Commercial Aviation: A Framework for Considering Federal	 
Financial Assistance (20-SEP-01, GAO-01-1163T). 		 
								 
The terrorist attacks on the World Trade Center and the Pentagon 
on Sept. 11 killed thousands of Americans and foreign nationals. 
The economic toll will also be enormous. Countless jobs and	 
retirement funds are now at risk. Estimates of the losses to the 
airline industry alone have ranged from $4 billion, according to 
many analysts, to more than $20 billion, according to some	 
airline officials. Congress has already appropriated $40 billion 
for emergency responses, including increased transportation	 
security, and Congress is considering financial assistance to the
airline industry. GAO believes that the government needs to	 
clearly define the nature of the problem--separating short-term  
needs from long-term challenges, industry wants from real needs. 
Although all airlines now face major financial challenges,	 
government assistance cannot overcome the financial difficulty	 
that confronted several carriers before the events of September  
11. The government has a range of options to assist the airline  
industry, from loans and loan guarantees to tax subsidies. The	 
choice and design of the assistance is critical to targeting	 
federal aid to the immediate problems, spreading responsibility  
among all industry stakeholders, and ensuring accountability to  
Congress and the American people. Because an unknown level of	 
risk will accompany such assistance, mechanisms must be put in	 
place to protect the federal government and the taxpayers from	 
excessive and unnecessary losses.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-1163T					        
    ACCNO:   A01948						        
  TITLE:     Commercial Aviation: A Framework for Considering Federal 
             Financial Assistance                                             
     DATE:   09/20/2001 
  SUBJECT:   Airline industry					 
	     Appropriated funds 				 
	     Congressional oversight				 
	     Emergency loans					 
	     Risk management					 
	     Terrorism						 
	     Transportation safety				 
	     New York (NY)					 
	     Pennsylvania					 
	     Pentagon						 
	     Ronald Reagan Washington National			 
	     Airport (DC)					 
								 
	     World Trade Center (NY)				 

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GAO-01-1163T
     
COMMERCIAL AVIATION

A Framework for Considering Federal Financial Assistance Statement of David
M. Walker, Comptroller General of the United States

United States General Accounting Office

GAO Testimony Before the Committee on Commerce, Science, and

Transportation, U. S. Senate

For Release on Delivery 2: 00 p. m., EDT, Thursday September 20, 2001

GAO- 01- 1163T

1

Mr. Chairman and Members of the Committee: We appreciate the opportunity to
testify on an issue so important to the national interests. On September 11,
2001, thousands of Americans were killed or injured through terrorist
attacks at the World Trade Center and the Pentagon and in the crash that
occurred in Pennsylvania. We mourn their deaths and extend our deepest
sympathies to their loved ones. While the human toll of last week?s events
was tragic and significant, there were economic implications as well. The
jobs of many employees and the retirement funds of others are threatened in
the aftermath of these attacks. In addition, aviation and related industries
have suffered significant additional financial losses which are projected to
continue, perhaps threatening the viability not just of individual firms,
but of the entire industry. Estimates of the total expected loss for major
U. S. commercial passenger airlines for this year range from over $4 billion
by many industry analysts to over $20 billion by certain airline officials.
The continuation of a strong, vibrant, and competitive commercial air
transportation system is in the national interest. A financially strong air
transport system is critical not only for the basic movement of people and
goods, but also because of the broader effects this sector exerts throughout
the economy. As a result, the federal government may need and want to
provide financial assistance to this industry. At the same time, care must
be taken to assure that the interest of the federal government and the
American taxpayers are safeguarded in connection with any such assistance
program.

The Congress has already appropriated $40 billion for emergency expenses to
respond to the terrorist attacks on the United States. Among other purposes,
these funds are available to provide increased transportation security. Now,
the Congress is considering various proposals to provide other financial
assistance specifically to the airline industry. In my statement today, I
would like to discuss some broad principles or guidance that the Congress
may wish to bear in mind when it considers providing financial assistance to
the airlines. We base our observations on prior GAO work and lessons learned
from previous federal financial assistance efforts, including those directed
to individual large corporations (such as the Chrysler Corporation and
Lockheed Aircraft Corporation) as well as public entities, such as New York
City. 1 These

1 See, for example, Troubled Financial Institutions: Solutions to the Thrift
Industry Problem (GAO/ GGD- 8947, Feb. 21, 1989), Resolving the Savings and
Loan Crisis (GAO/ T- GGD- 89- 3, Jan. 26, 1989), Options For Dealing With
Farm Credit System Problems (GAO/ T- GGD- 87- 11), and Guidelines for
Rescuing Large Failing Firms and Municipalities (GAO/ GGD- 84- 34, Mar. 29,
1984).

2

principles and guidelines can be grouped into three broad categories:
clearly defining the problems that need to be addressed, tailoring the
appropriate tools of government to address the identified problems, and
protecting the interests of both the federal government and the American
taxpayers.

In summary:

! The government needs to clearly define the specific nature of the problems
confronting the industry-- separating out short- term needs versus long term
challenges and industry wants from genuine needs. While all airlines are now
facing major financial challenges, government assistance cannot nullify the
serious but different financial positions that several carriers faced prior
to September 11. As a result, the Congress may wish to consider what losses
are being incurred that would not have occurred ?but for? the tragic events
of September 11. Moreover, the Congress may wish to further distinguish
between losses that are directly attributable to federal actions (such as
the closing of the entire national airspace or Reagan National Airport) and
those that are due to consumer shifts that may occur in the overall demand
for air travel.

! The government has a range of tools it can consider to address the
problems of the industry, from loans and guarantees to grants and tax
subsidies. The selection and design of the tool is critical to targeting
federal aid on the immediate problems, ensuring the sharing of
responsibility by all industry stakeholders, and promoting accountability to
the Congress and the public. Federal aid should be viewed as targeted and
temporary, and it should be designed to restore the industry to a self-
sufficient financial position.

! Because these assistance programs pose an uncertain level of risk to the
federal government, it is important to include appropriate mechanisms to
protect the federal government and the American taxpayers from excessive or
unnecessary losses. Specific mechanisms, structures, and protections should
be implemented to be prudent with taxpayer resources and manage the
government's risk consistent with a good faith attempt to achieve
congressional goals and objectives of any federal financial assistance
program.

3

Defining the Problems to Be Addressed

Although U. S. commercial airlines have been subject to cyclical swings in
profitability since deregulation, the industry has never before faced
financial hardship of the magnitude currently being discussed. During the
mid- to late 1990s, major airlines generated significant profits. Yet in the
past year or so, as the economy slowed and fuel prices rose, the industry?s
profits turned to losses. Until last Monday, industry analysts had projected
that the U. S. commercial airline industry would lose over $2 billion in
2001. Of course, not all carriers faced the same financial challenges prior
to the tragic events of last week. Southwest Airlines and Continental
Airlines, for example, were still able to report net operating profits
during the first two quarters of the year. United Airlines, on the other
hand, reported net operating losses exceeding $600 million. Following last
Tuesday's tragedy, some industry analysts estimated losses for the major
airlines will now exceed $4 billion for the year. Even airlines that had
reported second quarter operating profits are now experiencing significant
financial difficulties. According to reports from industry analysts, these
losses are of an unprecedented magnitude.

During the first few days of trading this week, airline stock values have
been very volatile- most dropped by roughly 40 percent on Monday, although
they rebounded somewhat in trading on Tuesday. A variety of factors may be
behind this decline, including uncertainty about the airlines? future and
public statements by airline executives that they many need to file for
bankruptcy protection if the federal government does not offer significant
financial assistance to the industry.

The airlines appear to face both short- and long- term financial needs. The
most immediate threat to many carriers is reported to be inadequate cash
reserves and negative projected cash flows combined with a tightening or
denial of credit by commercial lending institutions. This liquidity problem
is likely due to the interruption in operations following last week?s
tragedy. The Department of Transportation closed U. S. airspace for several
days, basing its decision on what it felt was in the overall interest of the
nation, given the facts and circumstances existing at the time. Some
analysts have estimated that U. S. airlines lost tens of millions of dollars
every day they could not operate. In addition, the federal government has
not yet decided when and under what conditions it may allow Reagan
Washington National Airport to reopen. This situation has clear financial
implications for the airlines and other businesses with significant
operations at

4

that facility. Additionally, commercial lenders may be less willing to
extend credit to the carriers because of uncertainty about the industry?s
economic viability.

The industry also faces potential longer- term financial needs. Some
analysts are further concerned that last week?s tragic events may have a
profound and lasting effect on the demand for air travel. Although it is too
early to tell how passenger demand will be affected in the long term by last
week?s events, it is clear that the airline industry now has significant
excess capacity, given the current and near- term expected demand. In
addition, several carriers had excess capacity prior to the events of
September 11.

The long- term viability of American Airlines and United Airlines as
individual corporate entities could be heavily impacted by the extent to
which they are found to be legally liable for claims stemming from the
events of September 11, 2001. If these airlines are found to be liable for
claims stemming from the loss of life, personal injury, and property damage
that occurred, their potential liability is likely to be unprecedented.
While these carriers presumably have liability insurance, insurance coverage
typically has limits beyond which the insurers had no legal liability. Also,
although airlines are responsible for the safety and security of their own
flights, if American and United had arrangements or contracts with other
carriers or security firms to provide security, those firms may also share
liability with American and United. 2

Furthermore, lenders and insurers will undoubtedly be concerned about losses
from possible future terrorist events. As a result, the issue of potential
limitations on liability for losses relating to such events needs to be
resolved in order to provide stability to related market activity.

Tailoring the Authority and Tools to Address Defined Problems

After the problems confronting the industry are better defined, the Congress
can then better determine which policy tools may be most relevant to
addressing the particular goals of the assistance program. The federal
government has a range of policy tools that might be considered to help the
industry - grants, loans, loan guarantees, regulatory relief, and tax

2 Additionally, because insurers recognize additional risks and because they
face the high cost of paying potential claims, liability insurance premiums
for the entire industry could rise considerably in the future.

5

subsidies are leading examples. Different tools may be more appropriate for
addressing different needs. Each tool has different implications for the
federal government and for the industry. These implications need to be
carefully weighed and balanced.

Our previous work on federal programs in general suggests that the choice
and design of policy tools have important consequences for performance and
accountability. Regardless of the tool selected, the federal government
should take steps to design and manage the assistance with the following
considerations in mind. First, immediate assistance should be targeted to
address the short- term problems associated with the attack last week, not
to resolve the longer- term structural problems affecting particular
carriers in the industry. Second, the federal assistance should be designed
and managed to promote shared responsibility by all interested parties in
the industry?s recovery from last week?s tragedy. Additionally, incentives
can be provided to help strengthen the longer- term competitive position of
the industry in the market. Finally, accountability should be built in so
that the Congress and the public can have confidence that the assistance
provided was prudent and consistent with the accomplishment of stated public
objectives.

Historically, the federal government has used loan guarantees in its
financial assistance to specific companies. Such guarantees assume that the
federal role is to help the industry overcome a cyclical or event- specific
crisis by gaining access to cash in the short term that it otherwise cannot
obtain through markets. Loan guarantees and loans alike assume that the
aided firms will eventually return to financial health and have the capacity
to pay back the loans. Credit assistance is often premised on the provision
of various forms of collateral and equity to protect the federal interest,
as well as various concessions by interested parties to share the risk and
promote a stronger outlook for the firm in the future.

Other tools are under consideration as well. For instance, grants may be
appropriate for reimbursing airlines for losses attributable to direct
actions mandated by the federal government, such as closing the national
airspace and particular airports. This decision, while prudent and
understandable, had a direct and negative impact on the airline industry-
carriers would not have incurred certain losses ?but for? the acts of the
government. Grants can provide an infusion of cash in the short term and can
be part of the recovery process. Grants can be

6

designed with eligibility criteria to target them to those most in need as
well as to ensure a federal agency role in approving plans and applications
up front from prospective grantees. As with credit, grants can be
conditioned on various concessions by interested parties.

Tax subsidies have also been proposed. For example, the carriers are
reported to have proposed being able to retain all ticket and cargo waybill
taxes and for relief from the federal tax on jet fuel. Unlike grants and
loans, tax subsidies are a more automatic tool of government and do not
generally permit the degree of federal oversight and targeting that these
other tools do. Generally, tax subsidies are designed to be available by
formula to all firms that satisfy congressionally- established criteria.
Federal oversight of tax subsidies generally comes after the fact through
audits of firms by the Internal Revenue Service. While federal oversight is
less direct, many argue that tax subsidies have certain inherent advantages
as well. For example, they can quickly become available for firms and are
generally less costly to administer.

Federal direct spending might also help to relieve the industry of certain
costs. For instance, it has been suggested that the screening function at
airports be taken over by the federal government, thereby freeing up
resources in the industry.

Although the Congress may well decide there is a compelling national
interest in providing financial assistance to ensure the viability of the
commercial airline industry, no one envisions that this industry should
remain under federal protection indefinitely. Having an exit strategy at the
beginning will provide congressional guidance to the airlines and the
program administrators on how the industry should emerge from the assistance
program.

Protecting the Interests of the Federal Government and American Taxpayers

Various mechanisms can be built into the design of an assistance program and
its oversight to protect the interests of the federal government and
American taxpayers. The Congress may want to create an oversight board whose
membership reflects the diverse elements that contribute to the assistance
program. For example, to administer the loan guarantee program created to
assist Lockheed, the government established a three- person board consisting
of the Secretary of the Treasury, the Chairman of the Board of Governors of
the Federal Reserve System, and the Chairman of the Securities and Exchange
Commission. Staff could also be

7

detailed from federal agencies represented on the board to support the
board?s review and oversight function. It would also be prudent to provide
the board with access to the financial records of any recipients of
assistance under the program. Furthermore, prior federal assistance programs
for failing firms and municipalities gave us the authority to audit the
accounts of the recipients; this authority enabled us to support
congressional oversight of the program?s administration.

If a board is established to oversee federal financial assistance for the
airline industry, the board could be tasked with implementing specific
procedures and controls over the financial assistance program to protect the
government?s interests. The board could also be required to report
periodically to the Congress on the assistance program?s operations and
results and the board?s stewardship of the program. The board would likely
be the logical entity to establish clearly defined eligibility criteria for
borrowers, consistent with statutory direction provided by the Congress, and
establish specific safeguards to help protect the government?s interests.
The specific safeguards could vary, depending on the nature of the financial
assistance tools used. Examples of safeguards over loans and loan guarantees
include the following.

! Potential borrowers should demonstrate that they meet specific eligibility
criteria, while at the same time demonstrating that their prospective
earning power, together with the character and value of any security
pledged, provides reasonable assurance of repayment of the loan in
accordance with its terms.

! Potential borrowers should clearly state the purpose of the loans so that
the board can make appropriate decisions about terms and conditions, as well
as collateral.

! Fees can be charged by the government to help offset the risks it assumes
in providing such assistance.

! The government?s loss exposure can be reduced by a requirement for pledged
security or liens as collateral.

8

! For loan guarantees, the level of guarantee can be limited to a given
percentage of the total amount of the loan outstanding.

The oversight board would be in a position to monitor the status of loans
and guarantees on a regular basis and to require regular reporting on the
part of the borrowers regarding their cash flow, the results of their
operations, and their financial position, including independent audits of
their records, as appropriate.

In evaluating applications for direct loans or loan guarantees, the
oversight board would be charged with acting on applications as quickly as
possible to meet the objectives of the assistance, while thoroughly
analyzing the risks to the government of providing the loans or guarantees.
Examples of external risk factors involve the pricing and demand risks that
are currently impacting the airline industry. Internal borrower risks,
however, result from a borrower?s own disadvantages or limitations, which
may have been present before the recent, tragic events, but are now being
magnified by those events. Potential borrowers would need to clearly state
the purpose of the financial assistance and provide operating and financial
plans that integrate their internal and external risk factors so that
appropriate decisions can be made about the nature and amount of assistance
to be provided by the government.

Another potential tool for providing financial assistance would be grants
for specific purposes, as noted previously. Examples of safeguards over
grants include the following:

! Applicants should demonstrate that they meet specific eligibility criteria
and clearly specify how they will use the assistance they receive.

! The oversight board should have clearly defined procedures and criteria
for approving grants.

! The oversight board should monitor the use of grant funds on a regular
basis, and require regular reporting on the part of the recipients regarding
the use of funds and results, including independent audits of grantees?
records.

9

Additional protections to the government?s interest could be achieved by
tying financial assistance to certain concessions from the recipients of the
assistance or others who have a stake in the outcome. For instance,
recipients could be required to provide the government with an equity
interest in exchange for the assistance, or with priority claims
guaranteeing that government loans or government- guaranteed loans be paid
first, thus subordinating other lenders? interests.

Conclusions

Clearly the tragic events of September 11, 2001 have had a dramatic impact
on not only many individual Americans, but also our nation as a whole.
Obviously, those who lost their lives and their family members and friends
have been affected the most. However, as we have discussed today, there are
significant implications for the U. S. economy-- and the airline industry
has been affected in a dramatic and fundamental way. Given the clear
national interest in a sound aviation system, it is appropriate that the
federal government consider measures to assist this critical industry in
recovering from the tragic events of last week. At the same time, any such
assistance needs to be properly targeted, managed, and overseen in order to
protect the federal government and American taxpayers.

My remarks today have focused on principles the Congress may wish to
consider as you contemplate possible financial assistance for the airline
industry. These lessons are drawn directly from GAO?s support of
Congressional efforts over several decades to assist segments of industries,
firms, the savings and loan industry, and even New York City. Our counsel
hinges on three basic elements:

(1) the need to clearly understand distinct dimensions of the problems
confronting the industry, including short- and long- term concerns as
appropriate;

(2) the need to carefully tailor appropriate tools to address well- defined
problems; and finally

(3) the importance of crafting effective mechanisms, controls, and oversight
to protect the interests of the federal government and American taxpayers.

10

The application of clear principles to the consideration of federal
assistance is especially important, since actions to assist the commercial
aviation sector are likely to set precedents for additional parties already
coming forward and seeking relief. In addition, we must be prudent about the
decisions we make for this industry because we still have long- range fiscal
challenges in other areas of the federal budget and our economy.

It is important to remain mindful that in a market economy the federal role
in aiding industrial sectors should generally be of limited duration and
purpose. The assistance should be structured to ensure that it prompts the
industry to recover and become self- sustaining in the future. It may be
appropriate to distinguish between losses that are directly attributable to
federal action (such as closing the nation?s airspace) and those that are
due to either individual circumstances of carriers or broad shifts that may
occur in the market demand for air travel. While this is a difficult and
tumultuous time, the Congress would be prudent to be clear about precise
objectives of assistance to the industry and assure a clear path for how the
industry can be expected to emerge from the assistance program-- hopefully
as a vibrant, stable and efficient force in the American economy.

GAO stands ready to assist the Congress in examining this issue-- as well as
the many interrelated issues brought to the fore by these tragic events--
including measures to improve airport security, provide air marshals, and
examine the future of Reagan Washington National Airport.

This concludes my prepared remarks. We hope that our testimony today has
been of assistance to you.

Contact

For further information on this testimony, please contact John H. Anderson,
Jr., on (202) 512- 2834.

544016
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