American Airlines Enters Bankruptcy

American Airlines filed for bankruptcy this morning, despite the fact that they have more than $4 billion in cash.  They were the last major US airline to have avoided the bankruptcy courts.


This certainly took me by surprise.  American had been locked in an intractable dispute with its pilot's union, but there was no particular reason that they had to do this right now.

On the other hand, why not right now?  If they couldn't come to a deal with their unions, it was only a matter of time.  Their compensation costs are much higher than their competitors, in an industry where price competition is brutal.

Legacy airlines are an almost uniquely terrible business to be in.  You've got an enormous fixed cost, in the form of giant, incredibly expensive planes, and landing slots.  Meanwhile, your product has practically no marginal cost--adding an extra passenger to a plane is a very small cost compared to getting the plane in the air.  And each passenger slot on a plane is a wasting asset: once the plane takes off, it's worth nothing to you.

That's a recipe for fierce pricing wars.  The airlines have made up for some of it with extremely sophisticated pricing strategies, but there's only so much you can do when everyone can comparison shop your product from the comfort of their couch.  No wonder airlines have struggled so much since deregulation.

Of course, that's not unique to airlines--hotels are expensive to build, and an unrented room can't be stored up to sell later.  But airlines do have another problem that's special to them: their unions, which are both powerful, and plentiful.

Whatever you think about the United Autoworkers, at least there's only one of them.  The union doesn't want to kill the company any more than management does.  In theory, at least, you should be able to work something out.

But when there are three or four unions--pilots, flight attendants, mechanics, and baggage handlers--things get complicated.  All of those groups are completely necessary to make sure that the plane gets in the air.  If one of them doesn't show up, you lose all the money on every seat.

Those unions are not just trying to get more money out of shareholders, or customers.  They're also in competition with each other.  A single union that leaves errs on the side of claiming too little value can hope to get some of it back in future negotiations. But if the pilot's union leaves money on the table, it's all too likely to get picked up by the flight attendants.

You can finesse this problem when the company's doing well--that's one of the reasons that Southwest has excellent relations with its unions, and why the union troubles didn't emerge at the majors after deregulation.  But when times aren't so flush, this dynamic becomes a problem.  The company's past labor agreements don't leave much margin for error--particularly when there were sizeable pensions, as there have been at most of these legacy airlines.

It's not clear what will happen to American's $8 billion worth of pension obligations, which are underfunded by billions, but I'd expect that the company will push hard to shed them.  It will also want the judge to rewrite its labor contracts.

That's a big blow for the workers, who have come to expect a certain standard of living--and a predictable retirement.  The pilots, in particular, would be hard hit--as I understand it, their pension payouts are normally quite a bit higher than the maximums insured by the Pension Benefit Guaranty Corp, which tops out at around $50,000 a year.  Indeed, last month I blogged about American pilots taking early payouts to avoid this sort of PBGC haircut--a sort of "pension run" which may have put further pressure on the company to declare bankruptcy.

But though it's terrible for the workers and pensioners, the company's in it's fourth straight year of losses, and they have very little room to raise prices.  Something had to give.
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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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