diet coke for breakfast

Tuesday, October 28, 2003

Posted by RFTR
True Believers, Please Rise: "The main critique is that it is ridiculously expensive to lease planes, rather than buy them. The Congressional Budget Office estimates that the leasing option will cost taxpayers an extra $5.6 billion, though scandal connoisseurs will appreciate that the deal also involves the use of 'special purpose entities,' the accounting mechanisms used by Enron executives in their glory days."

Brooks gives a serious critique of this whole process. James, do you have any insight that might help me understand if this is true or not?

James --

I don't know the specifics of the deal, but I certainly can speak to leasing in general. By and large, Brooks is correct that leasing would be more expensive than buying the aircraft. So, why would anyone in their right mind lease an aircraft? There are several reasons. One, which is probably irrelevant in this case, is concern over residual value risk. Some companies might be worried that they'll be stuck with a worthless plane that they can't sell, so they lease it, and at the end, it's the leasing company's problem to deal with. The other reason is availability of funds. Remember, a 767 can cost upwards of $100 million. Chances are, an airline or cargo carrier doesn't have that kind of cash on its balance sheet and would need to borrow in order to fund a fleet of new 767s. A lease is essentially the loan of equipment instead of money. Because the lessor still owns the plane, and could always take it back if the lessee defaults, the lessor might not need to charge as much interest in order to make the risk of lending profitable. Therefore, it might be less costly for an airline to lease an aircraft instead of borrowing the money to purchase it. But, the government works a little differently. For all intents and purposes, no one borrows more cheaply than the US Government. The rates on US bonds are often used as a baseline interest rate or a "risk-free rate". Boeing had to borrow (probably in the form of corporate bonds) in order to pay to build the planes. You can safely bet that the rate used to calculate the Air Force's lease payments was higher than the Boeing bond rate (otherwise the leases wouldn't be profitable), which in turn is higher than US Treasury rates. Brooks, the GAO, the CBO, and the OMB are probably right, this looks like a bum deal for the tax payers.


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