Too Big to Fail?

A national icon teetering on the brink of bankruptcy, dragged down by huge, underfunded legacy costs, a history of mismanagement and a harsh business climate. A new government determined to bail it out because it is “too big to fail”. General Motors in the U.S.? No, Japan Airlines, the country’s premier air carrier.

The situation facing the new government headed by Prime Minister Yukio Hatoyama was somewhat similar to that presented by General Motors when President Barack Obama took office. Like GM, the Japanese airline is a national icon that has fallen on hard times, not just buffeted by cruel economic circumstances but by its own missteps and generous pensions.

To carry the American analogy further, Japan’s second carrier, All Nippon Airlines, like the Ford Motor Co., is in better financial shape. The airline even had the wherewithal to hire Japanese teen golfing phenom, Ryo Ishikawa, as its official spokesman. JAL has suspended all broadcast advertising. It can’t afford the cost.

Even before the new Japanese government took office in mid-October, the former administration had been taking emergency steps to salvage the airline, which reported a JPY 96 billion operating loss for the first half of 2009. In June the government-owned Development Bank of Japan loaned the airline about JPY100 billion to help keep it afloat to the end of the year, one of several such loans over the past few years.

The Ministry of Lands, Infrastructure, Transportation and Tourism was orchestrating equity investments from other international airlines, such as Delta, American, and British Airways, while the company itself presented a new plan for cutting costs by layoffs and by cutting back on unprofitable routes. This was the situation when the newly elected government took charge.

The new transport minister, Seiji Maehara took a careful look at the restructuring plan and threw it out. He determined that the airline was in too deep for normal cost-cutting initiatives, not even draconian layoffs. Efforts to involve foreign airlines, especially Delta, were initially rejected as too little and too complicated, given the system if airline alliances.

(However, American Airlines announced late last week that it might team up with private equity firm TPG to invest some $300 million in JAL. The two air lines are members of the Oneworld aviation alliance; teaming with Delta would require JAL switching to SkyTeam, a costly and complicated transition. Meanwhile, Delta and alliaces have come up with their own $1 billion package.)

The new Democratic party of Japan (DPJ) might have decided to let the airline go bankrupt. After all, many American airlines have used bankruptcy protection to get their houses in order, including JAL’s presumed rescuer, Delta in 2005. Instead, it decided to essentially make it a ward of the state. To coin a phrase, it is too big to fail.

Or to put another way, JAL is too important to fail. With approximately 17,000 employees JAL is not quite in the General Motors’ class. Even if every JAL employee were laid off, it would hardly cause a ripple in the unemployment rate. It buys not builds aircraft so there is no widespread network of suppliers to worry about. There are other reasons to prop it up.

“We cannot afford to let JAL go under as its flights account for 60 percent of the total in Japan,” said Maehara. “If its flights stop, the Japanese economy as a whole, local economies and exchange with foreign countries will be seriously hampered.”

Under the new policy, JAL will become, in essence the ward of a new government-private sector Enterprise Turnaround Initiative Corporation, with Maehara and other government officials deeply involved. The government is prepared to guarantee up to JPY 1.6 trillion that the new corporations borrows to give to JAL and other companies.

The rebuilding of JAL will based on a government loan of JPY 300 billion, financial institutions forgiveness of debts and conversion of bonds into company shares, a JPY 180 billion bridge loan to carry the company over next perilous few weeks. The bridge loan is needed because the carrier’s business is deteriorating so fast that there was worry it would not survive past November.

Vast amounts of public money were injected into the major banks during Japan’s financial crisis in the 1990s, but in that case, the government was trying to prop up an entire sector of the economy. The money destined for JAL would be the largest amount spent on an individual, private corporation.

The government is also expected to take aim at JAL’s huge pension liabilities, which the government says need to be cut by about 200 percent if the airline is to recover. If the retirees don’t approve the cuts (and a two-thirds majority is required under current law), the government says it will pass a law mandating it. That would be a big step considering that the DPJ is supported by the unions.

Japan Airlines was the nation’s flag carrier from 1953 to 1987, when it was privatized. I n many ways it set the standard for many other Asian airlines that followed such as Singapore Airlines, Garuda and Thai Airways. There was a time when JAL’s super gracious passenger service was the standard for all airlines to emulate.

Although it was privatized in 1987, in many ways it remained Japan’s flag carriers and that contributed to its current difficulties. The previous government was famous for sprinkling public works projects around the country, including airports for every one-horse town. JAL was obliged to serve those airlines even though many were unprofitable. As part of its reorganization, JAL has been cutting back drastically on both domestic and international routes.

Japan airlines was been buffeted by many of the ill winds that have hurt the bottom lines of all the world’s airlines, such as the global recession, rising petroleum prices and the swine flu epidemic. But it has also suffered from other problems unique to Japan.

Landing fees at Narita International Airport and other international and domestic airports in Japan are among the highest in the world, and they eat into airline profits. The new government is on record as favoring lowering such fees. Similarly, taxes and jet fuel charges in Japan are fairly exorbitant.

Despite its dire straits, JAL has had no trouble attracting foreign companies, such as American and Delta, ready to prop up the company. Changes in aviation policy and the impending reconfiguration of Japan’s main airports make an alliance with JAL still an attractive proposition.

On Oct 26 U.S. and Japanese aviation officials started talks in Tokyo to reach an agreement, perhaps by year’s end, on an open-skies accord. It would allow airlines more flexibility in determining flight routes and numbers at their own discretion rather than government fiat.

Couple that with the expansion of departure and arrival slots at the two main Tokyo area airports, Narita and Haneda. Minister Maehara is on record as wanting to turn Haneda, which now serves mostly domestic flights, into an Asian aviation hub competing with such new aviation portals as Inchon in South Korea and Shanghai for Asian traffic.

Obama Sidesteps Bases Issue

It might come under the category of something that couldn’t have happened at a worse time. Less than one week before President Barack Obama arrived in Japan for a visit, a U.S. soldier was taken into custody on Okinawa in connection with a hit and run incident in which an elderly Okinawan man was killed.

It is, of course, incidents like this one, rare though they may be, not to mention noise, congestion and other daily irritants, that led Japan and the U.S. to negotiate a complex deal to lower the American military’s large “footprint” on the southern island, an agreement that has ballooned into a major alliance crisis in some minds.

In 2006 the two governments agreed and in early 2009 Secretary of State Hillary Clinton signed, an agreement under which Washington would withdraw 8,000 Marines and their families from Okinawa to Guam and close the Futenma Air Station in southern part of the island that is now totally surrounded by urban development.

In return, Tokyo agreed to foot a major portion of the estimated $10 billion relocation costs and build, also at Japan’s expense, the Marines a new high tech heliport on reclaimed land at a another, less populated location on Okinawa in the township of Nago.

In October Secretary of Defense Robert Gates laid down a strong marker saying bluntly that a deal is a deal and that Washington could not entertain any but minor adjustments. Move Futenma to another part of Okinawa or the whole deal is off, he said.

The Democratic Party of Japan (DPJ) came to power with one main fixed idea: that government ministers, not the civil servants, should be making policy. On the Futenma issue that has led to some confusion. Defense Minister Toshimi Kitazawa favors implementing the agreement as is. Foreign Minister Katsuya Okada wants to merge Futenma with the big U.S. Air force Base at Kadena,

But the final decision will be made by the new prime minister? Yukio Hatoyama, and he has yet to take a position one way or the other, except to say he wants to postpone any decision pending the outcome of a series of national and local elections coming in the new year.

Despite Gates, President Obama and his advisors reluctantly agreed to side step this issue during his visit, which began Saturday and give the new government a little latitude to reach a consensus “It will take several months for the new Japanese administration to become fully functional; we have to be patient,” Said Kurt Campbell, Secretary of State for East Asian and Pacific Affairs.

But it is also clear that Washington’s patience will wear thin pretty quickly. Every day that the decision is postponed brings forth more news stories and opinion pieces lamenting the “troubled U.S.-Japanese alliance.” Pretty soon they may become a kind of self-fulfilling prophesy. Washington wants to wrap this deal up by year’s end.

Hatoyama says he wants to defer a final decision at least until the election for Mayor of Nago, the host town for the new air base, scheduled for January. Beyond that is the July election for the half of the House of Councillors, the upper house of Japan’s bicameral parliament, and next November for the governor of Okinawa.

It is hard to know what Hatoyama expects to gain from delay. Perhaps he is hoping that incumbent Nago Mayor Yoshikazu Shimabukaru, who supports the new heliport in his town, will win re-election and give him some political cover for implementing the deal.

But public feelings against the relocation plan are rising rapidly on Okinawa, and even the Nago mayor is beginning to back pedal. “My stance remains unchanged, but the best idea would be to relocate it out of [Okinawa] prefecture,” the mayor told the Asahi Shimbun newspaper.

Hatoyama is obviously hoping that the DPJ will gain a clear majority in the July upper house election, so he is no longer dependent on his coalition partners to pass bills. They include the Social Democratic Party, which is even more strongly opposed to relocation. That would give him some added flexibility.

On the other hand, the longer this matter drags on, the more likely it could become a campaign issue in that election. The opposition Liberal Democratic Party, practically prostrate in the aftermath of its pasting in the general election last August, is beginning to perk up, sensing that the new government might be vulnerable on the charge of endangering the alliance.

The new government, in office for less than two-months, is already losing some support in public opinion polls. They are now around 60 percent favorable, albeit from unsustainable high levels of euphoria immediately after the government formally took office in mid-October. Successes in two upper house by-elections, confirms basic public support for the new government.

The proposed halt in Japan’s contribution to the War on Terror through refueling coalition warships in the Indian Ocean, set to expire in January, is another sore point, although it has not been elevated to the position of a “test” of the alliance in the same way that the Okinawan base issue has.

Most of the refueling this year has been for Pakistani naval vessels, so it is hard to maintain that the operation is “vital” to operations in landlocked Afghanistan. On the other hand, a pullback here might encourage other nations with unpopular troop commitments to withdraw also.

Hatoyama will outline his substitute plan to contribute between $4 and $5 billion dollars over the next five years for expanded job training, agricultural development and other civilian support activities, but he is not prepared to send Self Defense force troops to the region to protect the aid workers.