Attention All Passengers (7 page)

. . . and Against

Kevin Mitchell, the president of the Business Travel Coalition, asks this question: “Under deregulation, how many stakeholders are happy? Investors? Management? Labor? Customers? None of the above.” Consumer advocate Kate Hanni goes even further: “I think it has ruined the airline industry. It's nearly impossible for anyone to make money for more than three quarters. In general, the stockholders and low-level workers and passengers have borne all the risk, but not the executives.”

In 2009 I was contacted by Demos for a research project titled “Flying Blind: Airline Deregulation Considered.” The report concluded that the airline industry is more concentrated than ever, and “most of the major U.S. airlines” are relying on an increase in outsourcing, service cutbacks, hidden charges, employee wage and benefit reductions, and consolidation, with “the hope of surviving long enough to be in a position to turn a profit and expand again during a future economic recovery.”

Not surprisingly, many labor officials are unhappy with how deregulation has played out for the airlines, since by some estimates the industry worldwide has lost nearly one million jobs over the last thirty years. Robert Roach of the International Association of Machinists says it has spurred many job losses, and therefore customer service has deteriorated as well.
3
He adds, “It's been consistently downhill since 1978. With airlines it's always, ‘We have to compete with the lowest cost structures.' ” For his part, James P. Hoffa of the Teamsters says deregulation has led to a continual decrease in standards, which is stressing aviation.

Ironically, one of the loudest voices belongs to the man who arguably was more successful than any other airline executive at parlaying deregulation into corporate success: Robert Crandall. Under his stewardship, American Airlines didn't just have a growth plan, it had a Growth Plan, articulated and shared with the world. While deregulation helped kill former giants such as Pan Am, TWA, and Eastern, it also helped propel midrange carriers into today's industry titans: United, Delta, and certainly American. Yet Crandall has come full circle: just as in the 1970s, today he is opposed to deregulation and is probably the industry's strongest proponent for reregulating.

He told me, “Everything really was relatively fine up until 1978. Now I do think the CAB was unduly restrictive. I think we failed to appropriately regulate labor. So I think the CAB should have permitted more competition, and I think labor should have been regulated. But the whole notion of a regulatory structure that says the fares should be about the same on a per-mile basis . . . and that efficient operators should be able to earn a return on capital is appropriate for a utility-equivalent business.”

Other voices are drowning him out, notes Professor Paul Dempsey, an expert on aviation law who refers to Crandall as “the brightest man I ever met in the airline industry.” He attended a Wings Club luncheon in New York City in 2008, when Crandall spoke about the industry's need for “a dollop of regulation, along with new government policies and appropriate investment.” Several years later, Dempsey said it was extraordinary the remarks have attracted so little attention, as if they were never uttered.

The R-Word: Reregulation

Let's note an important point: it's not that airline executives are opposed to government intrusion; they're just opposed to it when it doesn't help them. In my travel column for USAToday.com in 2008, I addressed this phenomenon and noted that over the years airline executives have always been eager to welcome government intrusion when it works in their favor, a phenomenon best described as
hypocrisy
.

Over the course of researching this book I discussed with dozens of industry experts what some form of reregulation might look like. A time trip to 1978? Or minor tweaking, such as Crandall's “dollop”? But a problem emerges. With many airline executives and analysts, discussing the free market is akin to discussing Torah or the Koran or the New Testament, and heresy is not tolerated.

Dempsey has noticed it as well: “A lot of policy is driven by ideology. It's almost religious. . . . Communists were viewed as having a nearly religious passion—but free market economists have the same passion. Both are equally unwilling to look at the failures of their systems.” Referring to deregulation as a “mantra,” Dempsey says, “It has to do with belief rather than rational thought.” Even a strong free-market proponent such as Borenstein agrees.

Not all those who recommend some form of reregulation necessarily suggest the U.S. government get back in the business of determining fares. Dempsey notes this is rife with challenges: “Do you set the fares so that you make United unprofitable and make JetBlue profitable? Or so that you make United profitable and JetBlue obscenely profitable? This is politically risky.” He adds, “Airlines are doomed to fail in the long term.”

Others offer interesting perspectives as well:

• James Lardner of Demos: “Prior to 1978, under Alfred Kahn, there was a lot of dynamic stuff happening. Which suggests there is a middle ground between regulation and complete deregulation. . . . The airlines tend to get a disproportionate power through reservations systems, frequent flyer programs, fortress hubs, etc. So you can treat them like a public utility, either wholly or on routes where there is no competition.”

• Labor leader Pat Friend: “Complete reregulation is never going to happen. I think we need open-minded people to sit down and say, ‘Where can we tweak this?' The airlines are supposed to serve the public and serve the economy and not be allowed to run amok.”

• Labor leader Robert Roach: “We need a mild form of reregulation.” This would include restricting aircraft maintenance to the United States, banning predatory pricing, and tightening workforce rules.

• Consumer advocate Kate Hanni: “I don't know if it includes rates and routes, or simply a comprehensive reregulation without rates and routes.”

• Aviation law professor Paul Dempsey: “The mantra of the right is that the government can do no right and the market can do no wrong. . . . Still there is no meaningful discussion about reregulation. Things have to get a lot worse before they get better. So I guess things are not bad enough now. I guess it hasn't gotten bad enough yet if the secretary of transportation says reregulation is not on the table. I think deregulation has been a catastrophic failure. And I recognize that I'm in the minority. But I think I'm right. I wish I was wrong.”

For insight I turned to the best boss I ever had in the airline industry, Harris Herman, who was president of the Pan Am Shuttle in a kinder and gentler time. He noted that be began his airline career fourteen years before deregulation, when it was a very friendly, low-pressure environment. He also believes the industry could not have stayed regulated until today (even though undoubtedly Pan Am would still be around).

Michael Levine believes any talk of reregulation falls prey to the Nirvana Fallacy, in which some believe flawed markets can be corrected by perfect regulation, while others believe perfect markets are marred by flawed regulation. The truth, he asserts, is that in reality we have only flawed markets and flawed regulation, and zealots on both sides place too much belief in the inherent powers of both markets and regulation.

I pointed out to him what I've uncovered about airline maintenance outsourcing and the FAA's failure to provide oversight. And Levine responded, “So your problem is you have found flawed markets and flawed regulation. And I'm not telling you that you haven't found it. But I'm telling you that when you write about it, you need to ask, is it really going to be any better with more regulation? Or is [New York senator] Chuck Schumer just going to be able to stand up and have a press conference?”

Point taken. Ultimately we may need to decide which entity we trust
less
—the U.S. government or Corporate America.

The Best Airline Investment Advice: Don't!

The reregulation argument is bolstered by the industry's dismal financial performance since 1978. Airlines make for rotten long-term investments, and with the singular exception of Southwest, U.S. airlines are particularly rotten over time. In fact, some argue that all forms of transportation have duped investors. Sir Richard Branson, the founder of Virgin Atlantic Airways and its sister carriers located around the world, as well as minority owner of Virgin America, put it best. When asked how to become a millionaire, the man who had earlier founded Virgin Records replied: “There's really nothing to it. Start as a billionaire and then buy an airline.”

An awful lot has been written about the economic state of the industry, and analysts crank out more material every week. It's impossible to address virtually any aspect of the business—passenger service, labor, maintenance, safety, security—without providing an economic perspective. All roads lead back to airline costs, and what airlines are doing to cut those costs.

Throughout its history, the industry has weathered economic peaks and valleys, but since deregulation it's positively been a roller-coaster ride. For domestic airlines, there were losses of $23.7 billion in 2008 and $2.5 billion in 2009. Then a surprise return to profitability in 2010 due to increased demand and higher fares, followed by more losses for most U.S. carriers in early 2011. Along the way, fortunes have been made—and unmade. Travel pricing expert George Hobica points out, “All those many billions of dollars have been lost. Where did they go? . . . Who really has lost?” He counts employees, investors, and banks among the victims, and says, “It's incremental. ATM fees probably went up half a cent because banks took a bath with airlines.”

Many aviation pundits believe that any discussion of airline stocks begins and ends with Warren Buffett, arguably the world's shrewdest buyer and seller of capital. In a letter to shareholders of Berkshire Hathaway in February 2008, he famously stated: “The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a
durable
competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.”

Buffett went on to detail his “shame” in buying preferred stock in USAir (later US Airways) back in 1989, just before “the company went into a tailspin.” He further noted, “The airline industry's demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.” But Buffett won't make the same mistake twice: “I have an 800 number now which I call if I ever get an urge to buy an airline stock. I say, ‘My name is Warren, I'm an air-aholic,' and then they talk me down.”

Former American Airlines CEO Bob Crandall maintains investors and airlines are simply a bad match: “No, you can't make money in the airlines. You can trade. But from an investment point of view, they're a catastrophe. They always have been a catastrophe.” He's echoed by legions of analysts, journalists, and everyday investors. As columnist Joe Brancatelli noted on Portfolio.com: “Say whatever else you will about airlines, but one fact is incontrovertible: They make lousy investments. For about 20 years, give or take a quarter or two, only the shorts have profited from airline stocks.”

And with credit ratings, Airlines for America points out that
no
passenger airline—even the most efficiently run—enjoys a rating of A- or better:

Southwest                  BBB-

Alaska                       BB-

Allegiant                   BB-

Delta                         B

United                       B

American                  B-

JetBlue                      B-

US Airways               B-

As for these titanic losses, economist Severin Borenstein says, “The legacy airlines do not have a workable business plan. And they compensate by using their power to fence out competitors and continue to sustain high costs. In some cases they don't have the management capability and in other cases they don't have labor union cooperation.” He adds, “We are seeing a trend of legacy airlines entrenching long-run.”

But there is one notable exception. In an industry known for burning through barrels of fuel
and
barrels of red ink, Southwest Airlines has consistently, reliably, and repeatedly done what
no
other U.S. air carrier has managed to do since Richard Nixon was president: make money. At the end of 2010, the Dallas-based company marked its thirty-eighth consecutive year of profitability.

Others have made a comfortable living betting against airline profitability. As one major airline CEO points out, “There's a dirty little secret about industries such as this one. There are always people who profit and benefit from dysfunction.”

Grounded Forever: Airline Bankruptcies and Shutdowns

In late 1991 I left the airline industry for good after the Pan Am Shuttle was sold to Delta and Pan Am itself succumbed; that same year saw the shutdowns of two other major domestic carriers, Eastern and Midway. That fall I applied for unemployment insurance and traveled to the New York State Department of Labor office in Flushing, Queens, close to both LaGuardia and JFK airports. I soon found that in order to expedite our claims, there were two lines in the office; one handwritten sign read
PAN AM & EASTERN
and the other sign read
ALL OTHERS
.

Since deregulation, bankruptcies have become ubiquitous in the airline business. According to Airlines for America, there have been 189 bankruptcy filings just since the deregulated era began in 1979. The A4A points out that prior to 1978, bankruptcies were “extremely rare,” with the CAB arranging “marriages” between failing carriers such as Northeast and surviving carriers such as Delta.