Friday, March 27, 2020

Bailouts v Bankruptcy

Bailouts are back. It's all 2008 all over again.

Bankruptcy of a large corporation does not leave a crater behind. Bankruptcy is reorganization and protection, not liquidation. The point of bankruptcy is precisely to keep the business going. When a corporation files for bankruptcy, the stockholders are wiped out, bondholders lose a lot and become the new stockholders. The company rewrites a lot of contracts -- union contracts requiring a plane to fly even with empty seats, contracts to buy fuel at high prices, gate leases, and so forth.

Bailouts are bailouts to stockholders, bondholders, creditors, unions. The first three all basically signed up to write insurance, and got a fee for doing so. Bailouts are not bailouts to "the corporation" which isn't a thing.  Maybe maybe there was a case in 2008 that big banks were "systemic" and their creditors could not take the losses that they had signed up to take. Not so industrial companies.

Airlines and similar companies are in this mess because they took on way too much debt. If the government does bail out their stockholders and creditors, it makes a lot of sense not to let them take on  so much debt again. Repurchases per se are not the villain, as companies can borrow and pay big dividends. We might also start by finally, finally, removing the huge subsidies to debt.

If you're not persuaded, Veronique de Rugy and Gary Leff have an excellent and exhaustive article on this The Case Against Bailing out the Airline Industry. 


  1. The proximate cause of the problems for the airline industry are outside of their doing: a sudden (and hopefully temporary) tightening of credit markets and a global pandemic which has decimated travel. What is achieved by putting them into bankruptcy? A new company taking over the airplanes tomorrow will not suddenly find people who want to fly, will not find interest rates on bonds lower, will not enjoy a lower equity risk premium.

    The United States will benefit from continued service. You can achieve it by lending the airlines money or you can achieve it by paying airlines in effect a "stand by fee" for maintaining some level of service.

    The airlines are very different from, say, the fracking industry which may not be viable even with loans and very different from the foreign owned cruise lines which do not provide the sort of essential service to Americans that the airlines do.

    Bankruptcy is a messy, uncertain, and expensive business and should be avoided if possible.

    1. But this applies to virtually all industries.

    2. You are still baking in moral hazards w bailouts and it is naive to assume people will expect this only happens during an unforeseen pandemic. The Auto industry got a bailout too during the 08 recession.

      All of these bailouts presume the American economy is flush with cash. But last I checked we had a huge debt plus a bunch of unfunded liabilities.

      No one likes a spoilsport and an economist job is to point out budget constraints.

    3. A few months ago, DAL (Delta Air Lines) had a market cap of about ~40G$, and a fleet of more than 900 airplanes. Their balance sheet total assets were ~60G$ and Balance sheet equity was ~15G$, Debt was ~17G$ and other liabilities were ~32G$.

      Airplanes are expensive. A smaller airliner Boeing 737 or Airbus 32X costs more that 100M$. The bigger ones like the Boeing 777 can run 300M$. Of course an airline company can't just own airplanes, they need ground equipment, computer systems, training facilities, etc.

      Airlines, in the best of times, are financial high wire acts. When oil was over 100$/bbl earlier in the decade, profitability was almost impossible.

      Given all of the risks in the business and the enormous capital investments, I am really reluctant mulct any airline management for borrowing money and leasing equipment. And yes, they have to pay dividends and make share buybacks when times are good, or they would never be able to attract equity.

      The United States is an enormous country. We must have affordable rapid travel across this country. It is an important mission of the Federal Government to ensure that it is available. And it has been so for more than 200 years. Remember the transcontinental railroad? How about the National Road?

      I agree with Absalon, bankruptcy proceedings with their attendant costs and uncertainty are simply unnecessary. The Federal Government can make loans to the airlines and Congress can assert priority for them over other debts of the Airline, similar to 31U.S.C. §3713. DiP financing would not be better.

      After the dust settles, the Federal Government should look at future mechanisms, to prevent future problems. There could be a special business interruption insurance facility. But, because of anti-trust issues and the uncertainty of pricing, the feds will have to be involved in its establishment.

    4. American Airlines is already underwater(underwater by 5 billion if you dont count goodwill) as of March 2020. The debt load will keep adding up until a vaccine is found. Even after the vaccine is found, people arent going to suddenly jump on planes. With bankruptcy protection, they can restructure and still keep their jobs. I feel its only a matter of time before they do this, but you never know what the government has in store. Either ways, too risky!

  2. When you speak of bankruptcy as a "...reorganization and protection, not liquidation", you are referring to Chapter 11 which is a debtor-in-possession arrangement with creditors. Bankruptcy leading to liquidation refers to Chapter 7 of the code. The difference comes down to a decision that the corporation is worth more dead than alive. Chapter 11 bankruptcy requires a source of bridging finance that will see the corporation through the often very lengthy legal process until it can emerge as a resuscicated entity. Absent that financial life-line, the corporation moves quickly into Chapter 7 (dissolution and windup). For multi-billion dollar corporations, Chapter 11 is likely viable; for small and medium sized corporations who rely on commercial banks for debt financing, Chapter 7 is more prevelant. If you're looking at a broad swathe of businesses entering bankruptcy, then it may make more sense for government to step in an provide a safety net. That was the case in 2009. It may well be the case in 2020. Principle is one thing; expediency is another. Do we know what the consequences of choosing principle over expediency are at this point?

  3. If they took "way too much debt". What should be the proporton htat should be optimal? Airlines are not startups. Like utilities, they have a high proportion of tangible assets.

    Maybe the problem are absurd regulatons. Take for instance Qantas. For some unexplained reason, the Australian Government considers it a strategic asset, so it cannot be taken over by a foreign owner. As a consequence, it has continuously blocked any attempt by Qantas to merge with regional partners, Like Emirates or Singapore Airlines, to improve efficiency and reduce costs.

    And now with this problem, should Qantas not expect to be helped by the government, for the same absurd "national interest" excuse they peddled until now? It does not seem fair to me.

  4. The government made the mistake of thinking like a commercial creditor. As the provision is for a public purpose (maintaining solvency for companies during the pandemic that the market would not fund) and the goals are different (keeping employment and capital stock ready to go for recovery), the "bailouts" could have been structured differently.

    A simple way to do this would have been to put the government loan at a very low interest rate (maybe based treasuries?), but at higher standing that unsecured creditors.

    In addition, companies could not pay dividends either in cash or in-kind, repurchase stock, divest or acquire significant assets or other companies, or repay lower-priority debt before their maturity dates until the government loan was retired.

    No commercial entity would make this loan. But government can. The onerous restrictions would provide the incentive for companies to repay the loan ASAP.

  5. Companies going bankrupt, in a perfect world, does indeed punish bad corporate strategy and behavior. As you said, equity holders out, bond holders take control (lawyers get rich...) But in this situation with millions of Americans through 401-K's, endowments, foundations, etc. getting whacked due to a random, destructive, economy-wide event like this, the typical solution is not a good one

  6. One idea that came to my mind is that essentially all debt contracts should come with an “crisis provision”, as follows: if the government decides to declare a “systemic financial emergency”, each debt security immediately converts to a prespecified quantity of equity. In normal times, companies can go bankrupt and reorganize, and can lever up to their heart’s content. But if we are in a situation like today, the government can pull a simple trigger. Yes there is a strong element of discretion, but still it might be an improvement over the current setup.

  7. Bankruptcy would mean that stockholders who went along with management's leverage strategy, would loose something for that behavior.

  8. Why not bankruptcy instead of bailouts? United Airlines filed for Chapter 11 reorganization in 2002. During restructuring UAL continued to operate, emerging from bankruptcy in 2005. Taxpayers were not forced to bail out creditors and the risk of complete loss was confined to shareholders and creditors.

  9. Of course repurchases are a problem. When times were good the debt/equity holders encouraged this behaviour and enriched themselves. Now when times are bad you want the taxpayer to transfer their wealth to debt/equity holders? They need to be taken to zero. The taxpayer needs to become the new equity holder.

  10. John, what do you think about the argument that a lot of the reason we trust airlines is because of the franchise / brand value of the company and the unwillingness of stockholders to damage that brand value. Once the value of the company's stock essentially becomes an option on the company if it were to be bailed out (i.e, the real equity of the company is wiped out due to a discontinuity in markets caused by a shock like the coronavirus) there is no incentive for management to protect that brand value UNLESS there is at least the possibility of a bailout. I've heard even some libertarians make this argument to justify bailouts in a situation such as coronavirus, where the moral hazard risk is not as substantial as in 2008.

    I don't entirely buy this argument, but I've heard some smart people who I generally agree with support it, so I would like to hear your response to it.


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