[Senate Hearing 109-1093]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 109-1093
 
                      AIRLINE FINANCIAL STABILITY

=======================================================================

                                HEARING

                               before the

                        SUBCOMMITTEE ON AVIATION

                                 OF THE

                         COMMITTEE ON COMMERCE,
                      SCIENCE, AND TRANSPORTATION
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 13, 2005

                               __________

    Printed for the use of the Committee on Commerce, Science, and 
                             Transportation




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       SENATE COMMITTEE ON COMMERCE, SCIENCE, AND TRANSPORTATION

                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION

                     TED STEVENS, Alaska, Chairman
JOHN McCAIN, Arizona                 DANIEL K. INOUYE, Hawaii, Co-
CONRAD BURNS, Montana                    Chairman
TRENT LOTT, Mississippi              JOHN D. ROCKEFELLER IV, West 
KAY BAILEY HUTCHISON, Texas              Virginia
OLYMPIA J. SNOWE, Maine              JOHN F. KERRY, Massachusetts
GORDON H. SMITH, Oregon              BYRON L. DORGAN, North Dakota
JOHN ENSIGN, Nevada                  BARBARA BOXER, California
GEORGE ALLEN, Virginia               BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire        MARIA CANTWELL, Washington
JIM DeMINT, South Carolina           FRANK R. LAUTENBERG, New Jersey
DAVID VITTER, Louisiana              E. BENJAMIN NELSON, Nebraska
                                     MARK PRYOR, Arkansas
             Lisa J. Sutherland, Republican Staff Director
        Christine Drager Kurth, Republican Deputy Staff Director
                David Russell, Republican Chief Counsel
   Margaret L. Cummisky, Democratic Staff Director and Chief Counsel
   Samuel E. Whitehorn, Democratic Deputy Staff Director and General 
                                Counsel
             Lila Harper Helms, Democratic Policy Director
                                 ------                                

                        SUBCOMMITTEE ON AVIATION

                    CONRAD BURNS, Montana, Chairman
TED STEVENS, Alaska                  JOHN D. ROCKEFELLER IV, West 
JOHN McCAIN, Arizona                     Virginia, Ranking
TRENT LOTT, Mississippi              DANIEL K. INOUYE, Hawaii
KAY BAILEY HUTCHISON, Texas          BYRON L. DORGAN, North Dakota
OLYMPIA J. SNOWE, Maine              BARBARA BOXER, California
GORDON H. SMITH, Oregon              MARIA CANTWELL, Washington
JOHN ENSIGN, Nevada                  FRANK R. LAUTENBERG, New Jersey
GEORGE ALLEN, Virginia               BILL NELSON, Florida
JOHN E. SUNUNU, New Hampshire        E. BENJAMIN NELSON, Nebraska
JIM DeMINT, South Carolina           MARK PRYOR, Arkansas


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on July 13, 2005....................................     1
Statement of Senator Burns.......................................     1
Statement of Senator DeMint......................................    44
Statement of Senator Inouye......................................     2
    Prepared statement...........................................     2
Statement of Senator Lautenberg..................................    46

                               Witnesses

Baker, Jamie N., Vice President, U.S. Equity Research, JPMorgan 
  Securities, Inc................................................    30
    Prepared statement...........................................    31
Hecker, JayEtta Z., Director, Physical Infrastructure Issues, 
  U.S. Government Accountability Office..........................     3
    Prepared statement...........................................     5
May, James C., President/CEO, Air Transport Association of 
  America, Inc...................................................    19
    Prepared statement...........................................    21
Roach, Jr., Robert, General Vice President of Transportation, 
  International Association of Machinists and Aerospace Workers 
  (IAM)..........................................................    36
    Prepared statement...........................................    37


                      AIRLINE FINANCIAL STABILITY

                              ----------                              


                        WEDNESDAY, JULY 13, 2005

                               U.S. Senate,
                          Subcommittee on Aviation,
        Committee on Commerce, Science, and Transportation,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 9:58 a.m., Senate 
Russell 253, Hon. Conrad Burns, Chairman of the Subcommittee, 
presiding.

            OPENING STATEMENT OF HON. CONRAD BURNS, 
                   U.S. SENATOR FROM MONTANA

    Senator Burns. We'll call the Committee to order this 
morning, and there are quite a lot of things going on in this 
part of the world, and we want to thank our folks for coming in 
this morning. I welcome this panel of witnesses, and especially 
in our continuing efforts to work toward ideas for the next FAA 
reauthorization bill, we are examining the financial condition 
of the airline industry. It is our intent to focus on a wide 
array of internal and external factors that shape the industry 
today. I think it's important this subcommittee understands the 
underlying principles, and problems in the industry in order to 
make an educated policy decision. As you know, as policymakers, 
we should operate with the idea to do no harm, and when we do 
know there are extenuating circumstances under legislation and 
sometimes we don't see it coming.
    There are certainly several caveats to the airline 
industry. I anticipate that we will discuss them, among others, 
the relationship between the legacy carriers and the low-cost 
carriers, so-called rising fuel costs, aviation taxes and fees, 
labor and management relations, capacity concerns, fair 
pricing, aircraft leasing, industry consolidation, and the role 
that Chapter 11 bankruptcy plays in the industry. As if there 
is not enough on the platter already, this sort of fills the 
boat.
    Since 2000, many in the airline industry have experienced 
poor financial results and have lost somewhere around $35 
billion with the expectation of heavy losses this year. A 
majority of those problems can be traced back to the horrific 
events of 9/11 and SARS, but there are also several factors 
that were in place, and starting to evolve prior to 9/11.
    Legacy carriers--the business models--have been criticized 
for years, but the fragile line between profitability and red 
ink was not exposed until we had seen the events of 9/11, and 
the effects of that along with the downturn of the overall 
economy. One could argue that we are starting to see the actual 
results of deregulation now much more than the 1980s and 1990s.
    We now have prospering, low-cost carriers, evolving 
business, and aviation ventures, and because of it, more people 
are flying today. In fact, just last month we had a hearing on 
passenger levels and system capacity. Our traffic levels are 
back to record levels, planes are full, but many of the legacy 
carriers are still seriously struggling.
    It's tough to understand why, in a business that seems to 
be booming, most of the legacy carriers are busting. For a 
Senator from Montana, it's even more disconcerting to see our 
legacy traditional hub-and-spoke carriers in dire straits. The 
hub-and-spoke model has provided historical foundation for 
rural access to my state and many others that do not fit into 
the traditional low-cost carrier business plan. Legacy carriers 
are making significant gains in improving their bottom lines, 
but still reporting large financial losses. Today we look at 
some of the reasons why.
    Our panel consists of a broad spectrum of aviation experts, 
and I look forward to their testimony. This morning I want to 
thank them for coming, because we know the industry is vitally 
important to this country for commerce and I know you take your 
job very, very seriously. Senator Inouye, thank you for coming 
in this morning, also.

              STATEMENT OF HON. DANIEL K. INOUYE, 
                    U.S. SENATOR FROM HAWAII

    Senator Inouye. Well, I thank you very much. I have a 
prepared statement I'd like to have made part of the record. 
Like a few of my colleagues, I do a lot of flying. In fact, 
last week, I spent more time in the air than on the ground. I 
spent 20 hours in Hawaii and 22 hours in the air. And so I'm 
well aware of the low fares. I'm well aware of the packed 
aircraft, and, yet, I know that since 2001, we have a shortfall 
of $35 billion. About 150,000 have lost their jobs, so this is 
a serious situation, and we are looking for answers, and I 
would like to commend my Chairman for calling this hearing.
    [The prepared statement of Senator Inouye follows:]

 Prepared Statement of Hon. Daniel K. Inouye, U.S. Senator from Hawaii

    Most aviation observers understand that despite the low fares and 
packed airplanes that have become commonplace, the Nation's airlines 
continue to struggle through the toughest financial period in the 
history of commercial aviation. This has not been a blip on the 
proverbial radar screen.
    This has been an extended economic slump that resulted in the 
collective loss of tens of billions of dollars by the major carriers 
and the elimination of nearly 150,000 airline jobs over the past four 
years.
    Most Americans recognize how important a healthy aviation industry 
is for a country as large as the U.S. However, it is often easy to 
forget the complex factors affecting our airlines, particularly, when 
planes generally run on schedule and move passengers thousands of miles 
in a fraction of the time that other modes require.
    In my home State of Hawaii, the service air carriers provide is 
vital to our way of life. Hawaii residents use planes as a primary mode 
of transportation. Many do so on a daily basis as part of their commute 
to and from work.
    Whether travel, tourism, or trade, in Hawaii, we depend on the 
commercial aviation industry to provide us with timely contact between 
the islands, the continental U.S., and the rest of the world. Yet our 
two primary airlines, Hawaiian and Aloha, have operated under 
bankruptcy protection for much of the past two years. Their precarious 
financial situation has constantly threatened significant service 
disruptions, which would be devastating to the local economy.
    Hawaii primarily counts on major carriers for service beyond our 
borders, and like our local carriers, these airlines are facing great 
financial difficulties.
    When the Federal Government shut down the Nation's airspace for 
several days following the 9/11 attacks, most Americans experienced a 
temporary limit to their mobility in the wake of the tragedy. For the 
people of Hawaii, the shutdown directly and immediately impacted their 
livelihoods. For those needing medical assistance or facing subsequent 
emergencies, it became a matter of life or death.
    There are many rural or isolated communities that could face 
similar circumstances if a local airline fails or their access to the 
National Airspace System is reduced in the wake of extreme cost-cutting 
measures. In a globalized economy reliant upon air travel, the impact 
to rural communities could be increasingly detrimental. We must 
continually work to ensure that all of our citizens have a fair 
opportunity to access this nation's unparalleled aviation 
infrastructure.
    I wish to take this opportunity to recognize the employees in the 
aviation industry. They have been especially resilient during this 
difficult period. They have seen nearly one-third of all airline jobs 
eliminated, and virtually every employee has seen their pay and 
benefits reduced. They understand intimately the importance of this 
industry and have gone above and beyond to see that it survives.
    Unfortunately, if we do not begin to solve the problems plaguing 
the air carriers, we will see more failures in coming months and 
certainly more jobs cut. The combination of excess capacity, record gas 
prices, and a market flush with consistent, low fares has effectively 
neutralized the major carriers' intense, cost-cutting measures. The 
Bush Administration's effort to add additional security and pension 
fees has not been helpful either.
    The U.S. airline industry is now at a crossroad. Some legacy 
carriers have spent the last few years aggressively working to compete 
will the budget carriers and are now approaching profitability. They 
are beginning to prove that they can adapt and survive. Yet at the same 
time, factors like spiraling gas prices are pushing others to the brink 
of bankruptcy or limiting their ability to get out of it.
    The financial stability of the airlines is one of the most 
important issues that we face this session. We must carefully consider 
the needs of the industry as a whole, make certain that urban, 
suburban, and rural communities can access air travel, and advance 
forward-thinking initiatives that will help ensure a prosperous, 
vibrant aviation industry for decades to come.

    Senator Burns. Thank you very much, Senator, and your full 
statement will be made part of the record. We'll just take the 
panel now this morning. As it's listed here, Ms. JayEtta Z. 
Hecker, Director of Physical Infrastructure Issues, U.S. 
Government Accounting Office, GAO, and we welcome you this 
morning and look forward to your testimony. By the way, we 
would like to condense some of this. You bring up the 
highlights and then we'll put your full statement in the 
record. Thank you.

           STATEMENT OF JayEtta Z. HECKER, DIRECTOR,

                PHYSICAL INFRASTRUCTURE ISSUES,

             U.S. GOVERNMENT ACCOUNTABILITY OFFICE

    Ms. Hecker. Thank you, Mr. Chairman. Senator Inouye, I'm 
very pleased to be here today. As you know, we've been 
conducting analyses of the airline industry at the direction of 
Congress for a number of years. We had a prior report last year 
that talked about the factors that were leading to the 
extremely difficult financial condition. The current work that 
I'm reporting on is focusing on bankruptcy and pension issues 
in airlines and my remarks--I do have a slide presentation. I 
don't know if you have that. It may be useful because I have a 
number of charts that I think tell the story.
    Senator Burns. We all have copies, I think, and as you 
know, this is a technology committee, of which we have none.
    Ms. Hecker. Hopefully paper will work in this instance. The 
two topics are the financial difficulties faced by the legacy 
carriers and the major factors behind them, and then the effect 
of bankruptcy on the industry and competitors.
    On the first topic, there is, of course, no secret that the 
airlines face severe financial difficulties. There has been not 
only the significant change in demand, particularly the 
increased price sensitivity of business travelers, but there 
have also been enormous changes in the competitive environment 
where low-cost carriers now are available to 85 percent of all 
passengers. The low-cost carriers are really the price setters 
and have transformed their competitive environment in the 
airline industry.
    This really has led to the major effort by the legacy 
carriers to control costs, and the next slide, the one with the 
two lines, basically outlines the changes in the costs for 
available seat-miles for both the legacy carriers and the low-
cost carriers, and you see they were going up until 2001, and 
then both were coming down, but the main point is that the 
difference has actually increased, so as the low-cost carriers 
have continued to expand, their costs-per-seat-mile have 
actually gone down, and the difference--the cost disadvantage--
has actually increased, and you see the factors there, labor, 
pensions, fuel, and a wide variety of other factors.
    Of course, the next page shows the fuel prices, and there 
is no doubt the prior page said that the difference, this is 
not the total fuel, but the difference in the fuel costs for 
low-cost carriers, they actually had a fuel advantage, more 
fuel efficient airplanes and more efficient use of airplanes, 
so all of the costs have been hurt by these rising prices, but, 
of course, on a differential basis. My main point is really 
this next chart about fixed obligations, and what is important 
here is its absence of the liquidity that really drives 
carriers into bankruptcy, along with inability to renegotiate 
obligations and acquire new capital.
    The first column is the cash on hand at the end of 2004 and 
then the next four bars basically outline the fixed 
obligations. These are fixed. These are not flexible with 
changing your business model, and how they severely strain and 
overpower the amount of cash on hand. The other thing is to see 
how diverse these factors are. There has been a lot of talk 
about pensions. Pensions is only one-sixth of the fixed 
obligation overhang that is so threatening the financial 
condition of the major carriers.
    The second objective, then, is to look at the whole issue 
of bankruptcy. There is widespread expectation of presumption 
that bankruptcy was used to harm competitors by either lowering 
prices or keeping capacity in the market longer. Our first 
chart on page 8 basically outlines how bankruptcy and 
liquidations are more common in the airline industry. In fact, 
the airline industry is one of the worst performing sectors of 
all, and what we have here is, not only is the rate of 
bankruptcy and liquidation more common, but the potential to 
recover is also more difficult for carriers.
    Our data shows that of 160 bankruptcies since 1978, only 20 
have actually survived to this day. Another factor we found is 
the airline bankruptcies last longer, and as I said have these 
less successful outcomes. The next, page 9, is this growth of 
airline industry capacity and charted along with major airline 
liquidations, and the point here is that we found little 
evidence that bankruptcies are actually contributing to the 
overcapacity. As you see, it's really those gray areas, it's 
the recessions that have been the only factors that lead to 
decreases in industry capacity.
    We have concluded that bankruptcies are not looked at for 
competitive advantage. It's not a panacea. It involves many 
costs, many risks, and in our view is looked at by firms as a 
last resort. And if anything, the poor history really is a 
testimony to that.
    Our concluding observations then is that we, as you said, 
Mr. Chairman, the industry is really still playing out the 
deregulation policies of the 1970s. The restructuring is 
continuing. The emergence, the full, powerful, ever present 
emergence of low-cost carriers, as I said, is available to 85 
percent of the population, and the legacy carriers 
profitability depends on controlling those costs where they 
still have that disadvantage.
    An important part of our conclusion, contrary to what is 
seen as accepted wisdom, bankruptcy and liquidation are a 
reflection of, but not the cause of industry stability, and in 
our view, some carriers will terminate pension plans through 
the bankruptcy process under the current conditions. Our most 
focused observation is this last point, though, and it's the 
terminating pensions or amortizing their contributions over a 
longer period will not solve the underlying legacy problems, 
fundamental structural concerns and cost disadvantage, so even 
though there may be a potential for a temporary reprieve, it is 
only a limited part of the liquidity problem, and the cost-
differential, and, thus, in our view, there shouldn't be a 
sense that there is a silver bullet to somehow fix the dire 
financial condition of the legacy carriers. That concludes my 
remarks, Mr. Chairman.
    [The prepared statement of Ms. Hecker follows:]

          Prepared Statement of JayEtta Z. Hecker, Director, 
 Physical Infrastructure Issues, U.S. Government Accountability Office

    Mr. Chairman and members of the Subcommittee:
    We appreciate the opportunity to participate in today's hearing to 
discuss the financial condition of the U.S. airline industry--and 
particularly, the financial problems of legacy airlines.\1\ Since 2001, 
the U.S. airline industry has confronted financial losses of 
unprecedented proportions. From 2001 through 2004, legacy airlines 
reported losses of $28 billion, and two of the nation's largest legacy 
airlines--United Airlines and US Airways--went into bankruptcy,\2\ 
eventually terminating their pension plans, and passing the unfunded 
liability to the Pension Benefit Guaranty Corporation (PBGC).\3\ Two 
other large legacy airlines have announced that they are precariously 
close to following suit.
    In recent years, considerable debate has ensued over legacy 
airlines' use of Chapter 11 bankruptcy protection as a means to 
continue operations, often for years. Some in the industry and 
elsewhere have maintained that legacy airlines' use of this approach is 
harmful to the airline industry as a whole, in that it allows 
inefficient carriers to stay in business, exacerbating overcapacity and 
allowing these airlines to potentially under-price their competitors. 
This debate has received even sharper focus with US Airways' and 
United's defaults on their pensions. By eliminating their pension 
obligations, critics argue, US Airways and United enjoy a cost 
advantage that may encourage other airlines sponsoring defined benefits 
plans to take the same approach.
    Last year, we reported on the industry's poor financial condition, 
the reasons for it, and the necessity of legacy airlines to reduce 
their costs if they are to survive.\4\ At the request of the Congress, 
we have continued to assess the financial condition of the airline 
industry, and, in particular, the problems of bankruptcy and pension 
terminations. Our work in this area is still under way.\5\ Nonetheless, 
we can offer some preliminary observations about what we are finding. 
Our statement today describes our preliminary observations in three 
areas: (1) the continued financial difficulty faced by legacy airlines, 
(2) the effect of bankruptcy on the industry and competitors, and (3) 
the effect of airline pension underfunding on employees, retirees, 
airlines, and the PBGC. Our final report, which we expect to issue in 
September, will offer additional evidence and insights on these 
questions.
    In summary:

   U.S. legacy airlines have not been able to reduce their 
        costs sufficiently to profitably compete with low-cost airlines 
        that continue to capture industry market share. Challenges that 
        are internal and external to the industry have fundamentally 
        changed the nature of the industry and forced legacy airlines 
        to restructure themselves financially. The changing demand for 
        air travel and growth of low-cost airlines has kept fares low, 
        forcing legacy airlines to reduce their costs. However, legacy 
        airlines have struggled to do so, and have been unable to 
        achieve unit-cost comparability with their low-cost rivals. As 
        a result, legacy airlines have continued to lose money--$28 
        billion since 2001--and are expected to lose another $5 billion 
        in 2005. Additionally, airlines' costs have been hurt by rising 
        fuel prices--especially legacy airlines that did not have fuel 
        hedging in place.

   Bankruptcies are endemic to the airline industry, the result 
        of long-standing structural issues within the industry, but 
        there is no clear evidence that bankruptcy itself has harmed 
        the industry or its competitors. Since deregulation in 1978, 
        there have been 160 airline bankruptcy filings, 20 of which 
        have occurred in the last 5 years. Airlines fail at a higher 
        rate than most other types of companies, and the airline 
        industry historically has the worst financial performance of 
        any sector. This inherent instability that leads to so many 
        bankruptcies can be traced to the structure of the industry and 
        its economics, including the highly cyclical demand for air 
        travel, high fixed costs, and few barriers to entry. The 
        available evidence does not suggest that airlines in bankruptcy 
        contribute to industry overcapacity, or that bankrupt airlines 
        harm competitors by reducing fares below what other airlines 
        are charging. The history of the industry since deregulation 
        indicates that past liquidations or consolidations have not 
        slowed the overall growth of capacity in the industry. Studies 
        conducted by others do not show evidence that airlines 
        operating in bankruptcy harmed other competitors. Finally, 
        while bankruptcy may appear to be a useful business strategy 
        for companies in financial distress, available analysis 
        suggests it provides no panacea for airlines. Few airlines that 
        have filed for bankruptcy protection are still in business 
        today. Bankruptcy involves many costs, and given the poor track 
        record, companies are likely to use it only as a last resort.

   While bankruptcy may not harm the financial health of the 
        airline industry, it has become a considerable concern for the 
        Federal Government and airline employees and retirees because 
        of the recent terminations of pensions by US Airways and United 
        Airlines. These terminations resulted in claims on PBGC's 
        single-employer program of $9.6 billion and plan participants 
        (i.e., employees, retirees, and beneficiaries) are estimated to 
        have lost more than $5 billion in benefits that were either not 
        covered by PBGC, or exceeded the statutory limits. At 
        termination in May 2005, United's pension plans promised $16.8 
        billion in benefits backed by only $7 billion in assets (i.e., 
        it was underfunded by $9.8 billion). PBGC guaranteed $13.6 
        billion of the promised benefits, resulting in a claim on the 
        agency of $6.6 billion and an estimated $3.2 billion loss to 
        participants. The defined benefit pension plans of the 
        remaining legacy airlines with active plans are underfunded by 
        $13.7 billion (based on data from the U.S. Securities and 
        Exchange Commission, or SEC), raising the potential of 
        additional sizeable losses to PBGC and plan participants. These 
        airlines face $10.4 billion in pension contributions over the 
        next 4 years, significantly more than some of them may be able 
        to afford given continued losses and their other fixed 
        obligations. Spreading these contributions over more years, as 
        some of these airlines have proposed, would relieve some of 
        this liquidity pressure but would not necessarily keep them out 
        of bankruptcy because it does not fully address the fundamental 
        cost structure problems faced by legacy airlines.

Legacy Airlines Must Reduce Costs To Restore Profitability
    Since 2000, legacy airlines have faced unprecedented internal and 
external challenges. Internally, the impact of the Internet on how 
tickets are sold and consumers search for fares and the growth of low-
cost airlines as a market force accessible to almost every consumer has 
hurt legacy airline revenues by placing downward pressure on airfares. 
More recently, airlines' costs have been hurt by rising fuel prices 
(see figure 1).\6\ This is especially true of airlines that did not 
have fuel hedging in place. Externally, a series of largely unforeseen 
events--among them the September 11th terrorist attacks in 2001 and 
associated security concerns; war in Iraq; the SARS crisis; economic 
recession beginning in 2001; and a steep decline in business travel--
seriously disrupted the demand for air travel during 2001 and 2002. 



    Low fares have constrained revenues for both legacy and low-cost 
airlines. Yields, the amount of revenue airlines collect for every mile 
a passenger travels, fell for both low-cost and legacy airlines from 
2000 through 2004 (see figure 2). However, the decline has been greater 
for legacy airlines than for low-cost airlines. During the first 
quarter of 2005, average yields among both legacy and low-cost airlines 
rose somewhat, although those for legacy airlines still trailed what 
they were able to earn during the same period in 2004. 



    Legacy airlines, as a group, have been unsuccessful in reducing 
their costs to become more competitive with low-cost airlines. Unit 
cost competitiveness is key to profitability for airlines because of 
declining yields. While legacy airlines have been able to reduce their 
overall costs since 2001, these were largely achieved through capacity 
reductions and without an improvement in their unit costs. Meanwhile, 
low-cost airlines have been able to maintain low unit costs, primarily 
by continuing to grow. As a result, low-cost airlines have been able to 
sustain a unit cost advantage as compared to their legacy rivals (see 
figure 3). In 2004, low-cost airlines maintained a 2.7 cent per 
available seat-mile advantage over legacy airlines. This advantage is 
attributable to lower overall costs and greater labor and asset 
productivity. During the first quarter of 2005, both legacy and low-
cost airlines continued to struggle to reduce costs, in part because of 
the increase in fuel costs. 



    Weak revenues and the inability to realize greater unit cost-
savings have combined to produce unprecedented losses for legacy 
airlines. At the same time, low-cost airlines have been able to 
continue producing modest profits as a result of lower unit costs (see 
figure 4). Legacy airlines have lost a cumulative $28 billion since 
2001 and are predicted to lose another $5 billion in 2005, according to 
industry analysts. First quarter 2005 operating losses (based on data 
reported to DOT) approached $1.45 billion for legacy airlines. Low cost 
airlines also reported net operating losses of almost $0.2 billion, 
driven primarily by ATA's losses. 



    Since 2000, as the financial condition of legacy airlines 
deteriorated, they built cash balances, not through operations, but by 
borrowing. Legacy airlines have lost cash from operations, and 
compensated for operating losses by taking on additional debt, relying 
on creditors for more of their capital needs than in the past. In the 
process of doing so, several legacy airlines have used all, or nearly 
all, of their assets as collateral, potentially limiting their future 
access to capital markets.
    In sum, airlines are capital- and labor-intensive firms subject to 
highly cyclical demand and intense competition. Aircraft are very 
expensive and require large amounts of debt financing to acquire, 
resulting in high fixed-costs for the industry. Labor is largely 
unionized and highly specialized, making it expensive and hard to 
reduce during downturns. Competition in the industry is frequently 
intense owing to periods of excess capacity, relatively open entry, and 
the willingness of lenders to provide financing. Finally, demand for 
air travel is highly cyclical, closely tied to the business cycle. Over 
the past decade, these structural problems have been exacerbated by the 
growth in low-cost airlines and increasing consumer sensitivity to 
differences in airfares based on their use of the Internet to purchase 
tickets. More recently, airlines have had to deal with persistently 
high fuel prices--operating profitability, excluding fuel costs, is as 
high as it has ever been for the industry.

Bankruptcy Is Common in the Airline Industry, but There Is No Evidence 
        That it Is Harmful to the Industry or Competitors
    Airlines seek bankruptcy protection for such reasons as severe 
liquidity pressures, an inability to obtain relief from employees and 
creditors, and an inability to obtain new financing, according to 
airline officials and bankruptcy experts. As a result of the structural 
problems and external shocks previously discussed, there have been 160 
total airline bankruptcy filings since deregulation in 1978, including 
20 since 2000, according to the Air Transport Association.\7\ Some 
airlines have failed more than once, but most filings were by smaller 
carriers. However, the size of airlines that have been declaring 
bankruptcy has been increasing. Of the 20 bankruptcy filings since 
2000, half of these have been for airlines with more than $100 million 
in assets, about the same number of filings as in the previous 22 
years. Compared to the average failure rate for all types of 
businesses, airlines have failed more often than other businesses. As 
figure 5 shows, in some years, airline failures were several times more 
common than for businesses overall. 



    With very few exceptions, airlines that enter bankruptcy do not 
emerge from it. Of the 146 airline Chapter 11 reorganization filings 
since 1979, in only 16 cases are the airlines still in business. Many 
of the advantages of bankruptcy stem from legal protection afforded the 
debtor-airline from its creditors, but this protection comes at a high 
cost in loss of control over airline operations and damaged relations 
with employees, investors, and suppliers, according to airline 
officials and bankruptcy experts.
    Contrary to some assertions that bankruptcy protection has led to 
overcapacity and under-pricing that have harmed healthy airlines, we 
found no evidence that this has occurred either in individual markets 
or to the industry overall. Such claims have been made for more than a 
decade. In 1993, for example, a national commission to study airline 
industry problems cited bankruptcy protection as a cause for the 
industry's overcapacity and weakened revenues.\8\ More recently, 
airline executives have cited bankruptcy protection as a reason for 
industry over-capacity and low fares. However, we found no evidence 
that this had occurred and some evidence to the contrary.
    First, as illustrated by Figure 6, airline liquidations do not 
appear to affect the continued growth in total industry capacity. If 
bankruptcy protection leads to overcapacity as some contend, then 
liquidation should take capacity out of the market. However, the 
historical growth of airline industry capacity (as measured by 
available seat-miles, or ASMs) has continued unaffected by major 
liquidations. Only recessions, which curtail demand for air travel, and 
the September 11th attack, appear to have caused the airline industry 
to trim capacity. This trend indicates that other airlines quickly 
replenish capacity to meet demand. In part, this can be attributed to 
the fungibility of aircraft and the availability of capital to finance 
airlines.\9\



    Similarly, our research does not indicate that the departure or 
liquidation of a carrier from an individual market necessarily leads to 
a permanent decline in traffic for that market. We contracted with 
InterVISTAS-ga\2\, an aviation consultant, to examine the cases of six 
hub cities that experienced the departure or significant withdrawal of 
service of an airline over the last decade (see table 1). In four of 
the cases, both local origin-and-destination (i.e., passenger traffic 
to or from, but not connecting through, the local hub) and total 
passenger traffic (i.e., local and connecting) increased or changed 
little because the other airlines expanded their traffic in response. 
In all but one case, fares either decreased or rose less than 6 
percent.

   Table 1: Case Examples of Markets' Response to Airline Withdrawals
------------------------------------------------------------------------
                                                               Change in
   Market      Year        Airline        Effect on passenger    fares
                                                traffic        (percent)
------------------------------------------------------------------------
Nashville,     1995  American Airlines    Other airlines'          -10.2
 TN                   eliminated hub.      traffic increased.
                                           Origin and
                                           destination
                                           traffic increased.
Greensboro,    1995  Continental Lite     Other airlines'           +5.5
 NC                   eliminated hub.      traffic increased.
                                           Origin and
                                           destination
                                           traffic decreased.
Colorado       1997  Western Pacific      Other airlines'          +43.6
 Springs, CO          moved operations     traffic decreased.
                      to Denver.           Origin and
                                           destination
                                           traffic decreased.
St. Louis,     2001  TWA acquired by      Other airlines'           +5.4
 MO                   American Airlines.   traffic decreased.
                                           Little change in
                                           origin and
                                           destination
                                           traffic.
Kansas City,   2002  Vanguard Airlines    Little change in          +4.2
 MO                   suspended service.   other airlines'
                                           traffic. Little
                                           change in origin
                                           and destination
                                           traffic.
Columbus, OH   2003  America West         Other airlines'           +3.6
                      eliminated hub.      traffic increased.
                                           Little change in
                                           origin and
                                           destination
                                           traffic.
------------------------------------------------------------------------
Source: InterVISTAS-ga\2\.
Note: Little change in traffic means that traffic increased or decreased
  less than 5 percent and that origin-and-destination traffic increased
  or decreased less than 10 percent. Changes in passenger traffic and
  fares are measured from 4 quarters prior to the airline departure to 8
  quarters after.

    We also reviewed numerous other bankruptcy and airline industry 
studies and spoke to industry analysts to determine what evidence 
existed with regard to the impact of bankruptcy on the industry. We 
found two major academic studies that provided empirical data on this 
issue. Both studies found that airlines under bankruptcy protection did 
not lower their fares or hurt competitor airlines, as some have 
contended. A 1995 study found that an airline typically reduced its 
fares somewhat before entering bankruptcy. However, the study found 
that other airlines did not lower their fares in response and, more 
importantly, did not lose passenger traffic to their bankrupt rival and 
therefore were not harmed by the bankrupt airline.\10\ Another study 
came to a similar conclusion in 2000, this time examining the operating 
performance of 51 bankrupt firms, including 5 airlines, and their 
competitors.\11\ Rather than examine fares as did the 1995 study, this 
study examined the operating performance of bankrupt firms and their 
rivals. This study found that bankrupt firms' performance deteriorated 
prior to filing for bankruptcy and that their rivals' profits also 
declined during this period. However, once a firm entered bankruptcy, 
its rivals' profits recovered.

Legacy Airlines Face Significant Near-Term Liquidity Pressures, 
        Including $10.4 Billion in Pensions Contributions Over the Next 
        4 Years
    Under current law, legacy airlines' pension funding requirements 
are estimated to be a minimum of $10.4 billion from 2005 through 
2008.\12\ These estimates assume the expiration of the Pension Funding 
Equity Act (PFEA) at the end of this year.\13\ The PFEA permitted 
airlines to defer the majority of their deficit reduction contributions 
in 2004 and 2005; if this legislation is allowed to expire it would 
mean that payments due from legacy airlines will significantly increase 
in 2006. According to PBGC data, legacy airlines are estimated to owe a 
minimum of $1.5 billion this year, rising to nearly $2.9 billion in 
2006, $3.5 billion in 2007, and $2.6 billion in 2008. In contrast, low-
cost airlines have eschewed defined benefit pension plans and instead 
use defined-contribution (401k-type) plans.
    However, pension funding obligations are only part of the sizeable 
amount of debt that carriers face over the near term. The size of 
legacy airlines' future fixed obligations, including pensions, relative 
to their financial position suggests they will have trouble meeting 
their various financial obligations. Fixed airline obligations 
(including pensions, long-term debt, and capital and operating leases) 
in each year from 2005 through 2008 are substantial. Legacy airlines 
carried cash balances of just under $10 billion going into 2005 (see 
figure 7) and have used cash to fund their operational losses. These 
airlines fixed obligations are estimated to be over $15 billion in both 
2005 and 2006, over $17 billion in 2007, and about $13 billion in 2008. 
While cash from operations can help fund some of these obligations, 
continued losses and the size of these obligations put these airlines 
in a sizable liquidity bind. Fixed obligations in 2008 and beyond will 
likely increase as payments due in 2006 and 2007 may be pushed out and 
new obligations are assumed. 



    The enormity of legacy airlines' future pension funding 
requirements is attributable to the size of the pension shortfall that 
has developed since 2000. As recently as 1999, airline pensions were 
overfunded by $700 million based on Security and Exchange Commission 
(SEC) filings; by the end of 2004, legacy airlines reported a deficit 
of $21 billion (see figure 8), despite the termination of the US 
Airways pilots plan in 2003. Since these filings, the total 
underfunding has declined to approximately $13.7 billion, due in part 
to the termination of the United Airline plans, and the remaining US 
Airways plans.\14\



    The extent of underfunding varies significantly by airline. At the 
end of 2004, prior to terminating its pension plans, United reported 
underfunding of $6.4 billion, which represented over 40 percent of 
United's total operating revenues in 2004. In contrast, Alaska reported 
pension underfunding of $303 million at the end of 2004, or 13.5 
percent of its operating revenues. Since United terminated its 
pensions, Delta and Northwest now appear to have the most significant 
pension funding deficits--over $5 billion and nearly $4 billion 
respectively--which represent about 35 percent of 2004 operating 
revenues, at each airline.
    The growth of pension underfunding is attributable to 3 factors:

   Assets losses and low interest rates. Airline pension asset 
        values dropped nearly 20 percent from 2001 through 2004 along 
        with the decline in the stock market, while future obligations 
        have steadily increased due to declines in the interest rates 
        used to calculate the liabilities of plans.

   Management and labor union decisions. Pension plans have 
        been funded far less than they could have on a tax-deductible 
        basis. PBGC examined 101 cases of airline pension contributions 
        from 1997 through 2002, and found that while the maximum 
        deductible contribution was made in 10 cases, no cash 
        contributions were made in 49 cases where they could have 
        contributed.\15\ When airlines did make tax deductible 
        contributions, it was often far less than the maximum 
        permitted. For example, the airlines examined could have 
        contributed a total of $4.2 billion on a tax-deductible basis 
        in 2000 alone, but only contributed about $136 million despite 
        recording profits of $4.1 billion (see figure 9).\16\ In 
        addition, management and labor have sometimes agreed to salary 
        and benefit increases beyond what could reasonably be afforded. 
        For example, in the spring of 2002, United's management and 
        mechanics reached a new labor agreement that increased the 
        mechanics' pension benefit by 45 percent, but the airline 
        declared bankruptcy the following December. 

        
        
   Pension funding rules are flawed. Existing laws and 
        regulations governing pension funding and premiums have also 
        contributed to the underfunding of defined benefit pension 
        plans. As a result, financially weak plan sponsors, acting 
        within the law, have not only been able to avoid contributions 
        to their plans, but also increase plan liabilities that are at 
        least partially insured by PBGC. Under current law, reported 
        measures of plan funding have likely overstated the funding 
        levels of pension plans, thereby reducing minimum contribution 
        thresholds for plan sponsors. And when plan sponsors were 
        required to make additional contributions, they often 
        substituted ``account credits'' for cash contributions, even as 
        the market value of plan assets may have been in decline. 
        Furthermore, the funding rule mechanisms that were designed to 
        improve the condition of poorly funded plans were ineffective. 
        \17\ Other lawful plan provisions and amendments, such as lump 
        sum distributions and unfunded benefit increases may also have 
        contributed to deterioration in the funding of certain plans. 
        Finally, the premium structure in PBGC's single-employer 
        pension insurance program does not encourage better plan 
        funding.

    The cost to PBGC and participants of defined benefit pension 
terminations has grown in recent years as the level of pension 
underfunding has deepened. When Eastern Airlines defaulted on its 
pension obligations of nearly $1.7 billion in 1991, for example, claims 
against the insurance program totaled $530 million in underfunded 
pensions and participants lost $112 million. By comparison, the US 
Airways and United pension terminations cost PBGC $9.6 billion in 
combined claims against the insurance program and reduced participants' 
benefits by $5.2 billion (see table 2).

                                Table 2: Airline Pension Termination Information
                                            (in millions of dollars)
----------------------------------------------------------------------------------------------------------------
                                               Fiscal year of                                 Net     Estimated
                   Airline                          plan          Benefit        PBGC      claim on  participant
                                                terminations     liability     liability     PBGC       losses
----------------------------------------------------------------------------------------------------------------
Eastern                                                  1991         1,686         1,574       530          112
PanAm                                              1991, 1992         1,267         1,212       753           55
TWA                                                      2001         1,729         1,684       668           45
US Airways                                         2003, 2005         7,900         5,926     3,026        1,974
United                                                   2005        16,800        13,600     6,600        3,200
----------------------------------------------------------------------------------------------------------------
Source: PBGC.
Note: ``Benefit liability'' is the value of the benefits promised to participants and their beneficiaries
  immediately prior to plan termination. ``PBGC liability'' is the amount that PBGC pays after statutory
  guarantee limits are imposed. ``Net claim on PBGC'' is the difference between the PBGC liability and the
  assets PBGC obtains from the plan. ``Estimated participant losses,'' the difference between the Benefit
  Liability and the PBGC liability, equals the value of the benefits that plan participants and their
  beneficiaries lose when PBGC takes over a plan.

    In recent pension terminations, because of statutory limits, 
active- and high-salaried employees generally lost more of their 
promised benefits compared to retirees and low-salaried employees. For 
example, PBGC generally does not guarantee benefits above a certain 
amount, currently $45,614 annually per participant at age 65.\18\ For 
participants who retire before 65, the benefits guaranteed are even 
less; participants that retire at age 60 are currently limited to 
$29,649. Commercial pilots often end up with substantial benefit cuts 
when their plans are terminated, because they generally have high 
benefit amounts, and are also required by FAA to retire at age 60. Far 
fewer non-pilot retirees are affected by the maximum payout limits. For 
example, at US Airways fewer than 5 percent of retired mechanics and 
attendants faced benefit cuts as a result of the pension termination. 
Tables 3 and 4 summarize the expected cuts in benefits for different 
groups of United's active and retired employees.

  Table 3: United Airlines Active Employee Pension Termination Benefit
                                  Cuts
------------------------------------------------------------------------
                                Active         Extent of benefit cut
                   Active     employees  -------------------------------
     Plan        employees       with
                  in plan      benefit     1% to <   25% to <      50%
                                 cuts        25%       50%
------------------------------------------------------------------------
Management,          20,784       19,231     1,696     15,885      1,650
 Administrativ
 e, and Public
 Contact
 Employees
Ground               16,062       16,062    11,448      3,441      1,173
 Employees
Flight               15,024       11,109     1,305      7,067      2,737
 Attendants
Pilots                7,360        7,270     3,927      2,039      1,304
------------------------------------------------------------------------
Source: PBGC.
Note: Calculation estimates made with 1/1/2005 seriatim data.


   Table 4: United Airlines Retiree Pension Termination Benefit Cuts:
------------------------------------------------------------------------
                               Retirees        Extent of benefit cut
                Retirees in      with    -------------------------------
     Plan           plan       benefit     1% to <   25% to <
                                 cuts        25%       50%         50%
------------------------------------------------------------------------
Management,          11,360        2,996     2,816        104         76
 Administrativ
 e, and Public
 Contact
 Employees
Ground               12,676        4,961     4,810        121         30
 Employees
Flight                5,108           29        27          1          1
 Attendants
Pilots                6,087        3,041     1,902        975        164
------------------------------------------------------------------------
Source: PBGC.
Note: Calculation estimates made with 1/1/2005 seriatim data:

    It is important to emphasize that relieving legacy airlines of 
their defined benefit funding costs will help alleviate immediate 
liquidity pressures, but does not fix their underlying cost structure 
problems, which are much greater. Pension costs, while substantial, are 
only a small portion of legacy airlines' overall costs. As noted 
previously in figure 3, the cost of legacy airlines' defined benefit 
plans accounted for a 0.4 cent, or 15 percent difference between legacy 
and low-cost airline unit costs. The remaining 85 percent of the unit 
cost differential between legacy and low-cost carriers is attributable 
to factors other than defined benefits pension plans. Moreover, even if 
legacy airlines terminated their defined benefit plans it would not 
fully eliminate this portion of the unit cost differential because, 
according to labor officials we interviewed, other plans would replace 
them.

Concluding Observations
    While the airline industry was deregulated 27 years ago, the full 
effect on the airline industry's structure is only now becoming 
evident. Dramatic changes in the level and nature of demand for air 
travel combined with an equally dramatic evolution in how airlines meet 
that demand have forced a drastic restructuring in the competitive 
structure of the industry. Excess capacity in the airline industry 
since 2000 has greatly diminished airlines' pricing power. 
Profitability, therefore, depends on which airlines can most 
effectively compete on cost. This development has allowed inroads for 
low-cost airlines and forced wrenching change upon legacy airlines that 
had long competed based on a high-cost business model.
    The historically high number of airline bankruptcies and 
liquidations is a reflection of the industry's inherent instability. 
However, this should not be confused with causing the industry's 
instability. There is no clear evidence that bankruptcy has contributed 
to the industry's economic ills, including overcapacity and 
underpricing, and there is some evidence to the contrary. Equally 
telling is how few airlines that have filed for bankruptcy protection 
are still doing business. Clearly, bankruptcy has not afforded these 
companies a special advantage.
    Bankruptcy has become a means by which some legacy airlines are 
seeking to shed their costs and become more competitive. However, the 
termination of pension obligations by United Airlines and US Airways 
has had substantial and wide-spread effects on the PBGC and thousands 
of airline employees, retirees, and other beneficiaries. Liquidity 
problems, including $10.4 billion in near term pension contributions, 
may force additional legacy airlines to follow suit. Some airlines are 
seeking legislation to allow more time to fund their pensions. If their 
plans are frozen so that future liabilities do not continue to grow, 
allowing an extended payback period may reduce the likelihood that 
these airlines will file for bankruptcy and terminate their pensions in 
the coming year. However, unless these airlines can reform their 
overall cost structures and become more competitive with low-cost 
competition; this will be only a temporary reprieve.
    This concludes my statement. I would be pleased to respond to any 
questions that you or other Members of the Subcommittee may have at 
this time.*
---------------------------------------------------------------------------
    * Individuals making key contributions to this testimony include 
Paul Aussendorf, Anne Dilger, Steve Martin, Richard Swayze, and Pamela 
Vines.
---------------------------------------------------------------------------
ENDNOTES
    \1\ While there is variation among airlines in regards to the size 
and financial condition, we adhere to a construct adopted by industry 
analysts to group large passenger airlines into one of two groups--
legacy and low-cost. Legacy airlines (Alaska, American, Continental, 
Delta, Northwest, United, and US Airways) predate airline deregulation 
of 1978 and have adopted a hub-and-spoke network model that can be more 
expensive to operate than a simple point-to-point service model. Low 
cost airlines (AirTran, America West, ATA, Frontier, JetBlue, 
Southwest, and Spirit) have generally entered the market since 1978, 
are smaller, and generally employ a less costly point-to-point service 
model. The 7 low-cost airlines have consistently maintained lower unit 
costs than the 7 legacy airlines.
    \2\ Two other smaller carriers--ATA Airlines and Aloha--are also in 
bankruptcy protection. Hawaiian Airlines just emerged from bankruptcy 
protection earlier this month.
    \3\ The Pension Benefit Guaranty Corporation's (PBGC) single-
employer insurance program is a Federal program that insures certain 
benefits of the more than 34 million worker, retiree, and separated 
vested participants of over 29,000 private-sector defined-benefit 
pension plans. Defined-benefit pension plans promise a benefit that is 
generally based on an employee's salary and years of service, with the 
employer being responsible to fund the benefit, invest and manage plan 
assets, and bear the investment risk. A single-employer plan is one 
that is established and maintained by only one employer. It may be 
established unilaterally by the sponsor, or through a collective 
bargaining agreement.
    \4\ U.S. Government Accountability Office, COMMERCIAL AVIATION: 
Legacy Airlines Must Further Reduce Costs to Restore Profitability 
(GAO-04-836) August, 2004.
    \5\ We found all relevant data for assessing the financial 
condition of the airline industry, analyses of the effects of 
bankruptcy on the industry as a whole and six case studies of hub 
markets affected by airline bankruptcy or service withdrawals, 
interviews with industry and subject area experts, and analyses of SEC 
and PBGC data to be sufficiently reliable for our purposes.
    \6\ Legacy airlines' fuel costs as a percentage of total operating 
costs doubled from 11.5 percent during the 4th quarter of 1998 to 22.9 
percent during the 4th quarter of 2004. Fuel costs for these airlines 
were $5 billion higher in 2004 than in 2003--an amount roughly equal to 
their net operating losses.
    \7\ Airlines may file for two types of bankruptcy. Chapter 7 of the 
bankruptcy code governs the liquidation of the debtor's estate by 
appointed trustees of the court. Chapter 11 of the code governs 
business reorganizations and allows, among other things, companies to 
reject collective bargaining agreements and renegotiate contracts and 
leases with creditors with the approval of the court. Companies may 
also convert from a Chapter 11 reorganization into a Chapter 7 
liquidation or may liquidate within Chapter 11.
    \8\ The National Commission to Ensure a Strong Competitive Airline 
Industry, Change, Challenge, and Competition, A Report to the President 
and Congress, August 1993.
    \9\ Conversely, consolidation within the industry may help remove 
some capacity. The pending merger between America West and US Airways 
contemplates an airline with approximately 10 percent less total 
capacity than what the two carriers now operate independently. The U.S. 
Federal Government will own a significant stake in the merged company: 
the Air Transportation Stabilization Board will own 11.2 percent of the 
company, and the PBGC will own at least 5 percent.
    \10\ Do Airlines In Chapter 11 Harm Their Rivals?: Bankruptcy and 
Pricing Behavior in U.S. Airline Markets, National Bureau of Economic 
Research Working Paper 5047, Severin Borenstein and Nancy L. Rose, 
February 1995.
    \11\ The Effect of Bankruptcy Filings on Rivals' Operating 
Performance: Evidence From 51 Large Bankruptcies, Robert E. Kennedy, 
International Journal of the Economics of Business; Feb. 2000; pp. 5-
25.
    \12\ These estimates include only legacy airlines that continue to 
sponsor defined benefit pension plans and reported their estimated 
pension obligations to PBGC. Pension law provisions prohibit publicly 
identifying the airlines that have reported this information.
    \13\ Pension Funding Equity Act of 2004 (Pub. L. 108-218, April 10, 
2004). The PFEA also changed the interest rate used to calculate future 
liability from the 30-year Treasury bond to a corporate bond rate, 
which effectively reduces future liabilities.
    \14\ SEC data and PBGC data on the funded status of plans can 
differ because they serve different purposes and provide different 
information. The PBGC report focuses, in part, on the funding needs of 
each pension plan. In contrast, corporate financial statements show the 
aggregate effect of all of a company's pension plans on its overall 
financial position and performance. The two sources may also differ in 
the rates assumed for investment returns on pension assets and in how 
these rates are used. As a result, the information available from the 
two sources can appear to be inconsistent. PBGC data also are not 
timely. For more information, see GAO, Private Pensions: Publicly 
Available Reports Provide Useful but Limited Information on Plans' 
Financial Condition (GAO-04-395) March 31, 2004.
    \15\ These 101 cases covered 18 pension plans sponsored by 5 
airlines.
    \16\ Pension funding rules permit sponsors to choose the interest 
rate used to determine the maximum deductible pension contribution 
permitted from an interest rate ``corridor''--a limited range of 
interest rates. In calculating the maximum deductible contribution, a 
higher interest rate produces a lower deductible contribution limit. 
The maximum deductible contributions referred to in this paragraph and 
figure 9 are calculated using the lowest interest rate permissible from 
the interest rate corridor.
    \17\ For further information, see U.S. Government Accountability 
Office, PRIVATE PENSIONS: Recent Experiences of Large Defined Benefit 
Plans Illustrate Weaknesses in Funding Rules, GAO-05-294, (Washington, 
D.C.: May 31, 2005).
    \18\ This guarantee level applies to plans that terminate in 2005. 
The amount guaranteed is adjusted: (1) actuarially for the 
participant's age when PBGC first begins paying benefits and (2) if 
benefits are not paid as a single-life annuity. Because of the way the 
Employee Retirement and Income Security Act of 1974 (ERISA), as 
amended, allocates plan assets to participants, certain participants 
can receive more than the PBGC guaranteed amount.

    Senator Burns. Thank you. Now we have Mr. Jim May, 
President and CEO of the Air Transport Association here. Thank 
you for coming.

           STATEMENT OF JAMES C. MAY, PRESIDENT/CEO, 
           AIR TRANSPORT ASSOCIATION OF AMERICA, INC.

    Mr. May. Thank you, Mr. Chairman, and thank you, Co-
Chairman Inouye, for allowing us to appear today. My starting 
point discussed at length in our written comments is the 
financial state of the industry. And unquestionably, as we all 
have acknowledged, the last few years have been our most 
difficult. 2001 to 2004 aggregate net losses were $32.3 
billion, and it has left our airlines deeply in debt, which is 
a related issue that we need to be sensitive to. At the end of 
2004, the industry's net was more than $81 billion with a debt-
to-capital ratio of 110 percent.
    Now, my comments will focus on why a financially stable 
airline industry is important to this country, the key factors 
inhibiting industry financial stability, and some of the things 
that we think need to happen in order to regain, not just 
stability, but sustainable growth in profit. Simply put, a 
stable industry, including both the passenger and cargo 
airlines, is critical to a healthy and robust U.S. economy. 
Pulitzer prize-winning economist Dan Gergen released his latest 
book last week and said as follows: ``every day the airline 
industry propels the economic takeoff from our nation. It is 
the great enabler, leading together all corners of the country, 
facilitating the movement of people and goods that is the 
backbone of economic growth. And it also firmly imbeds us in 
that awesome process of globalization that is defining the 21st 
Century.''
    Now, the alternative to this vision is a wounded industry 
unable to provide the air transport demanded by the shipping 
and traveling public and unable to provide a return to 
shareholders. It is not an acceptable alternative. Over the 
past 4 years, airlines have engaged in dramatic efforts to 
reduce those costs that are within our control, and I'd like to 
stress that point. Reduce those costs that are within our 
control. Out of adversity, we have transformed ourselves in 
many ways, capital spending, $9.5 billion, a 62 percent 
reduction from year 2000 levels. Pay and work rule changes were 
hammered out to achieve a 20 percent productivity improvement. 
Operating costs have been trimmed, even to the point of 
removing pillows and pretzels, and operations have been 
streamlined to reduce fuel burn, and we have improved overall 
system efficiency, closed up, eliminated routes, and taken down 
frequencies.
    Now, in this difficult and painful process, as my good 
friend Mr. Roach knows, 135,000 dedicated men and women have 
lost their jobs. That's an 18 percent reduction from August of 
2001.
    Unfortunately, the benefits of these changes that have been 
made which brought the cost structures of the older network 
carriers much closer to those of their younger low-cost 
brethren, and I have a small disagreement with the first 
witness here on that point because I think we have reduced and 
narrowed the cost differences with the low prices have been 
more than offset by costs the airlines can't control; fuel, 
taxes, and fees. Unfunded mandates, in particular those 
unfunded mandates caused by security imperatives. And with oil 
trading at an all-time high and the price of jet fuel 
skyrocketing, and my colleague to my left will talk about the 
difference between the crack spread, which is the difference 
between what oil is trading, and what we are actually paying 
for jet fuel for airplanes. This industry cannot achieve a 
sustained profit sufficient to repair the damage of the last 4 
years.
    We are looking at a rolling 12-month forecast for the price 
of oil to stay above $60 a barrel. Now, in short, those high 
fuel prices are overwhelming our ability to achieve 
profitability. It's noted that X fuel minus the cost of the 
increased fuel, a number of our carriers would have had the 
most profitable second quarters in their history, so it's those 
external costs.
    We are delighted at reports of improved revenues and system 
yields at some of the carriers, and certainly the possibility 
that one or two airlines might even report some small profits 
for the second quarter of this year, but domestic yields in 
particular are still weak and it remains to be seen if these 
revenue improvements will carry over into the fall and the 
winter quarters. At current oil prices, we predict a net 
industry loss for the year 2005 in excess of $5 billion.
    Now, our industry recovery is also inhibited by the many 
taxes and fees it must contend with, and I think this is an 
area where the government and this Congress could help more by 
doing less. Airlines will pay more than $15 billion in taxes 
and fees in 2005, resulting in the highest tax rate of any 
industry, according to one respected Wall Street analyst. Even 
a modest reduction of the tax burden will help restore the 
industry to financial health, facilitate jobs and economic 
growth and it's not a new or revolutionary idea that I'm 
suggesting to you. More than 10 years ago, the national 
Commission to ensure a strong, competitive airline industry, 
the so-called Nanetta Commission, recommended, ``the industry 
be released of its unfair tax burden''. Now, that was 10 years 
ago. Looking forward, I think there is a tremendous opportunity 
for positive action approaches. Together, we have a chance to 
reshape the FAA's air traffic control system to meet current 
and future needs, and reduce our costs in that system. Our 
antiquated air traffic control system based on ground-based 
radars should be retired to the Smithsonian, where it can be 
admired as one of the marvels of 1950s technology. I think we 
need to proceed swiftly and purposely with the creation of the 
new satellite GPS-based system, one that will reduce costs, 
relieve congestion, authorize traffic flow, and open up air 
space for future growth. If the industry is to achieve 
sustained profitability, it is imperative that Congress and the 
FAA do three things.
    First, establish an ATC funding mechanism that distributes 
costs equitably among all system users, creating a reliable 
funding stream that's bonding and flexible enough to 
accommodate changes in the way the system is used. We need to 
have the FAA operate the ATC more efficiently, including 
consolidating unnecessary facilities, decommissioning obsolete 
facilities and equipment, and rationalizing the workforce.
    There are 14,000 different communications entities within 
the FAA as part of the air traffic control system. That is 
unsafe.
    Finally, the FAA must develop and implement procedures and 
technologies that will increase current system capacity and 
efficiency as quickly as possible, and that will enable future 
growth.
    Mr. Chairman, with the health of the airports or the re-
authorization of the airports, and not only this industry and 
this committee, I think it's time for an exercise in very 
difficult choices. If together we do it right, we are going to 
lay the foundation for a bright future for the airlines and the 
economy that we enable. We are going to be attacking those 
costs that we can't attack without your help, and we are going 
to continue to attack the costs that we have some control over 
in our own systems. Thank you for the opportunity to appear.
    [The prepared statement of Mr. May follows:]

          Prepared Statement of James C. May, President/CEO, 
               Air Transport Association of America, Inc.

    The Air Transport Association of America, Inc. (ATA) appreciates 
the opportunity to comment on the financial health of the U.S. airline 
industry. Unfortunately, the overall financial picture remains grim 
because the price of oil continues to surge. Increasing oil and fuel 
prices have offset the recent modest improvement some carriers have 
experienced on the revenue front. We would like nothing better than to 
dwell on what little good news there is, but to do so would be 
misleading. The truth is, the financial health of the U.S. airline 
industry remains poor, and the industry still has a long way to go 
before it can be declared healthy again.
The Current Industry Snapshot
    The U.S. airline industry in 2005 remains in critical condition and 
is poised to add over $6 billion to the $32.3 billion in losses 
incurred between 2001 and 2004. The current state of the industry is 
the result of factors and events that have altered industry 
fundamentals. The fact that industry fundamentals have changed 
distinguishes this down-cycle from all prior cycles.
    One fundamental that has changed is that spending on air travel has 
dropped to 0.7 percent of U.S. GDP from its historical level of between 
0.9 and 1.0 percent of GDP. This means that on a proportional basis 
Americans today are spending considerably less on flying than in 
previous years--amounting to roughly $29.5 billion annually. If 
spending had slipped to just 0.8 percent of GDP, the industry's 
financial condition would be markedly different.
    All airlines have been affected by these fundamental changes, and 
all airlines have responded in kind by sharply reducing or limiting 
controllable costs, paring back capital spending, revising long-
standing collective bargaining agreements, streamlining operations, and 
improving productivity. While there may be pockets of such costs still 
to be addressed at some airlines, no one should forget that more than 
100,000 employees--one out of six--have lost their jobs since 9/11. 
There is no question that the airline industry has drastically reduced 
controllable costs.
    Notwithstanding these Herculean efforts, industry profitability 
remains elusive, and the timing of the industry's return to 
profitability is unclear. While recently there have been some hoped-for 
signs of recovery, those signs have been inconsistent and the 
industry's financial health remains dependent on many factors outside 
of its control: a strong economy, effective security worldwide, reduced 
or stable oil prices, and an air traffic control system that will 
accommodate, safely and efficiently, the growth demanded by the 
American public.
    Notwithstanding these financial challenges, it should not be 
overlooked that airline safety has remained rock solid. ``Safety 
first'' remains the core industry value. In 2004, the National 
Transportation Safety Board (NTSB) reported only one fatal accident in 
over 10 million scheduled departures. In the three years 2002-2004, 
there were just three fatal accidents in 31 million scheduled 
departures. In those three years, airlines providing Part 121 scheduled 
operations carried nearly 1.9 billion passengers. Without question, 
scheduled air service is incredibly safe.
    The events and factors that knocked the U.S. airline industry into 
a condition requiring the equivalent of intensive care are well known 
and need not be repeated here. However, there are certain factors that 
warrant further attention because they continue to adversely affect the 
industry's financial condition. The common thread running through these 
factors is that they are beyond the direct control of the airlines.
1. The Cost of Fuel Forecloses Financial Recovery
    The simple truth is that, but for the high price of fuel, the U.S. 
airline industry today could earn a small profit. As industry 
fundamentals go, the price of fuel is the most significant force 
affecting the industry today. For the ten year period 1992-2001, the 
median price of crude oil was $19.90. Even in 2001 and 2002, crude oil 
was relatively stable in the $25-$26 range. In 2003, the average price 
jumped to over $31 a barrel, and in 2004 the average price jumped again 
to more than $41 a barrel. Today, crude is over $60 per barrel, and the 
2005 price is expected to average at least $52 per barrel. In fact, the 
twelve month rolling forecast currently has crude oil at over $60 per 
barrel through July 2006.\1\ In essence, oil prices have nearly doubled 
in two years, and when compared to the 1992-2001 median average they 
have tripled.
---------------------------------------------------------------------------
    \1\ Fimat, Energy Overview (July 8, 2005), found at http://
research.fimat.com/dominoapps/fimatres.nsf/
C5934649E5F8BDB886257038004DFC75/$FILE/tcc1_new.pdf.


    Jet Fuel prices have mirrored the price of crude oil, and 2005 
prices are expected to surpass the 2004 record prices. The true cost 
impact on the airlines of this unprecedented increase is staggering and 
virtually defies comprehension. As the charts below show, the 
industry's 2004 jet fuel expense would have been $11.8 billion at the 
average price paid during the 1992-2001 period, compared to the actual 
$21.4 billion paid in 2004. We now expect the industry fuel bill to 
rise another $6.7 billion in 2005, to more than $28 billion, assuming 
fuel consumption remains unchanged. At some airlines, fuel costs now 
exceed personnel costs as the number one expense category.\2\
---------------------------------------------------------------------------
    \2\ Jet Fuel Expense Surges Past Personnel Costs, MSNBC.com (July 
11, 2005).





    Given the vigorous competitive climate of the industry, discussed 
below, airlines have not been able to include in ticket prices the 
increased cost of fuel. To cover the jet fuel price increases from 2003 
to 2004, for example, passengers would have had to pay on average an 
additional $21 per ticket. Yet ticket prices during this period fell 
because of intense competition. The industry would be in a much 
different, healthier condition had the airlines been able to pass on 
their actual fuel costs.
    An operating fundamental of the industry is that airplanes run only 
on jet fuel. There is no alternative. The related economic fundamental 
is that the dramatic change in the price of fuel now appears to be 
permanent. The days of $20-$35 per barrel oil are over. We will be 
fortunate if the price slips back to $40-$50 per barrel. Given the 
worldwide demand for oil products and finite refining capacity, 
particularly in the U.S., some analysts predict even higher prices. A 
recent Goldman Sachs report suggests prices may rise as high as $105 
per barrel.\3\ Moreover, the market is highly susceptible to any 
possible supply disruption, as the price spike in anticipation of 
tropical storm Arlene in early June illustrated.\4\ On June 17, oil 
surged to a then-all time high--exceeding $58 per barrel--over concerns 
about both supply and refining capacity.\5\ Last week, oil prices 
eclipsed $60 per barrel, continuing an apparently inexorable climb 
upward.
---------------------------------------------------------------------------
    \3\ Goldman Sachs, ``U.S. Energy: Oil--Super Spike Period May be 
Upon Us,'' March 30, 2005.
    \4\ A June 10, 2005 report issued by the Energy Risk Management 
Group of Fimat, for example, stated: ``The response to Arlene's 
approach shows with brutal clarity how sensitive the market is to any 
possible supply disruption. With the potential impact on production and 
transportation at least part of the rally was justified. . . . The 
storm headlines surprised and prompted waves of short covering and 
possibly a moderate amount of fresh speculative buying, as well.'' 
http://research.fimat.com/dominoapps/fimatres.nsf/
0B9A9C6DBB71AF2E8625701C004AA162/$FILE/tcc1_new.pdf.
    \5\ ``Oil Prices Surge All-time High,'' MSNBC, June 17, 2005, at 
http://www.msnbc.msn.com/id/5612507.
---------------------------------------------------------------------------
    The increase in the price of fuel has been rapid and dramatic. 
Because of the complexity of market forces at play in the airline 
industry, this fundamental economic change strongly affects the cost 
side of the ledger, increasing the revenues needed for profitability. 
As a result, complete recovery--defined by a return to profitability--
remains foreclosed. When the industry might achieve profitability 
remains uncertain. As one market analyst observed recently:

        On a non-fuel basis, operating profitability . . . is as good 
        as it was in the late 1990s. While these facts are exciting . . 
        ., they may also be totally moot if oil prices do not return to 
        [historical norms] . . . Unfortunately, high fuel prices are 
        consuming what would otherwise be an upcycle for the 
        industry.\6\
---------------------------------------------------------------------------
    \6\ Gary Chase, Lehman Brothers, ``Industry Update,'' March 15, 
2005.

2. Taxes and Fees Weigh Down the Industry
    The industry continues to be weighed down by excessive taxes and 
fees imposed on airlines and their customers. The negative economic 
impact of these taxes and fees is a drag on the industry and hampers 
its ability to return to profitability. This is one area in which the 
government could help more by doing less. As one analyst has noted:

        [T]he airline industry pays the highest Federal tax rate of any 
        industry as it continues to lose massive amounts of money 
        through user and security taxes that amount to an estimated 10 
        percent of revenues . . . in reality, in a highly competitive, 
        weak revenue environment, the taxes are paid for by the 
        airlines . . .

        Ray Neidl, Speech at the National Air Service Conference 
        (January 24, 2005).

    The tax and fee burden on airlines operating in, to, and from the 
U.S. exceeded $14 billion in FY 2004 and are expected to exceed $15 
billion in 2005. This tax burden distorts the normal functioning of 
market forces and fundamentally depresses the industry. Nonetheless, 
the appetite for taxing the industry remains strong. Since 1988, the 
average tax on a $200 domestic round-trip ticket has increased 250 
percent, while average domestic yields have actually declined 3 
percent. This is so despite the 1993 recommendation, made by the 
National Commission to Ensure a Strong Competitive Airline Industry, to 
relieve the industry of its ``unfair tax burden.'' \7\
---------------------------------------------------------------------------
    \7\ ``Tax policies often have had a major and adverse effect on the 
industry. Although the Commission concluded that tax changes alone will 
not restore the industry to profitability, we believe there are several 
tax provisions that impede the ability of the industry to return to 
financial health. We believe those provisions violate reasonable 
principles of common sense and good public policy and we are of the 
opinion changes must be made to relieve the airline industry's unfair 
tax burden.'' Change, Challenge and Competition: A Report to the 
President and Congress (August 1993), The National Commission to Ensure 
a Strong Competitive Airline Industry.



    Aviation taxes have outpaced inflation and prices, and air 
transportation is taxed at a higher rate than the consumption of beer 
and liquor, telephone service, and most notably, bus and rail 
transportation, which face no Federal travel tax.

           Federal Consumption Taxes and Fees High on Flyers*
  Uncle Sam Taxes Low-Priced Air Travel Above Sins, Luxuries, and Other
                                  Modes
------------------------------------------------------------------------
         Product            Percent            Product           Percent
------------------------------------------------------------------------
Plane Ticket: One-Stop         44.2   Heavy Firearms /              11.0
 ($100) \1\                            Ammunition
Plane Ticket: Non-Stop         25.6   Distilled Spirits ($20)       10.7
 ($100) \1\                            \4\
Plane Ticket: One-Stop         25.6   Sport Fishing Equipment       10.0
 ($200) \1\
Plane Ticket: One-Stop         19.4   Pistol or Revolver            10.0
 ($300) \1\
Pack of Cigarettes             18.2   Can of Beer ($1.00) \5\        5.0
 ($4.50) \2\
Plane Ticket: Non-Stop         16.3   Luxury Vehicle (Portion        3.0
 ($200) \1\                            > $40K)
Plane Ticket: Non-Stop         13.2   Telephone Service              3.0
 ($300) \1\
Arrow Components               12.4   Elec. Outboard Motors /        3.0
                                       Sonar \6\
Heavy Truck / Trailer /        12.0   Ship Ticket ($1,000) \7\       0.3
 Tractor
Gallon of Gasoline             11.5   Bus Ticket                     0.0
 ($1.60) \3\
Bows                           11.0   Rail Ticket                    0.0
------------------------------------------------------------------------
\1\ Roundtrip with federally approved $4.50 PFC.
\2\ Taxed at 82 cents per pack.
\3\ Taxed at 18.4 cents per gallon.
\4\ Taxed at $2.14 per 750-milliliter bottle.
\5\ Taxed at 5 cents per can.
\6\ Up to a maximum of $30.00.
\7\ Taxed at $3.00 per ticket.
Note: The Federal Government also taxes the sale of tires over 40
  pounds, coal, wine, vaccines, foreign-issued insurance, and selected
  other items.
*Analysis considers Federal taxes and fees only; does not examine the
  broader impact of State and local taxes, which can be especially high
  on alcohol and tobacco.
Sources: ATA research; Internal Revenue Service; Bureau of Alcohol,
  Tobacco & Firearms.

    ATA appreciates this Committee's efforts to upend the 
Administration's proposed increase of the passenger security fee for FY 
2006. As this Committee is well aware, security fees and taxes account 
for a significant portion of the overall tax and fee burden on the 
industry. In FY 2005, we estimate that the industry will provide to DHS 
over $3.2 billion in direct fees and taxes. Add to this the foregone 
revenue from certain federally mandated programs and the out-of-pocket 
expenses for other unfunded mandates, and very quickly the industry's 
annual security cost burden exceeds $4 billion. That number will only 
increase as more passengers fly. Yet the Administration and Members of 
Congress continue to discuss and debate several new mandates.\8\ The 
airline industry cannot be expected to achieve profitability if the 
government continues to impose more and more taxes, fees, and unfunded 
mandates.
---------------------------------------------------------------------------
    \8\ These include, but are not limited to, installation and 
maintenance of counter-manpads devices, additional in-line EDS baggage 
screening equipment, increased cargo screening on passenger and all-
cargo flights, implementation of the DHS Secure Flight passenger 
screening program, and promulgation of a rule requiring airlines to 
transmit passenger manifest and related passport data one hour before 
departure of in-bound international flights.
---------------------------------------------------------------------------
    Unfortunately, the ``cash cow'' view of the airline industry 
infects the rest of the world. Several G-8 member states recently 
proposed a ``solidarity tax'' on airplane tickets as a mechanism to 
raise money to assist developing countries address health and welfare 
needs. In the view of these countries, because the airline industry 
facilitates globalization, and because ``airline passengers seldom 
belong to the poorest segments of the population,'' a tax on air 
transportation is justified. The problem with this approach, of course, 
is that it is basically an ``ends justify the means'' argument and 
could apply to any number of issues regardless of merit.
    As we have said previously, it does not matter whether a tax or fee 
is imposed on passengers or airlines. It is the imposition of the tax 
that is significant,\9\ with the result being that the more the 
government collects for air travel, the less the airlines are able to 
charge. As Treasury Secretary Snow has stated, ``Economics tells us 
that anything you tax, you get less of. That's why high marginal taxes 
. . . are a bad idea--they kill jobs.'' In our view, with the right tax 
policy, the government can foster job creation and financial stability 
in the industry.
---------------------------------------------------------------------------
    \9\ ``The statutory incidence of a tax indicates who is legally 
responsible for the tax. . . . Because prices may change in response to 
the tax, knowledge of statutory incidence tells us essentially nothing 
about who is really paying the tax. . . The [economic] incidence of a 
unit tax is independent of whether it is levied on consumers or 
producers. . . In general, the more elastic the demand curve, the less 
the tax borne by consumers. . . The key point to remember is that 
nothing about the incidence of a tax can be know without information on 
the relevant behavioral elasticities.'' Public Finance (4th Ed.), 
Harvey S. Rosen (Princeton University Department of Economics).
---------------------------------------------------------------------------
    Unfortunately, excessive taxes on the airline industry are 
crippling a vital segment of our economy. The U.S. airline industry 
plays a major role in driving the commerce of the United States and the 
growth of our national economy. An economically crippled airline 
industry is a drag on the national economy and ultimately will prevent 
it from realizing its full potential. Robust air transportation is 
critical to sustaining our recovery and catalyzing the next round of 
growth essential to our nation's economic competitiveness. As airline 
job losses continue to mount, and service to small- and mid-size 
communities is cut, it is not simply the airlines and their employees 
who are suffering; it is the broader economy that feels the results. 
Air transportation grows both the national and local economies--its 
absence reverses that effect.



3. Pricing Power Remains Inadequate for Airlines To Recover Costs
    Throughout 2004, and well into 2005, U.S. airlines were unable to 
raise prices. Numerous efforts failed because of the intense 
competitive nature of the industry and the fundamentals of supply and 
demand. Market analysts uniformly observed that all airlines lacked 
pricing power to pass through increased costs. For example:

        [L]egacy carriers and LCCs continue to fight strenuously for 
        market share with a complete lack of pricing power creating an 
        anemic revenue environment . . . Fuel . . . remains a major 
        factor in the industry's inability to make a profit, and we 
        remind investors that this is not the first time the airlines 
        have been faced with tough year over year comps. However, this 
        is the first time that carriers have not been able to pass 
        these costs on to the consumer as evident by several failed 
        fare increases and the declining yields.

        Reno Bianchi and Steven K. Burton, Citigroup Corporate Bond 
        Research, Airline Industry Research Report, December 21, 2004.

    The following chart illustrates the lack of pricing power from 
January 2001 through the first quarter of 2005 by tracking mainline 
passenger yields:



    Recently, airlines have been able to maintain some price increases, 
and this modest success offers a glimmer of hope for the future. At 
this point, however, it remains only a glimmer. During the second week 
of June, for example, multiple attempts at fare increases failed under 
competitive pressures.\10\ Passengers remain extremely price sensitive, 
and price competition among all airlines is robust.\11\ Consequently, 
even low-cost airlines are not sanguine about increasing revenue 
through fare hikes, as confirmed by Independence Air's Eric Nordling: 
``The flying public is highly elastic; it is very sensitive to price.'' 
\12\
---------------------------------------------------------------------------
    \10\ ``Airfare Momentum Stalls After Successive Price Hikes,'' 
Business Travel News, June 7, 2005; ``Airline Profits Are So Close, Yet 
Still So Far,'' New York Times, June 12, 2005; ``Northwest Pulls Fare 
Increase,'' Aviation Daily, June 14, 2005.
    \11\ ``[Several airlines] raised fares on some routes, then cut 
them a day or two later when bookings fell . . .'' ``Even if they 
wanted to take advantage of the heavy demand for summer travel, the big 
airlines do not have carte blanche to raise fares, because low-fare 
airlines keep them from doing so.'' New York Times, June 12, 2005.
    \12\ Id.
---------------------------------------------------------------------------
    The simple truth is that if the airlines could raise their prices 
to cover fuel costs and the many taxes and fees they pay, they would 
have done so by now. They haven't, and basic marketplace principles--
competition and elasticity--are continuing to prevent them from doing 
so. It remains to be seen when, if ever, pricing power returns to the 
point where profitability can be restored notwithstanding increasing 
fuel prices.

4. Expanding the Air Traffic Control System's Capacity and Enhancing 
        ATC Productivity Is Critical to the Financial Health of the 
        Industry
    The American people want convenience and value for their money. 
That is why they are flying in record numbers this summer. U.S. 
airlines provide safe, convenient, and reliable service at a fair 
price.\13\ Maintaining system reliability, however, is becoming 
increasingly difficult as airlines, responding to marketplace demands 
for service, add flights. The financial health of the industry--today 
and in the future--depends in part on the ability of the FAA's Air 
Traffic Control (ATC) system to provide the capacity needed to meet not 
only the demand for scheduled passenger and cargo operations, but also 
the growing appetite of the non-scheduled sector, including air taxis, 
business jet operations and, in the near future, Very Light Jets.\14\
---------------------------------------------------------------------------
    \13\ Adjusted for inflation, domestic airfares, net of taxes, have 
dropped 51 percent over the past 25 years.
    \14\ Year One--Taking Flight: 2004 Annual Performance Report, 
Federal Aviation Administration, Air Traffic Organization (March 2005) 
(the ``ATO 2004 Annual Report''), p. 23.
---------------------------------------------------------------------------
    Inadequate ATC system capacity will stymie airline growth and the 
ability of the industry to achieve and maintain financial health. That, 
in turn, will adversely affect the commerce of the United States and 
the American public. Without a dramatic change in the way our nation's 
airspace is managed, congestion and resulting delays will be 
overwhelming for consumers and businesses alike. As it is, 86.5 million 
ATC delay minutes were responsible for adding an estimated $6.2 billion 
to direct operating costs for U.S. airlines in 2004. The FAA is 
predicting that by the end of 2005 commercial aviation flights will 
have regained the peak levels of 2000.\15\ Operations at en route 
centers actually have surpassed the number handled in 2000.\16\
---------------------------------------------------------------------------
    \15\ ATO 2004 Annual Report, p.23.
    \16\ Next Steps for the Air Traffic Organization, Statement of the 
Honorable Kenneth M. Mead Before the Committee on Transportation and 
Infrastructure, Subcommittee on Aviation, United States House of 
Representatives (April 14, 2005) p. 2 (Mead Testimony), p.2.
---------------------------------------------------------------------------
    Just maintaining the safety and efficiency of our air traffic 
system at the current level of operations is not an option. The FAA 
will have to increase system capacity and productivity to accommodate 
an estimated 25 percent increase in the volume of air traffic in the 
next decade.\17\ In fact, the Joint Planning and Development Office is 
seeking to expand capacity by as much as 300 percent by 2015 to 
accommodate changes in aircraft size as well as the projected growth in 
demand.\18\ ATA members support these efforts.
---------------------------------------------------------------------------
    \17\ Federal Aviation Administration, Aerospace Forecasts, Fiscal 
Years 2005-2016, Table 36, X-37.
    \18\ Joint Planning and Development Office, Next Generation Air 
Transportation System Integrated Plan (December 2004), p. 8.
---------------------------------------------------------------------------
    The alternative, measures that restrict operations such as those 
imposed at Chicago's O'Hare International Airport, are unacceptable. 
Arbitrary restrictions on operations will undermine the public benefits 
Congress envisioned when it deregulated the industry. Ultimately, such 
restrictions will add new operating costs as access to the system is 
rationed. Indeed, within the Administration, the notion of ``market-
based'' solutions to allocate landing and take-off rights at certain 
airports is gaining currency already. These solutions could result in 
new fees and charges that airlines would have to pay. Realistically, 
given the fierce price competition within the industry, it is unlikely 
these new charges could be passed on to customers.
    The solution lies in a modernized ATC system that uses technology 
and operational measures to increase capacity and enable growth. In the 
near term, consolidating facilities and decommissioning outdated 
equipment and procedures should provide help at the margins. Capacity 
of the current system can be increased by leveraging existing on-board 
technologies and creating new satellite-based routes that are more 
flexible than existing routes; gains can also be achieved by doing a 
better job keeping slower airplanes separated from faster moving 
airplanes. A key measure is to manage the ATC system from a national 
perspective instead of the current patchwork of airspace components, 
each managed individually. This locally-driven system creates too many 
opportunities for bottlenecks and inefficient use of the airspace from 
a total system perspective. Looking forward, any new system must be 
built on a scalable architecture that maximizes flexibility and ease of 
growth.

Conclusion
    The U.S. airline industry remains in dire financial condition, with 
several airlines in Chapter 11 and other airlines facing that 
possibility as oil prices continue to climb. The prospects for a return 
to stability and profitability remain uncertain in light of factors 
largely out of the control of the airlines. Nevertheless, it can be 
said that a glimmer of hope is on the horizon. People are flying again 
in record numbers, and airline cost-cutting measures are having a 
positive impact.
    Looking forward, Congress and the Administration will play a 
significant role in the financial health of the industry. The tax and 
fee burden remains excessive and should be reduced. By no means should 
new taxes and fees be added, no matter what the purpose. Further, when 
the Aviation Trust Fund comes up for reauthorization in 2007, it will 
be imperative that Congress support the FAA's efforts to expand ATC 
system capacity to permit expected industry growth. At that time, 
Congress should adopt a new funding formula that fairly apportions 
trust fund contributions among system users according to their use of 
the ATC system.

    Senator Burns. Thank you. Mr. Jamie Baker, Vice President, 
JPMorgan Securities, Incorporated, thank you for coming this 
morning.

         STATEMENT OF JAMIE N. BAKER, VICE PRESIDENT, 
        U.S. EQUITY RESEARCH, JPMorgan SECURITIES, INC.

    Mr. Baker. Thank you. Chairman Burns, members of the 
Committee, I do want to thank you for the opportunity to in 
fact speak here this morning. Again, my name is Jamie Baker. 
I'm the U.S. airline equity analyst at JPMorgan. Please do take 
note that the statements that I make here today don't reflect 
the official position of JPMorgan on these issues.
    Let me start out by emphasizing that, and echoing some of 
the recent testimony that it is in fact fuel prices, not 
industry mismanagement, that can primarily explain why we have 
convened here today. Fuel prices are continuing to mask an 
underlying recovery in the airline industry, of which many are 
not aware, and I would suggest that with the exception of fuel, 
all of the relevant industry cockpit gauges, if you will, are 
in the green for the first time since September 11.
    Ex-fuel costs for the legacy carriers have not been this 
low since 1997, and they are, in fact, headed lower. If you 
exclude one-time non-cash and focus on core costs, those that 
suggest future performance, then legacy carriers have in fact 
decreased their cost disadvantage to the low-cost carriers by 
nearly 50 percent. Air fares and revenues both continue to rise 
with no apparent negative offset on demand. U.S. capacity, 
while still growing is in fact growing at a slower rate than 
many of us feared at the beginning of this year. If in fact 
fuel casts were hypothetically not an issue, both American and 
Continental Airlines would have just enjoyed their most 
profitable second quarters in their corporate histories. While 
we are not suggesting legacy carriers can fully match the 
efficiency of some of the smaller, low-cost competitors, the 
gap between the two is clearly diminishing. But unfortunately, 
these carriers that I'm employed to follow, they don't fly 
gliders, and therefore stripping out fuel expenses is merely an 
analytical exercise. Despite nearly a dozen mostly successful 
efforts at raising air fares this year, we estimated only $7 
per barrel of crude has managed to be offset leaving the 
effective price of that still above historic norms. As such, 
liquidity is expected to decline significantly.
    Delta and Northwest will burn through more than $1 billion 
in cash this year inclusive of the capital they have raised 
here today, and furthermore, the industry's ability to go 
deeper into debt, while seemingly never exhausted, is rapidly 
diminishing. Since 2000, airlines have borrowed more than $27 
billion. They have seen their credit ratings fall 
substantially, and while legacy airlines have begun turning to 
nontraditional sources of capital such as the hedge fund 
community and the manufacturers, I think the ability to further 
tap these resources are unlikely unless pension reform can 
positively impact their credit ratings.
    Delta has disclosed that its projected minimum pension 
funding requirements under current rules will increase to $600 
million in 2006, and to more than $1.5 billion by 2008. 
Similarly, at Northwest, they are estimating $800 million for 
requirements for 2006 and $1.7 billion for 2007. For this 
obvious reason, both Delta and Northwest are likely to seek 
bankruptcy protection and follow the damaging precedent set by 
United Airlines in terminating its defined benefit program. 
That is unless we are allowing for long-term amortization 
period of deficits for sponsors agreeing to freeze their DB 
plans comes into law, and I would suggest sometime within the 
next 6 months or so.
    These are not my analytical opinion. The broader market 
implies between a 55 and 59 percent one-year bankruptcy 
probability for Northwest and Delta. For American and 
Continental, arguably two better positioned carriers, the 
implied bankruptcy probability over the next 4 years is roughly 
the same. I point out that these figures have actually worsened 
since my colleague, Mark Streeter, testified before the House 3 
weeks ago.
    But legacy Chapter 11 filings, and the accompanying toll on 
workers, and likely service decline to smaller communities, 
these are not necessarily inevitable occurrences. Legacy 
airline management would much prefer to avoid the Chapter 11 
process and instead be left alone to do what they currently 
are, further reducing their competitive disadvantage to the 
more youthful and fit, those carriers that have sprung up since 
deregulation.
    Now, if the government sponsors the flexibility to stretch 
payments over a period of several years, the sponsors, they 
must be forced to maintain fiscal discipline in my opinion. The 
price to legacy carriers of potential pension reform should 
include at a minimum restrictions on their ability to 
repurchase stock, pay dividends, or offer increased defined 
benefits, even if funded with cash.
    Members of the Committee, if the proposed pension 
legislation not supported by the legacy airlines does become 
law, I agree with the broader market that both Delta and 
Northwest will be forced to file bankruptcy within the next 
year or so. The ability of these carriers to complete their 
ongoing restructuring outside of the court process is almost 
directly tied to pension reform that does not result in onerous 
near-term deficit reduction contributions. With United having 
already sought its subsidy and therefore having set a damaging 
precedent, the government instead has an opportunity to allow 
other carriers the opportunity to make good on promises that 
they have already made to their employees, while further 
protecting taxpayers in the process. Thank you again for the 
opportunity to speak here this morning.
    [The prepared statement of Mr. Baker follows:]

         Prepared Statement of Jamie N. Baker, Vice President, 
             U.S. Equity Research, JPMorgan Securities Inc.

    Chairman Burns and members of the Committee, thank you for inviting 
me to speak this morning. My name is Jamie Baker, I am the U.S. Airline 
equity analyst at JPMorgan. I would like to provide the Committee with 
an overview on the U.S. airline industry, its ongoing efforts at 
recovery, and how the pension issue and other factors will continue to 
impact this recovery. I will also focus certain comments on the 
remaining legacy airline defined benefit plan sponsors, AMR Corp, 
Continental Airlines, Delta Air Lines, and Northwest Airlines. Please 
note that my testimony and statements are my personal views and do not 
represent the official position of JPMorgan.

Fuel Is Masking Fundamental Recovery
    Unfortunately for the airlines, fuel costs are masking a 
fundamental recovery that is well underway. Were an industry cockpit to 
exist, we would suggest all non-fuel gauges would be reading into the 
green, the first such instance since September 11, 2001. For example, 
ex-fuel unit costs haven't been this low since 1997, and they are 
expected to head lower still. Airfares and revenue are both continuing 
to rise, with no apparent offset on demand. Capacity, while still 
increasing domestically, is rising at a slower growth rate than feared, 
with the majority of that growth coming from low-cost carriers. In 
fact, if fuel were not an issue, both American and Continental would 
have just concluded their most profitable second quarters in their 
history. While it is not our intent to suggest that legacy carriers can 
fully-match the efficiency and cost competitiveness of their smaller, 
low-cost carrier competitors, the chasm between the two sub-sectors is 
continuing to diminish.



But Fuel Is a Reality, and Legacy Airlines Don't Fly Gliders
    Regrettably, stripping out fuel expense is but a mere analytical 
exercise. Jet kerosene prices have actually risen by a greater degree 
than raw crude, in part given the shortage of refinery capacity. Year-
to-date, jet kerosene has risen 44 percent vs. a 39 percent increase in 
the price of crude.
    Despite nearly a dozen, mostly successful efforts at raising fares 
in 2005, we estimate that merely $7 per barrel of crude agony has 
managed to be offset, leaving the effective price of that commodity 
still well above historic norms. While carriers will likely continue 
pressing fares higher this year and beyond, each successive fare 
increase is expected to generate a diminishing return, given the price-
sensitivity of demand.



Liquidity Is Under Pressure
    Legacy airline liquidity is expected to decline significantly in 
2005. We estimate that Delta and Northwest will each burn through more 
than $1 billion this year, inclusive of the capital raised year-to-
date, unless assuming cash reserves can somehow be replenished.
    The industry's ability to go deeper into debt, while seemingly 
inexhaustible, does appear to be rapidly diminishing. Since 2000, U.S. 
Airlines have borrowed more than $27 billion, and have witnessed 
substantial declines in their credit ratings. And while legacy airlines 
have been turning to non-traditional lenders, such as hedge funds and 
the manufacturers, the ability to further tap these resources is 
unlikely, unless pension reform can positively impact their credit 
standings.





Our Bankruptcy Probabilities Are Largely Shared By the Market
    By looking at credit market implied cumulative default 
probabilities (a more accurate analysis, in our opinion, than relying 
on equity values), the market ascribes between a 55 percent and 59 
percent probability that Northwest and Delta will file bankruptcy 
within the next 12 months. Implied one-year risk for American and 
Continental, arguably two better-positioned carriers, is significantly 
lower, though their implied bankruptcy probability over the next four 
years remains in the mid-to-high 50 percent range.

                        Exhibit V: Credit Market Implied Cumulative Default Probabilities
                     Cumulative Default Probability Before Time Period Expires (in percent)
----------------------------------------------------------------------------------------------------------------
                                           1 year    2 years   3 years   4 years   5 years   7 years   10 years
----------------------------------------------------------------------------------------------------------------
AMR                                          12.5      29.1      45.2      57.1      61.1      69.9        80.0
CAL                                          14.6      30.5      44.4      54.9      64.6      72.3        82.0
DAL                                          59.0      75.6      80.1      85.0      87.8      93.9        97.8
NWAC                                         54.7      71.1      73.8      80.8      84.0      91.8        96.6
----------------------------------------------------------------------------------------------------------------
Source: JPMorgan, based on July 8, 2005 credit default swap quotes assuming 10 percent recovery in bankruptcy.

Can the Airlines Raise Additional Capital?
    As of late, legacy airlines have been turning to non-traditional 
lenders. Delta has pre-sold frequent flier miles forward to American 
Express and tapped General Electric for a securitized loan. Continental 
recently sold miles forward as well and borrowed against its last major 
unencumbered assets (Air Micronesia, its Guam-based operation).
    It remains to be seen whether or not other vendors and 
manufacturers are willing to invest further in their airline partners. 
Nevertheless, the proposed America West /US Airways capitalization 
includes proceeds from Airbus, hedge funds, traditional money managers, 
and an airline maintenance provider (Air Canada). Therefore, we can 
conclude that the legacy airlines could perhaps tap some of these same 
sources for additional liquidity, especially if pension reform 
positively impacts the credit standing of the legacy airlines.



Will Pension Reform Force Additional Legacy Airline Chapter 11 Filings?
    Under some pension reform proposals, the airlines that sponsor 
defined benefit plans will face incredibly onerous payments. Relative 
to the 2005 required minimum contribution of $450 million, Delta has 
disclosed that its projected minimum funding under the current rules 
will increase by 33 percent in 2006 to $600 million, by 111 percent in 
2007 to $950 million, and by 255 percent in 2008 to $1.7 billion. For 
Northwest, they are estimating $800 million in 2006, and $1.7 billion 
in 2007.
    For this reason, both Delta and Northwest are likely to seek 
Chapter 11, and follow the damaging precedent set by United Airlines in 
terminating its defined benefit plans. This, unless a rapid decline in 
fuel costs or reform allowing for a longer-term amortization of 
deficits for sponsors agreeing to freeze DB plans comes into law, 
sometime within the next six months or so.
    Continental is not as exposed to rising payments given the nature 
of the airline's defined benefit plan relative to Northwest and Delta. 
Nevertheless, the combination of the current oil price environment, 
current industry revenue, and higher required pension payments could 
force Continental to consider Chapter 11 as well in 2006.
    AMR has enough liquidity-raising options and current liquidity to 
perhaps bridge the gap between today's environment and one where 
industry revenue and stock market improvement make required pension 
payments more manageable.
    The issues surrounding credit balances and annual premiums, while 
important, are secondary to both the length of the amortization period 
and the interest rate to value liabilities in the cases of Delta and 
Northwest.
    For AMR, the interest rate assumption and premium payments are most 
critical given the company's and its workers' desire to maintain 
defined benefit plans rather than the freezing approach embraced by 
Delta and Northwest management.
    UAL is AMR's largest competitor. Although UAL's replacement defined 
contribution plan costs are significant, I nonetheless am concerned 
that AMR (and other legacy majors) will be at a strategic disadvantage 
to UAL going forward because of UAL's successful elimination of its 
defined benefit plans.

Multiple Bankruptcies Are By No Means Inevitable
    Legacy Chapter 11 filings, with their accompanying toll on workers 
and expected service declines to smaller communities, are not 
inevitable, in our opinion. Legacy airline managements would much 
prefer to avoid the process, and instead remain concentrated on the 
task at hand--further reducing their competitive disadvantage versus 
the more youthful and fit, those airlines that have sprung up since 
airline deregulation. Their ability to succeed, however, is largely 
predicated on favourable airline-specific pension reform and/or sharply 
lower energy prices.
    Should the government afford defined benefit sponsors the 
flexibility to stretch payments out over a period of several years, the 
sponsors must be forced to maintain fiscal discipline. Such discipline 
should include, though not be limited to, restrictions on the ability 
to repurchase stock, pay dividends, or offer increased defined benefits 
even if funded with cash.



Conclusion
    If the proposed pension legislation not supported by the legacy 
airlines is passed into law, we agree with the market that near-term 
Chapter 11 filings become significantly more likely. Put differently, 
certain airlines are likely to pursue a United-type strategy, whereby 
the PBGC shortfall will increase and taxpayers and plan participants 
will suffer as a result. Alternatively, pension reform that does not 
result in onerous near-term deficit reduction contributions would 
likely materially diminish bankruptcy risk from non-fuel related 
issues, and otherwise allow carriers the chance to make good on 
promises already made to employees, while further protecting taxpayers 
and stakeholders in the process.
    Thank you once again for allowing me to speak to you today.

    Senator Burns. Thank you. Now we have Mr. Robert Roach, the 
International Association of Machinists and Aerospace Workers 
and many years ago, I was a member of your good union.
    Mr. Roach. You can still be a member if you want to, Mr. 
Chairman. I'll sign you right up.
    Senator Burns. I don't think I can throw those baggies like 
I used to in Kansas City.

         STATEMENT OF ROBERT ROACH, JR., GENERAL VICE 
          PRESIDENT OF TRANSPORTATION, INTERNATIONAL 
     ASSOCIATION OF MACHINISTS AND AEROSPACE WORKERS (IAM)

    Mr. Roach. Mr. Chairman, thank you for the opportunity to 
speak today. My name is Robert Roach, Jr. I'm the Vice 
President of the Machinists Union. I'm appearing at the request 
of International President, R. Thomas Buffenberger. The 
Machinists Union represents more than 100,000 U.S. airline 
workers in almost every classification including ramp service 
workers, mechanics, public contact employees, and flight 
attendants.
    Mr. Chairman, the financial condition of the airline 
industry to date is clearly miserable, and without drastic and 
immediate change, the future continues to be bleak.
    September 11 was the start of the current crisis for 
airlines however the seeds for this calamity--excuse me, were 
planted many years earlier by the airlines themselves. When 
airlines were healthy, legacy airlines spent surplus cash by 
purchasing aircraft, foolish mega-mergers.
    One noted exception is Southwest Airlines, which prudently 
expanded their profitable margins while increasing cash 
reserves for the inevitable. However, it should be noted that 
Southwest Airlines, which is 95 percent unionized, pays the 
employees the highest wages and benefits in the industry. I 
want to reiterate that. Southwest Airlines pays the highest 
wages and benefits in the industry, while still maintaining 
profitability.
    At the same time, the airlines refuse to properly fund 
their pension plans and more than 100,000 participants at US 
Airways have lost money. To ask employees to further bail out 
corporations is disgraceful and to force retirees to subsidize 
corporate incompetence is unforgivable. The Machinists Union 
has met with ATA and airline CEOs on how to correct industry 
problems. I believe such partnerships should be continued and 
expanded. Norman Mineta convened an airline summit with 
government officials to jointly develop solutions to the 
problems. The IAM is proactive, but we cannot do it alone.
    In the airline industry we have suffered more than six 
Chapter 11 bankruptcies. Hawaiian and Aloha being two of them, 
and United Airlines. My colleagues have said on this panel we 
believe Northwest and Delta are fastly approaching that line. 
We have reduced costs. We have lost pension money, and our 
health benefits have been reduced.
    I believe what you're going to hear today is differences of 
opinion on how to fix the problem, and that you will hear we 
have the low-cost carrier, but the low-cost carrier advantage 
is because they are new and because they don't have the certain 
wages and benefits that they have today, but as time goes on 
they will catch up, that's why if you want to look at a low-
cost carrier, look at Southwest Airlines as a model, that they 
are properly managed, and that they have been around 27 years 
and at the same time maintaining profitability.
    We cannot sit here today and unlike my colleagues, if oil 
prices are what they are, then we must do something, and we 
believe that that effort is a coordinated effort. We don't 
think, as I said before this same committee on September 20, 
2001, that you can just throw money at the problem. That 
happened in 2001 and we are in worse condition today than we 
were then. I think we need coordinated effort. I think with 
government, Department of Transportation or some Senate 
committee, Presidential commission, along with management and 
labor need to sit in a room with a commission and try to find 
coordinated solutions to the problems that will confront us in 
the future, and to do otherwise would be putting a band-aid on 
a bleeding artery.
    I thank this committee for the opportunity to speak to them 
and present our point of view, and we are prepared to work with 
this committee and management to develop solutions to the 
problems. Thank you very much, Mr. Chairman.
    [The prepared statement of Mr. Roach follows:]

  Prepared Statement of Robert Roach, Jr., General Vice President of 
 Transportation, International Association of Machinists and Aerospace 
                             Workers (IAM)

    Thank you, Mr. Chairman, and members of this Committee for the 
opportunity to speak to you today. My name is Robert Roach, Jr., 
General Vice President of Transportation for the International 
Association of Machinists and Aerospace Workers (IAM). I am appearing 
at the request of International President R. Thomas Buffenbarger. The 
Machinists Union represents more than 100,000 U.S. airline workers in 
almost every classification, including ramp service workers, mechanics, 
public contact employees and flight attendants.
    Mr. Chairman, the financial condition of the airline industry is 
clearly miserable, and without dramatic changes, the future continues 
to look bleak. From 2001 to 2004, legacy carriers have lost more than 
$28 billion, and they are expected to lose an additional $5 billion in 
2005.
    Of the 146 airline Chapter 11 filings since 1979, in only 16 cases 
are the airlines still in business.
    September 11, 2001, is often cited as the start of the current 
crisis for airlines. However, the seeds for this calamity were planted 
years earlier by the airlines themselves.
    When airlines were healthy, legacy carriers spent surplus cash by 
purchasing unnecessary aircraft, irresponsibly expanding operations, 
and pursuing foolish mega-mergers. One noted exception is Southwest 
Airlines, which expanded prudently into profitable markets while 
increasing its cash reserves for the inevitable, recurring industry 
slump.
    At the same time, these airlines refused to properly fund their 
employee pension plans, and now more than a hundred thousand 
participants and beneficiaries at US Airways and United Airlines have 
lost more than $5 billion of their promised pension benefits.
    To ask employees to bail out failed corporations is disgraceful. To 
force retirees to subsidize corporate incompetence is unforgivable.
    The Machinists Union has met with the ATA and individual airline 
CEO's to discuss how to correct the industry's problems. I believe such 
partnerships should be continued and expanded.
    Earlier this year, I asked Transportation Secretary Norman Mineta 
to convene an airline summit so airline executives, labor leaders, and 
government officials could jointly develop solutions to the industry's 
problems.
    The IAM has been proactive in our efforts to transform the 
industry, but we cannot do it alone.
    For a snapshot of the financial condition of the airline industry, 
one only has to look at the unprecedented sacrifices employees have 
been forced to make just to keep this industry alive.

United Airlines
    Almost immediately after signing contracts with the IAM in 2002, 
United Airlines came to its unions seeking concessions. The IAM engaged 
in these discussions over a period of several months in an effort to 
keep the company out of bankruptcy.
    In support of the company's attempt to obtain a loan guarantee from 
the Air Transportation Stabilization Board (ATSB) in November 2002, 
ramp service and public contact employees agreed to cuts that would 
save the company $160 million a year.
    This was happening as employees saw the value of the company stock 
held in their ESOP and employees' 401(k) accounts dwindling. Many 
employees lost tens of thousands in retirement savings as a result.
    United failed in its attempts to reorganize outside of bankruptcy, 
and immediately after its Chapter 11 filing the company asked the 
bankruptcy judge to impose ``emergency'' pay cuts of 14 percent on IAM 
members. The judge authorized this request.
    Laboring under these court-imposed pay cuts, IAM members went to 
the bargaining table and in the spring of 2003 agreed to permanent cuts 
in pay and benefits that would save United $460 million a year ($2.644 
billion from 2003 to 2009). These concessions also included drastic 
reductions in retiree healthcare benefits for anyone retiring after 
July 1, 2003. As a result, many employees retired from the company in 
an effort to preserve these benefits.
    United then took steps to cut retiree benefits for existing 
retirees and filed a motion in court to ask a judge to impose cuts if 
agreements could not be reached with the retirees' representatives. 
This heartless move saved United $50 million a year.
    In the Spring of 2004, the ATSB denied United's bid for a loan 
guarantee a second time and, once again, United turned to its employees 
for more cuts. United also ceased funding its pension plans, the first 
in a series of steps which ultimately led to their termination by the 
Pension Benefit Guaranty Corporation.
    In January 2005, United once again sought ``emergency'' pay cuts 
from the bankruptcy court--this time it was 11 percent. The IAM and UAL 
reached a tentative agreement on June 17, 2005, that, if ratified by 
the membership, will provide United with an additional $176 million a 
year from 2003 to 2009. Savings attributable to the termination of IAM 
member's pensions will save United another $217 million a year.
    Successive rounds of cuts have delivered United annual savings of 
more than $853 million a year off the backs of IAM members. By the end 
of this bankruptcy case, IAM members will have sacrificed more than 
$4.6 billion for United Airlines, which is about three times more than 
the value of all loan guarantees given out by the ATSB.

US Airways
    In US Airways' first bankruptcy in 2002, IAM members agreed to two 
rounds of contract concessions totaling $276 million per year, or $1.8 
billion over 6\1/2\ years.
    Pay was cut by an average of 7.5 percent. Employees also 
experienced drastic increases in their contributions for healthcare 
coverage, which had the effect of reducing take-home pay even further. 
Employees' share of healthcare premiums roughly doubled for single 
coverage, and almost tripled for family coverage, translating into an 
additional reduction in take home pay of 1 percent to 3 percent, 
depending on the employee's classification.
    Immediately after filing for bankruptcy for the second time in as 
many years, US Airways management petitioned the court to impose 
``emergency'' pay cuts of 23 percent for all union-represented 
employees, as well as reduced contributions to pension plans. 
Management and salaried employees' pay was reduced by only 5 percent to 
10 percent.
    On October 15, 2004, the bankruptcy court allowed an emergency 21 
percent cut in pay.
    US Airways then approached the IAM to negotiate permanent 
reductions to pay and benefits, and filed a petition with the 
bankruptcy court to reject the IAM's collective bargaining agreements. 
Ultimately, the parties were not able to reach agreement and the court 
granted the company's request to abrogate the IAM's collective 
bargaining agreements on January 10, 2005. IAM members then voted to 
accept the company's ``last and final offer'' that involved pay and 
benefits reductions even more drastic than what were ratified in the 
first bankruptcy.
    Under these latest terms, IAM members will give up $346 million a 
year in pay, benefits, and work rules. Mechanic and related employees 
will see their pay reduced by an average of 15 percent. Almost all 
Utility jobs are able to be outsourced, and roughly a third of mechanic 
and stock clerk jobs can be farmed out.
    In addition, the defined benefit pension plans were terminated, 
with the sole exception being the IAM's multi-employer defined benefit 
National Pension Plan for our Fleet Service members, who experienced 
pay cuts of 12.8 percent to 20 percent. In addition to these drastic 
reductions in pay, holidays, vacation accruals, sick leave, and retiree 
medical benefits have also been significantly reduced.
    US Airways employees have accepted up to \1/3\ reductions in their 
standard of living in a very short period of time. The typical middle 
class household budget does not have a cushion anywhere close to \1/3\ 
of take-home pay; to be able to adjust to these kinds of reductions. 
Workers and their families are being forced into dramatic and drastic 
changes that affect the most basic, personal decisions, such as where 
to live, where and how to educate children, and making very hard 
choices regarding medical care.
    Many employees have concluded that a job with US Airways is one 
they cannot afford to keep, and as a result, the company is facing 
manpower shortages in many locations. This difficulty in finding 
employees willing to accept the meager wage scales imposed through 
bankruptcy is what caused US Airways' Christmas meltdown in 
Philadelphia last year. That event clearly demonstrates the effect of 
low wages on the reliability of the industry.

Hawaiian Airlines
    When Hawaiian Airlines approached its unions seeking concessions in 
an attempt to stay out of bankruptcy, the IAM stepped up to the plate.
    However, the company failed in its attempt to reorganize outside of 
bankruptcy and filed for Chapter 11 reorganization in the spring of 
2003. As part of the reorganization, a Trustee was appointed due to 
serious concerns on the part of creditors about actions taken by the 
prior CEO.
    The Trustee sought cost reductions of more than $1.5 million from 
IAM members. The IAM and the company ultimately reached an agreement in 
the fall of 2004. Because of the sacrifices made by IAM members, the 
company successfully restructured and recently exited bankruptcy.

Aloha Airlines
    In order to obtain $40 million in ATSB funds, employees at Aloha 
Airlines agreed to a 10 percent across the board pay cut in late 2002, 
designed to save the company $37 million annually. IAM members were 
willing to make these sacrifices to keep Aloha out of bankruptcy.
    Despite these cuts, management was unable to turn the airline 
around. The company filed for Chapter 11 protection in December 30, 
2004, and returned to employees seeking an additional 10 percent pay 
cut, on top of the cuts agreed to just two years before, as well as 
reductions in health benefits, changes to work rules, and a freeze in 
benefit accruals under the company's defined benefit pension plan.
    To force their demand, management went to court to seek abrogation 
of the IAM contract. IAM members ratified a second round of concessions 
this past winter. Despite reducing pay by more than 20 percent, the 
airline continues to struggle to reorganize.

Air Wisconsin
    Air Wisconsin was once owned by United Airlines, but for many years 
has operated as an independent express carrier for United. When United 
filed for bankruptcy, it sought to restructure contracts with its 
express feeders and as a result, in 2003, Air Wisconsin came to its 
employees seeking concessions. IAM fleet and customer service members 
agreed to significant cuts in pay and benefits in order to preserve 
their jobs at the airline.

Continental Airlines
    As part of a company-wide restructuring, Continental Airlines is 
seeking to reduce IAM-represented flight attendant costs by $72 million 
annually. Discussions with a Federal mediator are being scheduled.
Alaska Airlines
    Alaska Airlines management has demanded concessions and even locked 
out nearly 500 IAM ramp service members in Seattle, WA. By outsourcing 
our members' work to the lowest bidder, Alaska Airlines now ranks dead 
last in the DOT's on-time performance ratings. This is another example 
of how an airline's short-sightedness is negatively impacting the 
reliability of our nation's air transportation system.

Northwest Airlines
    Northwest is also seeking significant cost savings from employees 
and termination of pension plans in a bid to avoid bankruptcy.
    Mr. Chairman, members of the Committee, the financial condition of 
the airline industry is an absolute disaster. Passengers have returned 
since 9/11, but the continued reliance on failed business plans 
jeopardizes our air transportation system.
    Southwest Airlines pays their employees more than any other major 
carrier, yet remains profitable, so the industry's problems are clearly 
not the result of high labor costs. Nevertheless, employees have given 
more than their fair share, yet airlines are still struggling. Fuel 
prices are high, and employees are repeatedly asked to subsidize 
artificially low ticket prices.
    The industry needs new ideas. Airlines can't continue refusing to 
charge at least what it costs to provide their service and then claim 
financial emergencies.
    I urge this committee to explore ways to correct the suicidal 
pricing plaguing the industry. Whether it be a mandatory fuel surcharge 
or other government intervention, some re-regulation of the industry is 
clearly necessary. Left alone, airlines will price themselves out of 
existence.
    I thank the Committee for inviting us to participate in these 
proceedings and listening to our concerns.
    I look forward to your questions.

    Senator Burns. Thank you, Mr. Roach, for your testimony. 
I'm interested, Senator DeMint, do you have a statement this 
morning? Thanks for coming.
    Senator DeMint. Just wanted to listen.
    Senator Burns. You've come to a great place. I mentioned in 
my opening statement and the reference toward, you know the new 
carriers, the new low-cost carriers and Southwest as a model 
that so far has been very profitable, but I would look at them 
and say well, we know that they knew how to handle their fuel 
costs, that over time will run out. In your estimation, Mr. 
Roach, how long will it be that they will, before Southwest 
faces the same problems as say our legacy carriers?
    Mr. Roach. Well, they are confronting the same problems 
today. Fuel hedging slowly decreases up to 2009. What has to 
happen, and I believe Southwest management is working toward 
solutions as they go along and managing the business as they go 
along to be prepared for that. I think if you look at the 
pricing of airline tickets on Southwest Airlines, versus US 
Airways or United, you'll find that United and US Airways are 
charging less for tickets than Southwest Airlines, and so there 
is a serious problem. I think that we work with Southwest 
Airlines, and we represent 10,000 people there. We work with 
them to craft solutions to the problems that they will confront 
beyond 2009, such as ticketing problems, working with them in 
the areas of helping to move passengers through the airport, 
and having efficiencies in place, because, again, if we are 
going to have $60 a barrel of fuel, we can't just act like it 
doesn't exist.
    We have to understand it's going to exist. We have to look 
at pricing of the ticket. Every Senator flew in here. When they 
got to a cab at the airport, they didn't pay a surcharge. So 
you have to price the profitability, and that's what Southwest 
Airlines is doing.
    Senator Burns. Mr. Baker, do you have a comment on that, 
how long will it be before they face some of the challenges 
that legacy carriers face?
    Mr. Baker. Well, I would echo the point that they are 
facing many of those problems today. Our analysis suggests that 
if not for their hedge protection on pricing, on fuel pricing, 
they wouldn't be capable of producing profit in this economy, 
and while it's a factual statement that their labor rates are 
above the industry average, Southwest management now concedes 
that that puts them at a competitive disadvantage. And 
furthermore, many of the pricing changes that are taking place 
at the legacy level have negatively affected Southwest's 
performance, the revenue performance in cities such as Fort 
Lauderdale; Hartford, Connecticut and other secondary cities.
    I would suggest that over the next several years, Southwest 
will have to tackle these issues. They have conceded that it 
will be difficult to achieve wage declines because those 
declines are going to have to take place if they are going to 
remain competitive with the further-improving legacy carriers.
    Senator Burns. Well, I go to the airports right now and 
I'll tell you what, I have never seen airports more full, and I 
have never seen Washington, D.C. so full of tourists since 9/
11, so the travelers are back. As I mentioned in my statement, 
though, I come from a State that has a lot of tourist dollars 
and recreational flyers. But we also have a very healthy 
network of business up there and I am concerned about the rural 
connectivity because of the financial conditions of the legacy 
carriers. If it wasn't for the hub-and-spoke situation, well, I 
think we fall into a situation where we could lose much of our 
service into rural areas. I initially asked, why do airlines 
insist that it's so expensive to operate in the rural markets? 
From what I can tell, the planes seem to be full, and I know 
what it cost me to fly to Billings, Montana, roundtrip. You 
could make almost three round trips from Dulles to San 
Francisco. And I have a hard time justifying that, but I also 
know what the costs per mile are, and maybe what you've got to 
have, and you pretty much have to have a face in every window 
whenever that airplane leaves the airport, so I'm really 
concerned about those trends, so looking ahead, Congress has 
provided billions of dollars of direct and indirect assistance 
to airlines, and they continue to lose money. Chairman Stevens 
and I were discussing how to refinance the FAA. And your 
suggestions today, Mr. May, I take it you said over a thousand 
communication systems. Can you give me an example----
    Mr. May. 14,000, Senator. And it's extraordinary. We have 
an infrastructure that's been built up within the air traffic 
control system over the past 35 years that is more.
    Senator Burns. Can some of that be claimed as redundancy in 
case of emergency?
    Mr. May. Some of it can be claimed as redundancy in case of 
emergency, but I don't think we need triple and quadruple 
redundancies, and I think that there is the capacity to do a 
transition--I hate to use this phrase before this committee, 
but transition to digital that might be particularly 
appropriate for the airlines.
    Senator Burns. Appropriately delayed by the way.
    Mr. May. I understand.
    Senator Burns. Senator Inouye?
    Senator Inouye. Listening to the testimony, I gather that 
there are two major causes of the airlines' current 
difficulties, fuel prices and the government, taxes and fees. 
Then we hear the word globalization. And my question is how do 
we, number one, compare to the operations and the financial 
conditions of airlines abroad in Europe and Asia, for example? 
Ms. Hecker or anyone else?
    Ms. Hecker. I think Mr. May may have more detail, but I 
think generally the studies that have been done is that the 
U.S. does not compare favorably, that the top performing 
carriers because they have a very high growth market in Asia, 
and there has been a view that there has been more moderation 
in the U.S. in making the kinds of adaptations to the new 
market environment that, for example, Asian carriers have and 
some have failed. It's not as if they have all succeeded, but 
their growth rates, their efficiencies, their business 
strategies have admittedly in a growth market been largely 
successful.
    Mr. May. Senator Inouye, I think it's important to note 
that there are some very fundamental differences between some 
of the major European and Pan-Asian carriers, and those here in 
the United States. They rely to a very great extent on long 
haul international routes. The major big six and so-called 
carriers here in the United States do a tremendous amount of 
domestic short-haul business here in the United States, which 
is the essence of the hub-and-spoke system. As Senator Burns 
pointed out, without that hub-and-spoke system, we wouldn't 
have service to a lot of small and rural communities 
represented by this committee on a daily basis, and the 
competitive nature of the low-cost carriers is frequently in 
that domestic business, and in particular, for medium-sized 
communities in that system. So that the 85 percent competitive 
route structure of the low-cost carriers with legacy carriers 
is having a dramatic impact on domestic yields for our 
carriers.
    We are actually doing and comparing, very favorably with 
the international carriers on our long-haul international 
routes, but as my friend Giovanni Bezziana would tell you, they 
have many of the same kinds of issues with taxes, fees, and 
fuel costs that we do.
    Mr. Baker. Just to throw some numbers on top of that, 
Senator, for example, the U.S. carriers 75 percent of revenue 
is derived in the lower 48, the remainder coming in longer 
haul, and across the oceans, and internationally. For European 
carriers, those numbers aren't reversed and for that reason, 
their exposure if you look at British Airways or Lufthansa, 
their exposure to low-cost carriers is less, because they don't 
fly those long-haul routes. That's for a very good reason. The 
low-cost model, which is a low-labor cost model is not 
applicable to long haul travel. That's the reason Southwest 
doesn't fly across the ocean, nor does Jet Blue, so it's a 
reversal of the portion of revenues that are expensed to low-
cost carriers that, I think, in large part explains the 
financial difference between the two geographic sectors.
    Senator Inouye. None of the airlines of the United States 
have any government ownership interests, but, on the other 
hand, you take Saudi Airlines, and I suppose it's owned by the 
family, the government, Japan Airlines has a government 
interest in it, China Airlines may be completely government-
owned. Is that a level playing field for us?
    Mr. May. Makes it particularly difficult for us, Senator 
Inouye, but it is the reality of what we are left to deal with. 
Nobody ever said it was going to be a fair situation, and it 
does have an impact, but again, I think the biggest differences 
are not our ability to compete on an international scale, but 
the difficulties we have with more domestic short haul.
    Senator Inouye. An additional cost has been imposed upon 
our citizens, the cost of security, national security, and for 
example, airline security has just sky rocketed. In Europe and 
Asia, who pays for the security, airport security, for example, 
metal detectors?
    Mr. May. I'm not an expert on international security, but 
it's my understanding that more of it is paid by the 
government, as opposed to the individual carriers. In the 
United States, we pay either direct fees or mandated, indirect 
mandated costs, a billion dollars a year for aviation security 
right now.
    Senator Inouye. That's what I wanted to get to, because 
recently, it has been suggested that the airlines pay for 
airport security. And I don't think that's the case in Asia and 
Europe. It's a matter of their national security, isn't it, Mr. 
Baker?
    Mr. Baker. That's correct. I don't have the figures in 
front of me, but I would echo Mr. May's comments that overseas 
governments tend to be much more generous in terms of affording 
that level of security to airports and passengers than here in 
the states, where it's largely funded by the carriers out of 
ticket prices.
    Senator Inouye. Mr. Roach, what has been the response of 
the Administration on your suggestion that there be a summit?
    Mr. Roach. We had several meetings with Secretary Mineta. 
We visited with him in New York very recently. We have not 
established any summit meeting. While it has been favorably 
discussed, we have not had the meeting, and we think it's 
important.
    Senator Inouye. Are they open to your suggestion?
    Mr. Roach. Yes. Secretary Mineta has been fair to 
establish, we talked to several CEOs of several carriers, 
United, US Airways, Northwest Airlines and they all seem 
favorable to getting it done. We think that the Secretary of 
Transportation, or some government agency, needs to call the 
meeting and then we'll get everybody in the same room. We have 
had this on the Secretary's plate. Similar meetings have been 
fruitful, but we think it's important to get everybody in the 
same room to start talking about these issues.
    Senator Inouye. While all of this financial condition is 
existing, what about equipment? Are we keeping up?
    Mr. May. Senator, I think one of the most positive messages 
we can deliver to this committee is that safety in particular 
is at an all-time high. We have never had a more safe period in 
the history of our industry than we've got going right now, and 
I think that's a result of the extraordinarily, fine 
cooperation between the folks that Mr. Roach represents and our 
management, because no matter how great our difficulties, we 
have worked together to that common goal of keeping safety 
first, and we have got some extraordinary equipment that we are 
able to work with and take advantage of.
    Senator Inouye. Mr. Chairman, I have got a lot of 
questions. May I submit them?
    Senator Burns. We can submit them and they can respond to 
them. Senator DeMint.

                 STATEMENT OF HON. JIM DeMINT, 
                U.S. SENATOR FROM SOUTH CAROLINA

    Senator DeMint. Thank you, Mr. Chairman. I'm just sitting 
here trying to sort out how to fix this, and you have given 
significant review of the problem, and I think we have heard 
that some of the problems--clearly mismanagement over the 
years, as Mr. Roach talked about overreaching during good 
times, perhaps not making good decisions. We have also heard 
that labor used as considerable leverage over many years to 
push salaries and benefits way beyond sustainable levels.
    We have heard about the waste of FAA and problems with fuel 
costs, taxes and fees, and you know, my inclination is to say 
maybe we should sit back and let the market try to fix this, 
but I do see the government's hand in this and we perhaps 
intertwined to let it go. But it doesn't seem with all of what 
we have seen with the industry management, the labor that the 
government should come in and just try to fix this problem 
because we can. I'd just like to hear more from some of our 
witnesses of, I mean I don't know how we can sustain an airline 
industry with so many losses.
    I'm perplexed at how it continues to attract capital. And 
this is seeing something where the market really needs to work 
here, and much less government, but I'd be interested in any 
comments that you have on what the government should do at this 
point.
    Mr. May. Senator--I'll jump in here and I know Mr. Roach 
has some ideas, too. Mr. Baker said a minute ago----
    Senator Burns. Jim, pull your microphone a little, would 
you please.
    Mr. May. Thank you, sir. Mr. Baker said the market for 
Continental and American, except for fuel, would have been the 
most profitable quarters they have had in the history of the 
business, and I think the productivity gains that we are 
making, all of the changes that are taking place in the 
industry, and we make no bones we have been less than perfect 
in managing the business over the years, I think all of those 
changes have been extraordinary, and are leading to sustained 
profitability.
    Once we begin to address the uncontrolled costs, those 
costs over which we don't have any control and they are fuel, 
which has had a dramatic impact on our business, taxes and 
fees, and unfunded mandates, we spend $50 billion a year for an 
industry that only earns roughly 80. But here in the United 
States on taxes and fees, security mandates, so on and so 
forth. So I would love to sit down with Mr. Roach and bring our 
CEOs together and talk about how we need to reform the air 
traffic control system, how we need to reduce the impact of 
taxes and fees, and Senator, if you've got some magic for $60 
oil, I want to hear it, because we are at wit's end.
    Mr. Roach. It would be nice to let the market take care of 
the situation, but the market does not take care of it. For 
example, United Airlines and US Airways are currently in 
Chapter 11 insulated from the market and everybody else, 
Northwest, Delta, Continental, the other carriers, Southwest 
are now paying bills, and this is--the court is now running 
those through airlines. So if you can stay into Chapter 11 for 
3 years and not go to the government and dump your pension 
plans, then the market is not taking care of the situation. It 
is the government, it is the courts causing the Northwest, 
Delta, everybody else to now follow suit, but the protection 
has been given through the law on the Chapter 11, so it is 
again, I think, very important that we try to grab solutions 
collectively. I don't want to sit in the room and negotiate 
contracts with everybody.
    We need to sit down and figure out what it is we are going 
to do collectively working with the government. I don't want 
the government to come in and mandate what we should do. We 
should have solutions, and we should have some input from a 
governmental agency as to what the industry can do to fix it 
and work together.
    Mr. Baker. Senator, the testimony that I submitted today 
dealt with the issue of pension reform for the airlines. I 
think if carriers were seeking something to symbol as a 
handout, if you would, they would follow the precedent set by 
United Airlines. File Chapter 11, rid themselves of their 
obligations and put those obligations at the expense of workers 
to the government and to taxpayers. That to me smacks of 
subsidization. What certain carriers and lawmakers have 
proposed is simply allowing the carriers more time to make good 
on promises they have already made, and, therefore, 
substantially diminish in my opinion the near-term risk of 
bankruptcy.
    To me, this is a proposal that would potentially be less 
burdensome on workers and taxpayers.
    Ms. Hecker. If I can just add one point; that there is no 
doubt that pensions are an extremely serious issue. GAO, 
though, has done work widespread across the economy and the 
issue of pension underfunding, and pensions pushing liquidity 
problems on many industries is not exclusively a problem of the 
airline industry. And our work has vigorously called for broad 
and comprehensive pension reform that fixes the problems that 
the current system has created, both in this industry, and many 
others, where we have a nationwide severe crisis in the entire 
defined benefits system.
    Senator DeMint. Thank you, Mr. Chairman.
    Senator Burns. If it's anything that's getting our 
attention in this town right now is a situation we find with 
these pensions. This has the possibility of impacting the 
American taxpayer, to a greater extent than the S&Ls, and there 
are some folks up here that are very, very concerned about 
that, especially in the situation, and in light of our 
budgetary problems now, and I'm very, very concerned about it, 
and even though as your testimony would signify that only 6 
percent of the operating is of their total overall operating 
capital is impacted by the pensions, and that sounds greater to 
me than the figures would indicate.
    Mr. Roach. The issue of pensions, I'd like to say on behalf 
of our organization is that we saw this problem in 2000. This 
is not a new problem, and we went to the airlines and said this 
is a problem. You're not in the pension business. Let's sit 
down and work this out. And they refused. Why they refused--
because under current pension law you didn't have to make any 
contributions to those pension plans, but this is not just 
something that happened yesterday. We saw the problem coming 
and we said let's fix the problem before it becomes a crisis, 
and again because of the law, you're able to push these 
payments back and then all of a sudden they were due. The bill 
came due and he couldn't pay it so again, and I may sound like 
a broken record, we need to sit in a room together to figure 
out what to do next, because how do we address this problem in 
2000, I suggested by the Machinists Union we would not be here 
today. Believe me.
    Senator Burns. Can I suggest to you that the same thing is 
true in Social Security, Mr. Roach, and we are not getting much 
response from anybody to fix that report before it becomes 
uncontrollable and cannot be fixed. But then, as you well know, 
we all got ingrained in all of us here in this country that 
nobody gets excited. I can go down to your farm and tell you 
you're going to have to repaint your barn in 2015, do you want 
to sign the contract now. I doubt that you would do that. And 
that's, that's the American people, but right now, the cry has 
gone out--we have to fix these other funds, but nobody wants to 
do that now, but they will when those checks are 2 weeks late 
or they are halved in two. Senator Lautenberg.

            STATEMENT OF HON. FRANK R. LAUTENBERG, 
                  U.S. SENATOR FROM NEW JERSEY

    Senator Lautenberg. Thanks, Mr. Chairman. I'm sorry that I 
wasn't here earlier. As everyone knows, there are always 
competing committees, and this one ranks very high on my 
agenda, but the other one had to deal with chemical safety, and 
in my State of New Jersey, we worry about those things. 
Honestly, I also worry about the airlines. The service that 
commercial aviation provides to our country and our world is 
essential. The expansion that this country has had over the 
years would never have been possible were it not for the 
availability of commercial air service, so I look with 
considerable misgivings about what might happen in the aviation 
industry if the price of oil and other expenses continue to 
increase.
    However, I'd like to ask a couple of questions that relate 
particularly to the pension problem. I come out of industry. I 
ran a pretty good-sized company, a company that I started with 
two others and now has 40,000 employees. We had a lot of 
experience in running the company and managing the works, and I 
know one thing: pension plans are under assault like the 
Chairman mentioned. Lord knows where we go in terms of 
satisfying the belief that people have that if they work for 
Company A or Company B and they had a pension plan and that 20, 
25 years later they could go on with life and their families. 
Unfortunately, many are not able to do that. And it's not 
particular to the aviation industry. It's also true in other 
industries, especially manufacturing industries throughout our 
country.
    And so I must ask the question--kind of a generic 
question--that is: did everybody get treated equally when it 
came to protecting the pensions of employees in view of either 
credit reorganizations or bankruptcies? Are executive pension 
plans better funded than employee plans? Are executives taking 
the same heat that rank-and-file employees take? Did they run 
the same risks as not being able to get their pensions 
protected? Mr. May, can you comment on that?
    Mr. May. My, I am not an expert on the issue, Senator 
Lautenberg. I will offer two brief observations, and would be 
happy to do some research and come back to more specifics, 
obviously. My sense is that defined benefit plans, no matter 
how they are constructed or who they are for, are facing some 
very real and significant difficulties, and it's not just in 
the airline businesses. As you have pointed out, I was with 
somebody from General Motors the other day, and there are a 
number of concerns across industry.
    As to compensation for our executives, I think it has been 
slashed significantly across the board. I think there are very 
few of our executives that are coming anywhere close to their 
peers in other industries to compensation. As to whatever 
specific retirement plans that those executives may have, I 
don't happen to be privy to those. I know most of it, I think 
you'd be far more expert in this than I, are filed in 
disclosures with the SEC, and I know it's public information, 
and I would suspect that we could find the answer to that 
question there.
    Senator Lautenberg. Mr. Roach, how do you see it?
    Mr. Roach. Well, traditional pension plans both executives 
have, which was shown in American Airlines when they had pay 
cuts and $45 million put aside in special funds for their 
executives. I think there has been testimony in other hearings 
that there are bonus payments that are made. They don't call 
them pensions. But you are talking about millions of millions 
of dollars that go to executives, while employees pension 
benefit plans are being cut. It's not a level playing field.
    Senator Lautenberg. I just wonder whether reserving pension 
plans or termination programs for executives has in any way 
impaired the airline's ability to have some additional funding, 
in addition to the pain and the trauma that it causes for 
employees who have worked and depended on these pensions for a 
long time.
    Mr. Roach. Not only does it affect the current employee, it 
affects the retired employee. The employee that is retired is 
expected an amount of health care, health care costs have 
increased in certain cases, but employee who has depended on a 
dollar amount for months. It has been very difficult as we 
create a lot of morale problems at the airlines because 
employees were planning to retire. As you move the older 
employee out, younger employees come, it also reduced costs. So 
it causes employees to stay around and work longer.
    It has created a lot of serious problems with people again 
being focused, and that goes back to the question of security. 
Employees must be focused at airports. They should not be 
focused about should I pay my mortgage. They have to be focused 
on the traveling passengers, as well as employees. I think 
there is a serious problem. A lot of times in this country you 
don't want to confront things until there is a crisis, and I 
certainly agree with them and that's why today we have 
proposals with Continental Airlines and Northwest Airlines to 
fix their pension plans in coordination with some of their 
ideas that we have to fix the plans. We have to bite the 
bullet. We have to do what is necessary to get these problems 
fixed.
    Senator Lautenberg. Mr. Chairman, I would ask if you would 
consider one of these days having a hearing specifically on 
this question. I think it's important to find out what kind of 
obligations the Pension Guaranty Fund is going to have. It 
could be enormous, and I don't know what we do at that point.
    Senator Burns. I would say to my friend that that is not 
under jurisdiction of this committee, but it sure has an effect 
on how we set policy for our airlines. I'll guarantee you that.
    Senator Lautenberg. Information search would be a good idea 
if we could do it. I would ask whether recent events have 
effected equally the lower-cost carriers versus the legacy 
carriers. The competition is robust, as I see from some of the 
financial statements. Some of the regional and the smaller 
airlines seem to be able to weather this storm better. Is that 
true, Mr. May?
    Mr. May. Yes, sir, it is. And let's maybe try and divide 
the business into three parts. The regional carriers are either 
wholly owned, or have significant operating relationships with 
the major carriers, and they have been earning profits for some 
reasonable period of time because they effectively have a 
guaranteed income because of the contractual relationships they 
have with their brothers.
    The Independence Airs and the smaller low-cost carriers 
are, Robert has pointed out Southwest is a prime example, have 
had a mixed bag. Independence Air, I think it will come as no 
surprise reading the papers, is losing a very significant 
amount of money. Herb Kelleher, who is on my board and a great 
contributor to our industry, has made it abundantly clear that 
if it weren't for the fact he has hedged at $26 for oil, he 
would have lost money over the last year or so. And although he 
has hedges that aren't quite as favorable going forward, they 
rise up into the 40s. A 40-some dollar hedge looks awfully 
attractive when oil is trading on the Nynex at 60, so I think 
there is a mixed bag among the low-cost carriers, but they are 
being impacted as well as our carriers are, although it's easy 
to point out that the costs for the seat model is lower for 
those carriers. I think Mr. Baker is the bigger expert in this 
area.
    Senator Lautenberg. I would be interested in your comments, 
Mr. Baker. In terms of the financial viability, does the 
industry's structure permit the legacy carriers whom we 
desperately need, to survive through these drops and these 
periods of high-cost operating expenses?
    Mr. Baker. I believe most of them are well on the way to 
ensuring them whether it will allow them to endure the 
business. I would point out that in the first quarter of this 
year, if we just strip out fuel expense from both sub-sectors, 
low-cost carriers and legacy carriers, we actually witnessed 
the first year-on-year decline in low-cost carrier 
profitability in several years, whereas non-fuel profits, if 
you will, of legacy carriers, were up in excess of 25 percent, 
and the reason we witnessed the decline in low-cost carrier 
profits is because it coincides with these recovery efforts 
with the legacy carriers, choosing to no longer fall back and 
instead stand their ground and compete more effectively with 
these carriers.
    There is no question in my mind, Senator, that a 
significant reinvention of legacy cost structure is under way. 
It's just that that reinvention is being masked right now by 
the escalation of crude prices.
    Senator Lautenberg. Mr. May, Mr. Chairman--I'll conclude 
with this. I assume that you look at the air traffic control 
system and see how it's functioning. I think it functions very, 
very well, but I am concerned about the anticipated controller 
retirements, as well as the increase in volume of flights as we 
go to more regional jets, more activity in the air. We need a 
lot of space for military uses, et cetera, and the air space is 
not infinite. How will carriers be affected? Have you looked at 
that, sir, in terms of what the financial impact might be? 
Perhaps longer delays and problems that the FAA might not be 
able to quickly find solutions for?
    Mr. May. Senator Lautenberg, I think as I said in my oral 
testimony, we should take the current ATC system and retire it 
to the Smithsonian, where it can be admired as one of the 
marvels of 1950s technology. It is capable of handling the 
traffic we have today. It is fully incapable of handling the 
traffic for the future. One example, Net Jets, has well over 
600 aircraft. They are flying in and out of Teterborough in 
your state. That's a phenomenon. We have ultralight jets on the 
horizon. We have any of a number of regional carriers that are 
putting more planes into the system, and fewer of the larger 
57s, 67s, et cetera, so I think we have got a very significant 
problem on our hands in the future, and we are going to need to 
seriously engage in making it an exercise in difficult choices 
to make some fundamental change to this system from top to 
bottom.
    We have got to go to a fully-digital GPS-based system that 
can handle the traffic that's coming our way.
    Senator Lautenberg. Mr. Chairman, an observation that I 
would like to be permitted to make is that I always believed 
that FAA should be operating similar to companies where the CEO 
is employed to do a job over a period of time, regardless of 
what political party is in place or that kind of thing. An 
organization where the mission is professionalized and we 
thanked the people doing it. We have good FAA people, but the 
fact of the matter is one of the reasons the system is so 
antiquated, and when we try to change it, there are 
discontinuities created along the way. We have spent billions 
of dollars with some of the top agencies in the country in 
trying to reform the air traffic control system, and every time 
we had a start, we run out of cash. It is a system, and it 
works surprisingly well, but it's in overload mode most of the 
time. Thanks, Mr. Chairman. Thank you all very much.
    Mr. May. Senator, if I might be permitted, I know this is 
heresy, but if we could have maybe the Congress of the United 
States spend a little less time micromanaging the details of 
the FAA as to where ILS systems are going, and so on, and so 
forth, and earmarks, it would probably operate a lot more 
efficiently.
    Senator Lautenberg. Shocking suggestion.
    Senator Burns. It is heresy. Let's go over three areas. 
There are some areas of confusion, and in the area of Chapter 
11 bankruptcy, I think we have kind of ironed that out this 
morning. Buying new aircraft. Yesterday I read the testimony of 
all that are here today, Mr. Roach's testimony questions the 
purchasing of new aircraft by struggling air carriers. Do any 
of you refute that argument, or are there long-term gains on 
that investment? Do we talk about efficiency, or is it just a 
bad business decision when we start talking about the 
replacement of equipment?
    Mr. Roach. I think my testimony is the timing. You have to 
purchase new aircraft and you have, because there is more 
aircraft, it becomes less efficient, other aircraft becomes 
less efficient and it can't be maintained when companies can't 
pay their bills and ordering new aircraft, it's a timing issue.
    Mr. May. I think the other factor that's important, Mr. 
Chairman, is that I think our carriers, in particular the 
larger carriers, have learned a very good lesson from 
Southwest. Southwest has a single type of aircraft, 737. They 
are all effectively identical with the exception of the paint 
colors on the outside, and so they have managed their fleet in 
a very effective way.
    I think what we are seeing today is that many of the legacy 
carriers are significantly reducing the numbers of different 
airplanes in their fleet, and they are trying to upgrade, as 
Mr. Roach says, from a fuel efficiency point of view. I was 
with Boeing on Monday of this week up in Hartford, Connecticut, 
we were talking about the 787 which is the most fuel efficient 
aircraft ever designed, I think, and we are all looking for 
those efficiencies in our fleets, and we laid literally 
hundreds of aircraft down in the desert to get rid of older, 
less fuel efficient planes and bringing in more fuel efficient 
planes, so it is a process of renewal and standardization that 
is important for the industry.
    Senator Burns. On the efficiency part of these new 
airplanes, is there anywhere we can go to see what the airlines 
use to measure the payout or the return on investment, as far 
as efficiency is concerned? I say that because we are dealing 
with some new technologies here on this committee with regard 
to lighting.
    When you look at optical lighting, that these old light 
bulbs that we see here today are on their last legs. A lot of 
people don't realize that, and you see this optical lighting 
showing up in our traffic lights more than anywhere else. They 
use from 30 to 40 percent less electricity. So the payout, or 
the payback, for that investment is rather large. Do we see 
this kind of a situation in the aircraft that's coming onboard 
now from the 787 or other types of aircraft that's being 
introduced?
    Mr. May. I'm sure in our engineering team, along with 
Boeing or Airbus engineering teams would be happy to provide 
you and this committee with background.
    Senator Burns. Now in the area of leasing, some in the 
industry have been critical for the role aircraft leasers have 
been playing by providing outside cash and loan support. What 
role, good or bad, do you think this section of the industry is 
having, and what do you see their future role, how will they 
evolve in the future? What role will they play? Mr. Baker, 
you're probably in a better position to address that.
    Mr. Baker. Mr. Chairman, I think one thing that really 
separates the current airline crisis from that which followed 
the first Gulf War, and that being of somewhat less 
significance, is in fact the rise of leasing companies. We were 
unable to witness the number of actual liquidations, names like 
Eastern, Banff, carriers no longer with us, and the removal of 
their capacity played a role in the resurrection or the return 
to profitability that we witnessed for all carriers during the 
mid-1990s.
    I think the role of the leasing community is largely what 
is preventing any liquidations from taking place, so I do think 
it is yet another example of a barrier to exit, and the airline 
industry is notorious in terms of there being very few barriers 
to entry. You and I are free to start an airline with 
surprisingly little red tape and capital requirement for us to 
actually start an airline, and then ceasing to operate that 
airline is entirely different. That said, the leasing community 
clearly has to be mindful of the overall value of the demand 
for aircraft globally, which is why leasing companies such as 
GE are in fact playing an important, and critical role in the 
resurrection of carriers, the redesign of carriers such as 
Delta Airlines. They are now both a potential or an actual 
barrier to exit, but they are also aiding the recovery efforts 
of these carriers.
    Senator Burns. Tell me about in the airline industry. Why 
is it still attracting capital even though it has a very poor 
performance record?
    Mr. May. Senator, that's a great question, and I wish I had 
the answer for it. I can't remember the exact number, but there 
is something on the order of 16 to 20 applications resting at 
the FAA for people coming into the business, as tough as it is, 
and as horrible a record as it is, right now.
    Ms. Hecker. I think your interest in the role of 
manufacturers and lessors is right where the answers are, 
though. Those firms have been making money for a number of 
years, so they are playing the role, yes, in some recovery, but 
they are also keeping the capacity in the system, despite the 
limited pricing power, so it's a dynamic that is a very 
important one in the sector.
    Senator Burns. That tells me that I should be selling 
baggage carts rather than investing in the airline stock. Is 
that, everybody is making money but the airline, right?
    Mr. Roach. Historically in its business everybody connected 
with the airline, with caterers, people that sell, lease 
airplanes, fix airplanes. They all make money. It's the airline 
industry itself that doesn't make money. You're 100 percent 
right.
    Senator Burns. We'll have to look into that, I suppose. I 
started out there, when I came out of the Marine Corps, I 
worked for an airline. Now, the $64,000 question. That's not 
very much. Looking at the debt, looking at the asset-to-debt 
ratio, how much more time have we got before they are all in 
Chapter 11?
    Mr. May. Senator, how much longer are we going to have $60 
oil, and is it going to go to $70? I think you can measure the 
successful livelihood of the business in great measure with the 
price of oil. It's that important to the equation.
    Senator Burns. That we have very little control of right 
now. Right now China and there are a lot of foreign countries 
that are in the oil business, and are driving oil prices right 
now. But I would say on the other hand in Sydney, Montana, I 
don't see many, and Williston, North Dakota, if you know what I 
mean.
    Mr. Baker. Senator, I would suggest, barring a material 
price in crude or material pension relief, Northwest and Delta 
will be facing Chapter 11 decisions within the next 6 months. 
Other carriers are in better positions in terms of liquidity 
profiles, like Continental. I would suggest if nothing changed, 
if revenue trends stopped improving, if fuel costs stayed 
precisely where they are at the pump today, that Continental 
would be facing a Chapter 11 decision sometime toward the end 
of 2006, beginning of 2007, and American once they went through 
the actions consistent with a carrier trying to avoid the 
process, so selling off key assets what have you, making an 
additional return to labor for another contribution there, they 
would be facing a late 2007, or late 2008, bankruptcy decision.
    Senator Burns. Is consolidation an answer?
    Mr. Baker. I don't happen to believe that it is. I think 
that the America West-USAir example is probably the first and 
last significant form of consolidation that, that type of 
consolidation that we'll see for sometime. I do believe that 
over time, assets belonging to failing carriers as they exit 
the industry, they will, will ultimately emerge with fewer 
airlines, but I think it's more likely to occur if and when 
failures take place than through traditional M&A activity. 
Every airline cycle, for example, is accompanied by the loss of 
certain hubs after the first Gulf War. We lost National as a 
hub. We lost Raleigh-Durham. We lost San Jose. This time around 
we have lost Columbus, we have lost another iteration of 
Raleigh-Durham, and I would suggest going forward, somewhere 
down the road 5, 10 years, hubs like Memphis, Cleveland and 
Salt Lake would be on my short list.
    Mr. Roach. Senator, I think that the mergers and 
acquisitions, first of all, exit to the industry has been very 
difficult because of less service and Chapter 11, and people 
could hang on. We show a number of airlines leaving: TWA, 
American, Banff. There are a lot of airlines and 16 or 17 
applications to start new airlines.
    We talked about the Social Security crisis, the people not 
willing to address their problem. We are there in this 
industry. We are at a crisis in this industry. There is no 
putting it off until tomorrow. Something has to get done. It 
has to get done now. Otherwise, we are going to see several 
more airlines in Chapter 11 before the year is over.
    Senator Burns. The other members have questions, and we'll 
submit those questions to you for written response, and if 
you'll copy in the Committee with those responses, we would 
appreciate that. Thank you for coming today. I think overall we 
got a pretty good picture of our challenges. We didn't talk 
about taxes and fees enough, but I think there is some work 
that the GAO has done, and the information that all of you have 
given us, especially from Mr. May's office, where I think we 
are going to take a look at that, and we are going to make an 
argument for taxes and fees right now are a significant part. I 
think there is also an awareness now that even in security as 
the war on terror and as it becomes our enemy, that we can't 
protect everybody, because Americans are a mobile society. And 
anything that infringes on that freedom of movement is looked 
upon as not very good for our society. We are going to have to 
take a look at our mass transit and our other transportation 
facilities, one of these days we are going to have to look at 
the security of this country, and it was suggested up in 
Montana the other day that we had volunteers.
    We decided to send forces in two different ways in World 
War II to wage that war, and we left our own country 
vulnerable. And I'm saying we may be in the same situation, but 
there were voluntary groups, people volunteered to keep our 
country safe, and for observations and to respond to local 
emergencies. We may have to go back to that because we cannot, 
as a government, levy enough taxes to pay for all of it. And so 
I think you know there are a lot of us up here that are taking 
a different view of what our priorities are, especially in this 
area of transportation and keeping it secure.
    Thank you for coming this morning. We'll leave the record 
open for a couple of weeks. If you'll respond to those 
questions, why, we would appreciate that.
    [Whereupon, at 11:25 a.m., the hearing was adjourned.]

                                  
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