Washington DC, July 22, 2008 --  

High fuel prices and a slowing economy may soon kill off the worst of America's legacy air carriers.

A relentless string of bad news from the housing, financial, and energy sectors is creating a particularly gloomy economic outlook for America. But if there is truth to the cliche about all dark clouds having a silver lining, it may just be the long-overdue shakeup of the country's dysfunctional airline industry.

With fuel prices at record-highs, major U.S. airlines are bleeding money at historic rates. American Airlines recently posted a quarterly loss of $1.45 billion, and Delta Air Lines one of $1.04 billion.¹ These earning reports come just weeks after Moody's Investors Service called the business models of U.S. airlines "unsustainable."² Fitch Ratings, predicted that conditions may lead to "multiple bankruptcies and liquidation" for the airlines next year.³

This may not sound like much of a silver lining -- especially if you are an airline employee. But for the vast majority of us who are consumers of America's air travel system, this is fantastic news. Decades of deplorable service by the legacy carriers may be about to come to an end.

Keep in mind that airline liquidation doesn't mean the end of air travel. Once giant carriers like Trans World Airlines, Eastern Airlines, and Pan Am have come and gone without hampering Americans' ability to fly. Economists have long appreciated the cleansing power of recessions -- by forcing weak businesses to fail, capital is freed up for investment in more productive ventures.

In the case of the airlines, this scarce capital means the right to limited gate assignments at overcrowded American airports. If sickly carriers like Delta were to fold, other carriers like Southwest or Jet Blue would be able to take over their gate assignments and expand their businesses. This would be a boon to consumers because the newer low-cost airlines have both higher on-time arrival and overall customer satisfaction ratings.

Consumers who have noticed the lack of customer-orientation to the legacy carriers are not imagining things. U.S. Airlines are not normal companies in the sense that they typically do not exist to make money for shareholders or serve consumers -- they exist to perpetuate the jobs of employees and pay creditors. All of the legacy carriers except American have had their stock rendered worthless in the past by Chapter 11 bankruptcy filings. At different points in 2005, Delta, US Airways, United and Northwest were all operating under Chapter 11 bankruptcy protection.

When a publicly traded company files for Chapter 11, the stock becomes worthless, and bankruptcy court takes over from the board of directors. This court negotiates with the company management to produce a reorganization plan meant to repay creditors. Many entrenched employees keep their jobs as a result, wielding disproportionate power over the company, given the lack of investor direction. When the company emerges from bankruptcy protection, the company remains near worthlessness -- able to pay its bills, but probably not enough of a profit to attract any significant investor oversight.

For many U.S. airlines, this process has taken place more than once. U.S. Airways filed for bankruptcy twice before its reverse merger with America West. Continental has also twice suffered bankruptcy. And even never bankrupt American Airlines exists partially as a remnant of twice-bankrupt TWA, which it absorbed earlier this decade.

The next round of bankruptcies, likely to come early next year as airlines continue paying high fuel costs during the low-revenue off-season, could prove decisive. Airline executeives will be much harder-pressed to convince bankruptcy judges that thier reorg plans are viable under such a punishing environment of record high fuel costs, lower customer demand from a slow economy, and continued relentless competition form the low-cost carriers. With any luck, legacy carriers will be forced to file for not just Chapter 11 reorganization, but Chapter 7 liquidation. Only liquidation can once and for all eliminate their dysfunctional systems for torturing passengers, destroying wealth, and keeping a stranglehold on scarce gate assignments.

While there will certainly be some short-term pain for consumers during the shakeout, the ultimate result should be an overall plus. We may never return to the days of the glamorous jet set, but receiving decent service for a fair price should not be out of the question.

Related Web Coumns:

Let Them Die
The Ultimate Bad Service Solution, January 4, 2005

Notes:

1. Washington Post, American Airlines, Delta Post Steep Losses as Oil Costs Soar, July 17, 2008

2. Marketwatch, Moody's: Many US Airline Business Models 'Unsustainable', July 5, 2008

3. CNN Money, Bankruptcies Loom for Airlines - Report, July 15, 2008