Man Without Qualities

Wednesday, December 04, 2002

Not Afraid of No Zombies?

Holman Jenkins writes in the Wall Street Journal:

Notice, too, the ferocious lobbying of other carriers against a United bailout, violating an unspoken ethic that companies in the same industry don't embarrass each other in Washington. But a bankruptcy that wiped out United's experiment in labor-management collusion would be a salve for the entire industry. United's management could go back to managing. Labor could go back to trying to protect its members' interests in arm's length bargaining with the front office. And the airline business would no longer have its salary scales distorted by United's misbegotten experiment in worker ownership.

Mr. Jenkins is correct. But a prior post regarding the US Airways bankruptcy is just as true of a possible United Airlines bankruptcy - which the denial of government subsidies will likely hasten:

In fact, there are very serious historical reasons to view the US Airways bankruptcy as a potential disaster for competing airlines. Consider the bankruptcy of the old Eastern Airlines. As with many airlines bankruptcies, the Eastern Airlines bankruptcy court viewed the airline as a "public service" - a characterization which the court used to justify Eastern's consumption of virtually all of its cash, equipment and other assets. In the end, even the secured creditors and administrative creditors of Eastern Airlines received just a few pennies for each dollar of debt. In the case of the secured creditors, the court allowed the airline to so run down and cannibalize the equipment securing the debt that when the creditors were finally able to foreclose, the equipment was often worthless. The so-called "administrative creditors" were unsecured creditors who advanced credit to the airline (sometimes involuntarily) after the bankruptcy. Such creditors did poorly, but they beat out the general, unsecured creditors, who received absolutely nothing.

But as far as competing airlines are concerned, the real importance of the bankruptcy court's treatment of airline cases does not lie solely in the outrageous treatment of the airline's creditors. Rather, the problem for the competing airlines is that they have to compete against an airline which is empowered to exploit its creditors for an operating subsidy which the non-bankrupt airlines don't have unless they, too, declare bankruptcy. Competing with a bankrupt, zombie airline is very expensive. Eastern Airlines converted several billion dollars of its creditors' funds into operating subsidies with the blessing of its bankruptcy court.

But it gets worse. If the bankruptcy courts continue to advance their "public service" approach to airline bankruptcies, creditors of existing airlines must take into account not only the increased likelihood that their debtor will seek bankruptcy protection resulting from the need to compete with a zombie, but also the likelihood that the creditors will be subject to Eastern Airlines style gutting of creditors rights if such a bankruptcy occurs. That means the cost of credit to competing, non-bankrupt airlines will rise substantially - further increasing the risk of bankruptcy. This vicious cycle could easily expand without limit. With the current structure of the airline industry and its weakened condition, it is no exaggeration to say that the US Airways bankruptcy has the potential to destroy the entire worldwide airline industry if US bankruptcy courts insist on following precedents such as Eastern Airlines. And the policies of insolvency courts of other jurisdictions are generally worse than those of the US courts, further exacerbating the potential problem.

The best possible thing the US Airways bankruptcy court can do for the nation and the national airline business is to take a very hard look at US Airways viability - and utterly reject the ill-conceived "public service" model. If the US Airways plan of reorganization is not quickly produced and clearly shown to be viable, US Airways should be promptly liquidated.

But historically, that has not been the way bankruptcy courts have treated airline bankruptcies.

It is sometimes surprising how short lived memories are in the airlines business. Perhaps those who do not suffer from amnesia bouts can't stand being in that industry. But such bouts are not so serious that United's competitors are unaware of the risks and difficulties they will face competing against a bankrupt flying zombie. It is therefore likely that the competitors recognize that although bankruptcy often operates as a disguised subsidy to the bankrupt arilines as discussed above, government loans are an overt subsidy - in this case to be followed by a United bankruptcy-subsidy anyway. Moreover, additional government-guaranteed debt would make a reorganized United less likely, prolonging the zombie phase.

Such an understanding would explain why United's competitors are acting as if they have no fear of this flying zombie. But "acting as if" is not the same as not having actual fear. If United seeks bankruptcy protection, treating that case in the "public service" model would be a catstrophe for the national and worldwide airline industries.

Indeed, while United's problems go well beyond any possible effect that might be induced by the US Air bankruptcy, it would be interesting to see whether the bankruptcy court's treatment to date of the US Air case has exacerbated United problems and those of other airlines.

This is what I think: United Airlines Bankruptcy
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