Airline Bailouts Destabilize the Economy and Inflate Asset Prices
In the end, after all of the political posturing and all of the speeches and exhortations for Congress to “do something,” a $2 trillion “coronavirus stimulus” bill landed on the president’s desk for The Donald to sign. And sign he did, uttering all of the platitudes and everything else that comes with “historic” spending legislation that never should have seen the light of day. Although COVID-19 has helped expose vast weaknesses in public health systems in the USA, it also has shown that with much of corporate America, the emperor has no clothes.
Although tracking where the money goes is not an easy thing, we do know that the airlines will receive about $50 billion in cash and loans, while Boeing will receive a share of $17 billion earmarked for industries favored by Congress. Another $500 billion will go to cruise lines, hotels, and other firms that have lost business because of travel restrictions and the economic shutdowns.
Politicians of both parties heaped praise upon themselves for their “bipartisan” efforts, which in real life only can mean that Congress cleaned out what was left of the IOUs in the till. Rep. Thomas Massie, a Republican from Kentucky, drew attacks from all sides as he tried to force a roll call vote (as opposed to the voice vote that the members wanted) and announced his opposition to the bailout. President Trump called for his expulsion from the Republican Party while Democrats declared him to be an unsavory ideologue.
There is not much to do but to wait for the results, and they will unfold over time. However, much of this bill's harm is invisible, the way that termites quietly but surely destroy a house when homeowners fail to detect them. The politicians and the pundits, along with corporate executives, are hailing this infusion of public funds to business as a lifeline to the economic system itself, when, in reality, it will weaken these firms in the long run.
This commentary deals mostly with the airlines, but what we say here applies to any firm receiving rescue funds and loan guarantees. While some of these essentially bankrupt firms gain some relief as taxpayers and consumers pony up to pay the companies’ bills, the temporary cash infusion allows them to kick the financial can down the road and not deal with the underlying problems that they are facing, at least for now.
In a recent New York Times op-ed piece, Tim Wu of Columbia University asks the following: “Are taxpayers rewarding a decade of bad behavior?” If he is asking specifically about US airline firms, the answer is a resounding yes. Wu notes that in recent years the airlines have been very profitable but that instead of building defenses against possible downturns that are not easily predicted (such as the coronavirus crisis), they have used much of their profitability to buy back their own stock.
Obviously, stock buybacks are controversial, and as long as stock prices rise, company officials look like financial geniuses. However, if the markets crash or if bears loom on the horizon, all of that value vanishes very quickly and the companies are left in worse shape than when they began. As a financial strategy, stock buybacks are inherently risky and tie up cash that could go toward capital development or even the “rainy day” fund for the inevitable market downturn. Writes Wu:
During the past decade, flush with cash, most of the companies in line to get taxpayer money did not prepare for a downturn. Instead, they spent enormous sums on stock buybacks, which reward shareholders and increase executive pay. For example, the airline industry, which is prone to booms and busts, collectively spent more than $45 billion on stock buybacks over the past eight years. As recently as March 3 of this year, with the crisis already beginning, the Hilton hotel chain put $2 billion into a stock buyback.
Such behavior is especially galling given that the airlines received a major bailout in the immediate wake of the 2001 September 11 attacks that severely damaged that industry. Likewise, Congress spread out the rescue money in 2008 and 2009 to deal with the infamous housing bubble that the government and the Federal Reserve System created. Yet here are the Usual Suspects once again gathering around Washington, collective hats in hand.
Airlines this time are promising (or at least say they are promising) not to use the newest amount of rescue money to engage in stock buybacks, but that hardly is reassuring. There is a larger problem, and it is not limited just to overvaluing their stock or their inability to learn any lessons from past disasters.
The greater problem of which we speak the Federal Reserve's ongoing policy of pumping up the system the way that nineteenth-century cattle ranchers would “water” their herds shortly before sales by feeding them salt. The overly thirsty cattle would drink more water than usual, and when they would be weighed during a sale, would seem heavier—and fatter—than they really were.
While Fed pumping (and simultaneous suppression of interest rates) inflates the value of stock—providing a façade of an economy performing better than it really is—it also inflates the capital assets of companies, and airlines are no exception. Because of past bailouts, glorified money printing by the Fed, and corporate practices such as stock buybacks, the nominal values of these firms are substantially higher than they would be in a more free market.
It is not difficult to see the vast network of market misrepresentations that has come with these policies. Wu notes:
The past decade was also an “easy money” decade, thanks to federal monetary policy that favored liquidity and low interest rates. Many of the firms now asking for bailouts took advantage of low interest rates to borrow heavily. For their part, many creditors lent money at rates that did not fully reflect the risks to these industries. The debt loads have created their own fragilities during the economic downturn.
In other words, one set of policies to get around natural market constraints has led to one distortion after another. We now are at the point where airlines—and the banks that have been underwriting them—are hooked on cheap money, inflated stock prices, and overvalued capital assets. If Congress, Trump, and the Fed actually were to step back and let market forces work, the short-term results would be devastating—to current airline management. Yes, the airlines would be bankrupt, but in real terms, they have been bankrupt for a long time and the COVID-19 crisis now has exposed this industry for the financial fraud that it has been.
Given that the various players previously mentioned have decided to keep the fraudulence afloat, what does that mean for the future of the airline industry? One cannot necessarily predict future events and when they will happen, but one can say with utmost certainty that the airlines soon enough will bring a new generation of management to Washington bearing the same tin cups that their forebears carried.
There is no doubt that airlines, along with Boeing and almost certainly Airbus, will find themselves in a future crisis that keeps them at least partially grounded. It could be another pandemic, a terrorist attack, or just awful political leadership, but one can be sure that something will occur to significantly reduce airline ridership. Reduced ridership means reduced funds, and a similar scenario to what we see currently playing out is sure to follow. At some point, however, the financial damage will be so great that not even the Fed will be able to “water” airline stock anymore and the cold water of massive bankruptcies will follow, imperiling the entire financial system.
These bailouts don’t just reward irresponsible business behavior, but they also impose restrictions that will create future problems. Airline firms receiving federal funding are not permitted to cut worker pay or lay off workers until at least September 30, which means that the aid is a glorified welfare check to labor unions representing airline workers. (The bailout rules also forbid stock buybacks and freeze executive pay at 2019 levels.) Bloated union contracts also are part of the problem with airline financial policies, so, in the end, Congress and Trump have managed to reward most, if not all, of the bad actors in this sorry saga.
What is done is done, but at least we can take a look at what would have happened had Congress just said no to the airlines this time. Unlike the current situation, in which we will see the “good” effects first and the “bad” effects down the road, a “solve your own problems” approach to the airlines would result in immediate layoffs, bankruptcies, and at least some airlines would completely go out of business.
Although most politicians and airline executives want us to believe that airlines are an “essential” industry that is the equivalent of the “thin blue line” between prosperity and a depressed economy, the markets see things differently. First, and most important, with the current situation there is no way that airlines can meet their loan payments, issue stock dividends, or even pay all of their employees at current rates (including their executives). Faced with that situation, the healthier companies would most likely come to terms with their creditors and restructure their finances.
The unlucky firms, however, would go into Chapter 7 bankruptcy, with all assets sold to pay off their creditors. That means massive layoffs, fewer flights—and realistic valuation of their assets. If the economic need for airlines really were as great as airline executives and political pundits claim, then whoever has purchased those assets at bargain prices would be able to put them to use in no time. The industry will have had its necessary cold-water bath, and asset values, along with prices of airline tickets, would settle at true market values, not the bloated numbers that pollute current airline balance sheets.
Because the “bad effects” of allowing airlines to go under would result at first in massive layoffs, bankruptcies, and fewer passengers in the air, the media and political classes would be condemning those who voted down the federal largess. “Bad effects,” not surprisingly, are quite visible and the plight of the newly unemployed and of stranded travelers plays well on the news.
The “good effects,” however, are less visible. By the time airline assets were sold at bankruptcy auctions and new companies hit the airport runways with market-priced capital and market-paid employees, the media would be on another crusade and the resurrection of airlines would not receive the coverage it deserved.
By shoveling out cash to the airlines and more promises to the banks whose unsteady solvency always lurks in the background, Congress and Trump have perpetrated a financial fraud greater than much of the mess we saw on Wall Street more than a decade ago. Yes, they will receive praise in the media and votes from those grateful to have taxpayers pay their wages and salaries, but they have solved no problems and have created a generation of new ones. Almost surely we will be covering the next crisis on these pages.