In 1978, under the Airline Deregulation Act, the United States deregulated its domestic airline industry. The main purpose of deregulation was to remove government control and open the air transport industry to market forces. Previously, the Civil Aeronautics Board regulated all domestic air transport, controlling fares and setting routes. In this regulated market, airlines competed more through advertising and onboard services than through fares. When the industry was deregulated, “legacy” airlines carried over the cost structures that had been protected by price regulation. Similar to other highly regulated industries, the airline industry was heavily unionized, with a highly trained and stable workforce. By contrast, carriers that started operations after deregulation sought to attract passengers from legacy network carriers and to stimulate new passenger traffic—and did so—by offering lower fares. These airlines generally paid less for labor, on a unit cost basis, which helped them keep their overall operating costs low. In August 2004, we reported on the financial condition of the airline industry. High-end demand for air travel had begun weakening in 2000 because of an economic turndown, and demand dropped significantly following the September 11, 2001, terrorist attacks; the war in Iraq; and the outbreak of SARS. We found that in response to changing market conditions, legacy airlines had reduced costs, but mostly by reducing capacity and not nearly enough to be competitive with low cost airlines. Low cost airlines experienced significant growth and a fall in their unit costs as measured by cost per available seat-mile (CASM), whereas legacy airlines’ unit costs did not improve. In addition, we found that neither legacy nor low cost airlines possessed much pricing power and suffered declining unit revenue. As a result of their weak financial performance and mounting losses, legacy airlines saw their financial liquidity and solvency seriously deteriorate even as their debt and pension obligations mounted. Since our 2004 report was issued, losses have continued to mount for airlines even though traffic levels have returned to pre-9/11 levels. One of the primary culprits has been record fuel prices, nearly doubling since 2003 (see fig. 1). Low fares have affected 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 fig. 2). However, the decline has been greater for legacy airlines than for low cost airlines. Only during the first half of 2005 has stronger demand allowed airlines to increase fares sufficiently to boost their yields. Legacy airlines, as a group, have been unsuccessful in reducing their costs to become more competitive with low cost airlines. Unit-cost competitiveness is essential to profitability for airlines after years of declining yields. While legacy airlines have been able to reduce their overall costs since 2001, they have done so largely by reducing capacity and without improving their unit costs as compared to low cost airlines. Meanwhile, low cost airlines have been able to maintain low unit costs by continuing to grow and maintaining high productivity. As a result, low cost airlines have been able to sustain a unit-cost advantage over their legacy rivals (see fig. 3). In 2004, low cost airlines maintained a 2.7 cent advantage per available seat mile over legacy airlines. This advantage is attributable to lower overall costs and greater labor and asset productivity. Thus far in 2005, airlines have been able to trim most of their nonfuel-related costs, but high fuel prices and debt interest charges have kept airlines’ costs from falling. 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 (see fig. 4). Legacy airlines have incurred a cumulative $28 billion in operating losses since 2001. Despite a modest recovery for some airlines during the first half of 2005, analysts predict the industry will lose another $5 billion to $9 billion in 2005. Owing to continued losses, legacy airlines 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 doing so, several legacy airlines have used all, or nearly all, of their assets as collateral, potentially limiting their future access to capital markets. Airlines (and other businesses) that are unable to operate profitably over time may seek recourse under the U.S. Bankruptcy Code. In general, two major provisions of the bankruptcy code govern actions taken by airlines and other businesses: Chapter 7 of the code governs liquidation of the debtor’s estate and is often referred to as a “straight bankruptcy.” A trustee is appointed to sell off available assets to repay creditors. is designed to accommodate complicated reorganizations of publicly held corporations. Among other things, it allows companies, with court approval, to reject agreements made under collective bargaining and renegotiate contracts with other creditors. With the approval of the bankruptcy courts (which administer the bankruptcy laws), companies may also modify retiree benefits. Airline bankruptcies typically include a large number of stakeholders. The primary stakeholder is the airline itself, known as the debtor-in-possession. Federal stakeholders include the bankruptcy judge, who presides over the administration of the case and decides contested aspects, and the U.S. Trustee, whose duties include ensuring the integrity of the process and approving the retention of professionals (e.g., bankruptcy attorneys). During this most recent round of airline bankruptcies, two additional governmental entities have become major stakeholders in airline bankruptcies: the Air Transportation Stabilization Board (ATSB), which was formed after September 11 to administer a $10 billion loan guarantee program for airlines, and PBGC, which insures defined benefit pension plans. Both agencies have taken ownership stakes in bankrupt and nonbankrupt airlines through ATSB’s loan guarantees and PBGC’s taking over defined benefit pension plans terminated in bankruptcy. The entities that provide the financing while an airline is in bankruptcy (known as debtor-in-possession financing) and upon its exit (exit financing) are also major stakeholders, as are airline employees, many of whom are represented by labor unions. Other secured and nonsecured creditors and shareholders are also stakeholders in an airline bankruptcy. The interests of unsecured creditors (including labor) and shareholders are represented in the process by committees appointed by the U.S. Trustee. Among the largest cost elements for both legacy airlines and low cost airlines are those associated with employee compensation and benefits. As part of the retirement benefits offered, legacy airlines have tended to offer “defined benefit plans” and supplemental defined contribution plans, whereas low cost airlines tend to provide only “defined contribution plans.” Defined benefit plans typically provide participants with an annuity at retirement—a series of periodic payments over a specified period of time or for the life of the participant. As designed, defined benefit plan annuities are generally based on a participant’s retirement age, number of years of employment, and salary. As of December 31, 2004, nine major airlines sponsored defined benefit plans for their employees: Aloha, Alaska, American, Continental, Delta, Hawaii, Northwest, US Airways, and United. These airlines generally offered different pension plans for different groups of employees—pilots, machinists, and flight attendants, for example—with varying levels of promised benefits. Defined contribution plans base pension benefits on the contributions to and investment returns on individual accounts. Contributions may consist of pretax or after-tax employee contributions, employer matching contributions that require employee contributions, and other employer contributions that may be made independent of any participant contributions. In a defined contribution plan, the employee bears the investment risk and often controls how the individual account assets are invested. PBGC was established to encourage the continuation and maintenance of voluntary private pension plans and to insure the benefits of workers and retirees in defined benefit plans should plan sponsors fail to pay benefits. However, if a pension plan’s assets are insufficient to pay accrued benefits, the plan can be terminated under certain conditions, and PBGC then assumes responsibility for paying retiree pensions. PBGC may pay only a portion of the benefits originally promised to employees and retirees. For 2005, the maximum statutory limit of annual benefits guaranteed by PBGC is $45,613.68 per participant, for retirement at age 65. The amount paid decreases at earlier retirement ages. Bankruptcy filings are prevalent in the U.S. airline industry because of long- standing economic structural issues that have led to historically weak financial performance for the industry. Structurally, the airline industry is characterized by high fixed costs, cyclical demand for its services, intense competition, and vulnerability to external shocks. As a result, airlines have been more prone to failure than many other businesses, and the sector’s financial performance has continually been very weak. Airlines frequently seek bankruptcy protection because of severe liquidity pressures, but while bankruptcy may provide some immediate protection from creditors, airlines in bankruptcy have not always been able to reduce their costs or avoid liquidation. Owing to the long history of airline bankruptcies, the process is well developed, and the code includes provisions applicable just to airline bankruptcies. Even so, the process can be lengthy and contentious—for example, United is in its third year of bankruptcy, and its process to date has included litigation over aircraft repossessions as well as employee pensions. Since the 1978 economic deregulation of the U.S. airline industry, airline bankruptcy filings have become prevalent in the United States, and airlines fail at a higher rate than companies in most other industries. This has been particularly true for small, new entrant carriers. Since 1978, there have been 162 airline bankruptcy filings in the United States, 22 of them since 2000. Most of these bankruptcies were chapter 11 filings by small, new- entrant airlines that eventually liquidated.