Politics, combined with some doubts about the value of the US administration’s proposed bailout of Wall Street, caused a rout on the US stock exchange yesterday afternoon, when Congress failed to pass the necessary legislation. The impact was greatest on financial stocks, but some prominent consumer product companies, like Apple (-12%), lost heavily.

As the Dow Jones index fell more than 777 points, most US airline stocks dropped 8-12% across the board, with Northwest (-11.2%) and Continental (-10.7%) worst hit. American, Delta and United Airlines each lost just over 8%, while Southwest Airlines weathered the storm best of all, slipping only 3.0%. Canada’s Westjet lost a relatively modest 5.8%.

Prior to the news, which emerged after European exchanges had closed, European airline share prices had not fared well yesterday, with one key exception - Air France-KLM, down only 2.1%. Of the big three, British Airways took the worst hit, down 12.4%, and Lufthansa 5.6%, but Air Berlin stock slumped a painful 23.5%. Other large slides were easyJet, Ryanair and SAS, each falling close to 9%.

European airline share price falls, 29-Sep-08

Source: Centre for Asia Pacific Aviation; Yahoo Finance

After Washington failed to adopt a solution to short term problems, oil was sold off in US trading, with prices dropping 10%, to finish around USD96. For airlines, this reduction on the cost side is a part-counterpoint to the economic crisis. But the growing negative impact on demand is progressively overtaking this good news.

The bailout sought to reduce the US market’s exposure to subprime mortgage debt, by essentially spending up to USD700 billion to buy most of the poorer risk stock. The US Federal Reserve is also, along with European central banks, seeking to inject some liquidity into the inter-bank lending markets, so that commercial banks will be prepared to lend to business.

So long as the banks are nervous about risk, money gets tighter and tighter; businesses cannot obtain credit - so that for example, consignees of freight shipments are unable to finance their purchase and need to pay in advance out of cash flow. This inevitably places pressure on them, slowing freight movements.

This process, while not a dagger to consumers’ hearts, is a more brutal and slower strangling of money supply, as the financial supply chain seizes up with anxiety. The speed of that desiccation depends on the degree of nervousness of the financial institutions. And, after yesterday’s failure by US legislators to face up to the pain, the anxiety indicators are starting to go off the scale.

The direct impact on consumers is meanwhile still relatively muted, and their spending habits are not yet being inhibited by credit constraints, although the general concern in the air is hurting confidence. Even in Asia, anecdotal evidence at airport retailers in established markets such as Japan already points to a downturn in sales of high value and luxury items.

In trading today in Asia Pacific markets, airline share prices have been mixed, but have generally performed better than the market. Asian carrier stocks have not suffered significant downturns in recent days and the lower oil price may have helped support prices today. But US legislators now rise for two days for the Jewish Rosh Hashana holiday, leaving the world in suspense.

A response of some sort from Washington is now essential, but as time passes and more banks are threatened - two more banks in Europe were bailed out by governments yesterday - it will become harder to reassure markets and consumers.

Airlines are at the pointed end of this delicate consumer and business equation and strong balance sheets will determine who rides the storm best in coming days.