wages in the industry. As Rick Dubinsky, head of the pilots union, told management in 2000: "We don't want to kill the golden goose. We just want to choke it by the neck until it gives us every last egg."

Well, the goose is on government life-support now. But labor could always have used its clout to steer more eggs to the pension basket rather than the paycheck basket. A dirty little secret, however, is that it would have been crazy to do so. Pension underfunding (really, benefit overpromising) is too good a bargain to pass up -- a cheap option on government-paid pension benefits in the event of bankruptcy.

We specify "cheap" rather than "free," because the PBGC does charge a premium for insuring private pension plans, just not enough to make it uneconomic for troubled employers to engage in such flimflam. Look at the agency's main offenders: steel, autos, airlines -- companies with little hope of long-term prosperity and large, unionized work forces to keep placated in the meantime.

The pilots at United were in a particularly odd position, since many of the most senior were nominally entitled to pension benefits far in excess of the $46k-a-year the PBGC was willing to guarantee. No wonder their union was quick to propose a bankruptcy workout that would have given them a big new ownership stake in the carrier in return for dumping their plan -- oh yes, and on the condition that United also terminate the plans of lesser-paid employees.

But the larger point here is that defined-benefit pension plans aren't going out of style because they're structurally defective. They're going out of style because of a government-created incentive for weak companies to award more benefits than they have any hope or intention of funding.

In the wake of United's pension default, those worried about too much risk being placed on employees to manage their own savings might consider a solution: Abolish or privatize the PBGC...

In the meantime, the whole purpose of trying to legislate away some of capitalism's hard edges for workers and companies has come sadly unstuck in the airline business. Somehow the industry has to reduce itself to a smaller handful of more efficient network carriers that can maintain service to smaller markets even in the face of cherry-picking by Southwest, Jet Blue and their low-cost brethren. And if ever a company has earned the fate of being the odd man out, United is it.

It's spent nearly three years in bankruptcy, shucking off labor contracts, debts and now employee pensions, but still loses money...

...An orderly liquidation of United is an even better idea now that the federal government and taxpayers face an urgent need to get off the hook for a potential industry-wide airline pension default.

Jenkins makes the point well: The unions wanted to choke the golden goose by the neck to get every last egg. Thanks to government regulations, management and the unions of financially weak companies then knew neither would pay any price for overpromising and underfunding benefits. And who is left holding the bag - the taxpayers and consumers - while Washington officials run around talking righteously. Rather pathetic, isn't it?

For an alternative world view, consider this: Most families, who don't have lawyers or MBA's in their midst, somehow find a way to live within their family budgets. Why can they do what companies cannot do consistently well? The answer begins with the family knowing it must survive on its budget and live within its means - because there is no other alternative. That increasing spending in one area means reducing spending elsewhere, tapping the savings account or going into debt. That there is nobody waiting to bail out families who spend with reckless abandon.

Don't forget the lesson here: A big, meddling government does not have the public interest in mind, as they have become servants to the large corporations and unions who curry favor with them - all at the expense of working families and retirees. All of us pay quite a price for government meddling, don't we?

ADDITIONAL INFORMATION:

Bankrupt pensions, extraordinary healthcare insurance benefits, outrageous demands by private and public sector unions, lousy decision-making by some management teams as well as misguided incentives and marketplace meddling by government have been discussed previously on Anchor Rising:

Public Sector Issues
Misguided Incentives Drive Public Sector Taxation
A Call to Action: Responding to Government Being Neither Well-Meaning Nor Focused on the Public Interest
Bankrupt Public Pensions: A Time Bomb That Will Explode
Why Truly Free Markets & Timely, Transparent Information Are Needed to Protect the Freedom of American Citizens
RI Public Pension Problems
The Cocoon in which Entitled State Employees Live
The Union's Solution for the Future: Get More People in Unions
Bankrupt Public Pensions, Part II
How Public Pensions Make People Well-Off at Taxpayers' Expense
Public and Private Unions
Now Here is a Good Idea
Be Watchful
Rhode Island Unions Again Resist True Pension Reform

Private Sector Issues
If You Won't Deal With Economic Reality, Then It Will Deal With You
Underfunding Pensions, Public and Private, can Hurt Taxpayers
Why Truly Free Markets & Timely, Transparent Information Are Needed to Protect the Freedom of American Citizens
Outrageous Employee Compensation Liabilities Continue to Haunt General Motors; Will American Taxpayers End Up Paying the Bill?
Why the Big Three Auto Companies Could Easily Fail