Saturday, March 21, 2020

Why the U.S. Should Let the Airlines Go Bankrupt

Some corporations or industries are so intertwined in our national economy that their going out of business would cause catastrophic dislocations in our economy. The automobile industry is one; banks are another; airlines are a third.

Without governmental intervention, it is likely that most, if not all, U.S.-based airlines will be forced into bankruptcy. Their cash reserves are dwindling; new revenues are shrinking, and they have huge fixed costs. Unless these firms can arrange new financing, they will shut down. New lenders are reluctant to step in and catch a falling knife. Without government intervention, airlines are unlikely to receive enough financing to service current debts and continue in business.

Since politicians agree the U.S. must have an airline industry, they will provide a bailout. The question becomes what form it will take.

When a corporation becomes “too large to fail,” its leaders will act in a riskier manner. It makes economic sense for them: if the risks pay off, they are richly rewarded; if things go badly, the government provides a backstop. The insurance field refers to this concept as a moral hazard. If insurance covers all the risk, the policyholder has no reason to guard against that risk. To protect against that hazard, insurance policies includes deductibles and/or co-payments to make sure the policyholder also incurs a loss.

Critics of the airlines point to their high levels of debt and share buybacks as two examples of overly risky behavior. It’s not my purpose in this blog to discuss the merits of those arguments. I do think these are staples of early twenty-first century capitalism, in which corporations are run primarily for the benefit of management and shareholders, with little regard to other stakeholders.

What happens if the federal government does not intervene? The U.S. airline industry has already undergone vast consolidation, so a few strong airlines buying up weaker siblings isn’t an answer. They either go through Chapter 11 bankruptcy to reduce their debt loads and cost structures or liquidate, selling their assets to the highest bidders to pay off as much of their debt as possible. Either way generates huge uncertainty, and workers bear the brunt of the disruption.

By intervening, the government provides a guarantee that the companies will continue, eliminating that uncertainty.

This does not mean we the people should write airlines a blank check so they can continue business as usual once we recover from the coronavirus-induced curtailment of flights. No, we should lend airlines funds to survive, but force them through a Chapter 11 bankruptcy reorganization process as part of the deal.

Because the companies need the government (and therefore the people of the United States) to become lenders of last resort, the corporations have essentially defaulted on their obligations. In a default, bondholders become the new owners, and stockholders lose all rights to the corporation.

The U.S. government should receive common stock to reflect its cash infusions. Mortgage holders (those with claims on specific assets) are treated on par with the U.S. government. Subordinated bonds should participate in the equity to a lesser extent. Each class of bondholder, other than the federal government, would have to write off some portion of their debt. They all made risky bets that did not pay off, and they all should suffer a loss.

Without diving into detailed specifics, the government gets a substantial equity interest (which it will sell over time) and first call on future income to pay off the loan. Mortgage and senior debt suffer some loss, which, if the company survives, they can make up through their stock holdings. Subordinated debt holders will lose a significant portion of their investment.

Corporations often use bankruptcy as a lever to tear up union contracts, terminate pension and healthcare plans. As part of any government bailout, the corporation should not be allowed to reduce rank-and-file compensation and benefits. Executive plans would not get any such protection. When common stock becomes worthless, stock options also lose their value. Other nonqualified executive plans become general creditors of the corporation, receiving no more favorable treatment than provided under current bankruptcy law.

The purpose of an industry bailout is to save vital services the industry provides and to save as many jobs as possible for the long-term health of the industry; it is not to put additional money in the pockets of stockholders or executives running the corporations.

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James M. Jackson authors the Seamus McCree series. Full of mystery and suspense, these thrillers explore financial crimes, family relationships, and what happens when they mix. False Bottom, the sixth and most recent novel in the series is set in the Boston area. You can sign up for his newsletter and find more information about Jim and his books at

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