The stupid law that prevents foreigners from buying U.S. airlines.

Commentary about business and finance.
Jan. 2 2007 5:46 PM

Air Heads

The stupid law that prevents foreigners from buying U.S. airlines.

Every day, vast sums of capital wash up on our shores, buying bonds, condos, and companies. And every day, vast sums of capital flee our borders, destined for foreign stocks and bonds, oil fields, and factories. The massive flows are one of the distinguishing factors of our commercial culture, and a huge competitive advantage for the United States. 

And yet sometimes misplaced hostility to foreigners, national-security paranoia, and plain-old protectionism can damage American consumers and leave domestic industries hidebound. That's exactly what is happening in the airline sector, where an incredibly foolish law has barred foreigners from taking over American air carriers.

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American investors don't have many problems investing in foreign airlines. Back in 2004, Cerberus Capital, U.S. private equity firm, acquired control of bankrupt Air Canada and restructured the behemoth into a going concern. In mid-December, Australia's Qantas Airlines agreed to be sold to a group that included U.S. buy-out firm Texas Pacific Group.

But we are not nearly so hospitable to foreign airline investors. The Federal Aviation Act prohibits foreigners from owning more than 25 percent of an American airline. Last week, Virgin America, a U.S.-based start-up launched by British billionaire Richard Branson, was told that it had to change ownership before it could get an operating certificate. Meanwhile, FL Group, an Iceland-based investment company, announced it had amassed a 6 percent stake in American Airlines and was interested in getting more involved with the company's management. But because it is restricted from acquiring more than 25 percent, FL Group will likely not be able to exert much influence on the airline.

A law that may have made sense when it was enacted in 1938 is clearly obsolete today. What could possibly justify maintaining a law under which an airline's certificate of operation can be revoked if foreign ownership rises above the prohibited threshold? National security? Come on. Every day, thousands of planes belonging to airlines controlled by foreign investors—states, corporations, individuals—land at and take off from U.S. airports without incident. In theory, it's possible that foreign-owned companies might be more likely than U.S.-owned companies to allow terrorists access to their systems. But on 9/11, it will be recalled, the planes hijacked all belonged to U.S. airlines. Besides, in the post 9/11 world, we don't rely on airlines for security, we rely on the Transportation Security Administration * and government intelligence services to keep us safe.

Passenger safety? In theory, it might be more difficult to get companies owned by foreigners to adhere to the high safety standards the U.S. government imposes. But in a competitive market like the U.S., the incentives to maintain airplanes, hire qualified staff, and operate planes safely are the same for all competitors—regardless of ownership. The commercial-aviation business is one in which reputation matters, and in which the business sanctions for a failure to operate safely are immense. Indeed, as more companies enter the global aviation market, flying has never been safer.

How about protecting a vital national industry from ravenous competition? Clearly, the law hasn't done that. Even without competition from abroad, U.S.-owned airlines have bludgeoned one another into bankruptcy repeatedly. In the wake of 9/11, a good chunk of the U.S. commercial aviation industry—US Airways, United Airlines, Delta Airlines, to name a few—filed for Chapter 11.

No, the ban doesn't make sense any longer. And given the diffusion of wealth and the globalization of capital markets, it seems ever more difficult to enforce. Let's say five different portfolio managers—one in Japan, one in Hong Kong, one in Bombay, one in São Paulo, and one in London—each decide, independently, to take a 5.01 percent stake in American Airlines. Will the Department of Transportation ground the fleet?

The law does succeed in protecting incumbent airlines from potential competition. But that's not a good thing. When the universe of majority owners is limited to the world's 300 million American citizens, that shuts out a lot of really smart people. Recent history should have refuted the presumption that the sum total of knowledge on how best to run airlines resides in the 50 states. (Anyone who has flown one of the great foreign air carriers knows just how much U.S. airlines need to learn.) And in the commercial aviation industry, much of the ferment, and hence innovation, is coming from overseas. Richard Branson has started several airlines from scratch and seems to be doing well with them. FL Group has made hundreds of millions of dollars on its investments in Icelandair and EasyJet. Among its investments are a chunk of Finnair and Sterlin, a Denmark-based low-cost airline.

For many years, the lot of the commercial-aviation passenger has been an unhappy one: overcrowding and widespread delays in the boom years of the late 1990s; bankruptcies and security concerns in the wake of 9/11; and rising prices (a result of the mergers and post-bankruptcy capacity reductions) today. America's road warriors and leisure travelers would welcome Branson's new airline—and any new entrant, really—because the competition would bring down prices and perhaps spur service improvements. A study by consulting firm Campbell-Hill Aviation Group argued that Virgin America would save travelers $786 million per year.