The case for re-regulating the airlines

Facing an uncertain future.
Facing an uncertain future.
Image: AP Photo/Ross D. Franklin
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For the second time in less than two decades, US airlines have come, hat in hand, to the government. This time, they stand to receive more than $50 billion in assistance to shore up losses stemming from the coronavirus.

As with the attacks of Sept. 11, the events grounding planes and keeping Americans from flying are no fault of the airlines—terrorism then, a global pandemic now. But in both cases, the crises have exposed how vulnerable airlines are to the disruption of normal business, and how much the national and global economy depends on their continued operation.

Ordinarily, airlines should not need help. They have recently enjoyed some of the most profitable years in their history, prompting Doug Parker, the American Airlines CEO, to announce in 2017 that the company wasn’t “ever going to lose money again. We have an industry that’s going to be profitable in good and bad times.” But business decisions—including spending 96% of their free cash flow over the past decade buying back shares—have left them deep in debt, with limited cash on hand in this time of crisis.

Now, politicians, academics and taxpayers alike have begun to question whether the government’s support should come with serious strings attached, once the Treasury Department takes equity stakes in carriers in exchange for its assistance.

Some fairly minor restrictions are already being mooted as part of the bailout—it’s bye-bye for now to dividends and stock buybacks, while executive pay controls will pause raises for some and see pay reductions for the highest paid. It’s possible, too, that the government may prevent airlines from pulling out of certain otherwise underserved areas. But these conditions are fairly minimal, and likely to be limited in term.

This may only be the beginning of regulations that some believe are sorely overdue. Especially in a country like the US, where most interstate travel is necessarily done in an airplane, we need airlines in a way that we don’t need most other businesses. It’s time to acknowledge that, says Tim Wu, a law professor at Columbia University. “You can’t have a functioning economy without an airline industry right now,” he said in an interview. “We’ve experimented with just pretending they’re normal businesses, but in some ways they really aren’t.”

He gave the example of a friend currently stranded in Peru, where the airline he had traveled on was making no real effort to get him home. “When people are stuck in places and they can’t get home, [airlines] can’t be like, ‘Well, it’s not really profitable to fly that route any more.’ They have to behave differently. We need them, and that’s very different than your average corner store.”

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Not business as usual

In a New York Times opinion piece, published on March 16, Wu suggested that it would be inexcusable for airlines to return to “business as usual” after receiving loan relief, tax breaks, cash transfers, or any other kind of government support. Instead, he writes, “we must demand that the airlines change how they treat their customers and employees and make basic changes in industry ownership structure.”

Many countries have a “national flag carrier,” the technical term for a state airline, often partly or entirely owned by the government. Already, some countries have moved to entirely nationalize these airlines, including Italy’s debt-encumbered Alitalia, which is to be downsized. These national carriers often receive some government support and are expected to play a diplomatic or political role, assisting with deportations and repatriations.

Since the Second World War, however, the US has had a battalion of domestic airlines rather than one single national champion. Historically, they have received little government support and have far fewer obligations than national carriers. This has been especially true since 1978 Airline Deregulation Act, which took government entirely out of the equation. 

Ironically, the airline industry which profited so handsomely from deregulation opposed it from the start. In the years leading up to the bill, airline bosses did all they could to prevent it from passing, labeling it “ill‐conceived and potentially ruinous.” Ticket prices would rise, they said, while airlines would be placed at far greater risk of going bust or being nationalized. “The promise of lower fares in an era of continuing inflation is a cruel hoax and a delusion,” Arthur Kelly, the chairman of now-defunct Western Airlines, told the House aviation subcommittee in 1977. 

The bill, signed into law by US president Jimmy Carter, was a reaction to a rapidly changing economic and technological landscape. A rigid system with little competition led to customers paying through the nose for air fares—despite heavy air service subsidies. Part of the concern, in fact, was that airlines might indeed need to be bailed out by the taxpayer, as the Penn Central Railroad had been in 1970: Economists with close ties to the Democrats suggested that deregulation would make for a more efficient, less rigid industry.

Ultimately, the bill did pass, airlines (mostly) didn’t go bust, and fares did fall, dramatically. For Tom Petzinger, a former Wall Street Journal reporter and the author of the 1995 book Hard Landing: The Epic Contest for Power and Profits that Plunged the Airlines Into Chaos, there’s no doubt that it was the right thing to do: “I’m convinced years on that if the mechanism of regulation has remained in place, we’d be a different country and a different world,” he told Quartz. “And I’m not sure it would be as good a country and as good a world.” 

Through deregulation, Petzinger says, traveling by airplane was suddenly a feasible option for millions of Americans. “Flying became part of the furniture of modern life, in terms of economic activity and family bonding. Without deregulation, I’m not sure we would really have all that.“ In the first year alone, a record number of travelers took the skies, saving $2.5 billion through lower fares in the process, while the industry earned its highest ever profit. It hasn’t all been good, of course: More passengers have unsurprisingly resulted in crowding and more complaints; in the wake of deregulation, airlines slashed labor protections for most non-executive workers.

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Soaring profits

In the 40-odd years since deregulation, US airlines have undergone seismic change, variously collapsing and merging down to the present half-a-dozen. Passenger numbers almost quadrupled from 275 million in 1978 to a record 926 million last year, while lower fuel prices, higher revenue from fees, and less competition due to these mergers helped profits soar. These recent years of plenty culminated in the four largest airlines spending $39 billion to buy back their own stock over the past five years. (Certain international airlines, including British Airways’ parent company IAG and the budget carrier Ryanair, have also spent millions buying back their stock.)

It would be impossible, and likely undesirable for customers and airlines alike, to return to pre-1978 regulation, where the US government had jurisdiction over airline routes, ticket prices, and even airlines’ right to exist. But permanent regulation that might increase consumer protections or force airlines to behave in a more financially responsible way is beginning to look more and more plausible.

These calls are coming from voices with close ties to the industry, as well as from both sides of the political aisle. Speaking to CNBC, Sara Nelson, president of the Association of Flight Attendants, called for stricter rules. “That includes requiring employers across aviation to maintain pay and benefits for every worker,” she said. “No taxpayer money for CEO bonuses, stock buybacks, or dividends. No breaking contracts through bankruptcy.”

Democrats such as Alexandria Ocasio-Cortez tweeted their support for these kinds of restrictions, while Edward Markey, a Massachusetts senator, wrote: “Any infusion of money to the airlines must have some major strings attached—including new rules to prohibit consumer abuses like unfair change and cancellation fees. I will demand these conditions be met before supporting any airline bailout.”

The CARES Act (Coronavirus Aid, Relief, and Economic Security Act), signed into law on March 27, gives the administration the ability to take government equity stakes in airlines as a condition of receiving federal aid and bans stock buy backs for bailed out companies.

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Quid pro quo

“There are reasons we might want to regulate airlines,” says Kathryn Judge, a professor at Columbia Law School. “If they’re going to potentially be subject to a bailout, we might want to make sure that they have incentives ahead of time to build some buffers for those extreme tail risks.” At the same time, now-common business practices such as aggressive pricing strategies might be perceived as opportunistic or not serving customers. “This might be a time to renegotiate that bargain.”

Regulations, if they came, might target airlines’ anti-consumer practices, including high change and baggage fees and steadily-shrinking seats. These, writes Wu, “are not only uncomfortable and even physically harmful, but also foster in-flight rage and make the job of flight attendants nigh unbearable.” More probably, they could affect how airlines are owned and run, forcing airlines to keep a certain amount of cash on hand for crises or clamping down on common ownership, where natural competitors are owned by the same small set of large institutional investors, that Wu believes creates incentives to collude instead of compete.

Others take a radically different tack. Microeconomist Clifford Watson, a Brookings Institution fellow, and the author of The Economic Effects of Airline Deregulation, believes the only way to help airlines adjust to high-stress situations is to give them maximum flexibility to respond to shocks quickly and nimbly. “Regulation was all about inflexibility—you couldn’t choose your routes, you couldn’t choose your affairs, et cetera, et cetera,” he says. “The problem is, we’ve never gone far enough with deregulation. We needed to go further and give them even more flexibility and get them better in the habit of working together with others,” namely privatized airports and air traffic control. 

Ideally, Winston says, airlines would compete against one another for routes all over the world, exposing them to greater competition, which would in turn “create an environment which is more competitive and more innovative.” If the general public felt stock buybacks were unethical, for instance, they’d make that known through spending. 

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The pendulum swings back

Right now, there are few incentives for airlines to save for a rainy day—especially if the government continues to serve as their doomsday backer. Writing for Bloomberg’s Money Stuff newsletter, Matt Levine suggests airlines took sensible steps to serve their shareholders, given how the rules were written. Right now, airlines’ financial structure is optimized for shareholder value, he writes. “Spending money on other stuff—better planes or labor relations or customer service—would not have insulated American Airlines from its current problems; hoarding the money would have, but not completely,” he writes. “None of those things would have created as much long-term value for shareholders as just giving them money and letting bondholders (or, fine, the government) hold the bag.”

Changing those incentives may mean rewriting the contract on what happens if the government keeps having to intervene in times of crisis, and putting what’s perhaps best for society over what is best for airline shareholders.

Such a rewrite may not come until some time after the bailouts, once the dust has settled. In 2010, as part of its response to the global financial crisis, the US passed the Dodd–Frank Act, introducing sweeping changes to the US’ financial regulatory system, including amping up customer protections. This, says Judge, was a follow-up of sorts to the bail-outs, and an acknowledgement of consistent violations of consumer protection. “It said, ‘now that we’ve bailed you out, here are the new rules that we want you to abide by,’” she said. “It wasn’t specifically a string or a condition, but it was at least connected, in the sense of: ‘If you’re going to take this much government funding, we want to make sure it’s also protecting consumers.’”

Even then, some of these protections have already been chipped away. Since the start of the Trump administration, fewer than 10 banks are now subject to the strictest federal oversight, letting many small and medium banks off the hook for stress tests. Certain loan companies have also been exempted from some disclosure requirements. Future administrations may make these regulations lighter still. Airline regulations, if they come, should not necessarily be considered set in stone.

Since the 1950s and 1960s, the US has gone from heavily regulating industry, banks, and telecommunications alike to swinging “massively in the other direction,” she said. “We engaged in a very significant period of deregulation, and really trusting the market to figure these things out.” But both right now and in ‘08, she said, the government was called on by those same market participants in times of crisis.

“If the government has to be in the back and industry is actually saying, ‘we want you as a government to be an insurer of last resort and to stand behind us’, then maybe we have a right to demand more in terms of consumer protection,” Judge said. “What that social bargain is going to look like going forward is, I think, one of the things that’s up in the air right now.”