Flash - Plummeting Defense Stocks Poised to
November 4, 1999
 Neil Baumgardner, Hamre Worried About Defense Stock 'Pummeling,' Defense Daily, 4 November 1999
As I have said repeatedly in past messages, the Defense Department is locked in a Death Spiral, a turn of phrase coined by Jacques Gansler, the Under Secretary of Defense for Acquisition [see comment 182]. The Death Spiral is caused by three mutually reinforcing pressures: (1) a modernization program that can not modernize the force even if it is perfectly executed, (2) a rapidly deteriorating readiness posture that is a consequence of the rising cost of operations, and (3) a corrupt accounting system that makes it impossible to assemble the detailed information needed to sort out the first two problems and makes a mockery of the accountability clause of the Constitution.
The reasons for the death spiral are complex, but its roots are now obvious: Our obsession with ever more complex and costly technology is at the heart of the problem.
Each new generation of weapons costs far more to buy and operate than its predecessor, notwithstanding promises to the contrary. Moreover, when embedded in an economy shaped by the give and mostly take of cost-plus contracting, increasing technical complexity creates a structural relationship where unit costs (procurement costs and operating costs) ALWAYS grow faster than budgets grow, even when budgets increase rapidly, as they did in the 1980s. The result is a reflection of a political and bureaucratic value system that subsidizes cost growth and special interests at the expense of efficiency, strategy, and policy shrinking forces, aging equipment, continual pressure to reduce readiness, and increasing cries for higher defense budgets.
The evidence of misplaced focus is simply overwhelming. Hundreds of earlier messages have dealt with parts of this problem. New readers to this list can start their catch-up journey by reading the three reports and Comment #169 at the hot link beneath the signature block, as well a the related comments. Additionally, my briefing on the "Defense Death Spiral" can be downloaded from War, Chaos, and Business.
It is clearly the responsibility of senior management in the Pentagon to reverse the decline in a way that protects the taxpayer, whose wealth is at risk, and the soldier, whose blood is on the line. The end of the Cold War gave us a once in a lifetime opportunity to fix our problems, but decision makers chose instead to duck the hard decisions. They recklessly squandered a unique opportunity to put the Pentagon's house in order. The taxpayers and soldiers and ultimately the defense industry -- will suffer as a result, because we have now reached the point where there is no easy way to pull out to the descending spiral without massive surgery, better thought of as programmatic triage.
Decision makers, nevertheless, continue to back away from doing what is necessary. They understand that the decisions needed to correct the problem will inflict sever pain in the short term on the defense industry.
Their paralysis goes well beyond mere incompetence and/or pusillanimity and creeps into conflict of interest. The military industrial congressional complex (MICC) operates according an internal logic that revolves around a distorted value system that puts its own welfare and special interests ahead service to the nation's general welfare.
The defense industry, for example, is clearly the most coddled industrial sector in our economy. It is propped up totally by government spending; it is insulated form the invigorating effects of competition; it is governed by central planning and administered prices that are more at home in socialist systems than in free-market economies; it is awash in the poison of patronage, revolving doors, and self-interested bureaucratic power games; and it has shown itself to be largely incapable of economic conversion to produce civilian products that sell at competitive prices in commercial markets
The referenced report by Neil Baumgardner of Defense Daily, a high-cost industry newsletter, shows how wacko the distortion of values has become.
Someone on the Pentagon staff apparently convinced John Hamre, the Deputy Secretary of Defense, to give a policy speech expressing worry because the stock market is not propping up the prices of defense stocks high enough!!!!! Read it closely it is very revealing.
Note how the Deputy Secretary of Defense concluded his talk by describing three policy priorities that would HELP the suffering defense industry. Firstly, he argued for steady, stable defense budgets, avoiding the "rollercoaster" defense budgets of the last 15 years. Secondly, Hamre called for more stability in the acquisition process, such as multi-year contracts. Lastly, he called for eliminating acquisition policies that put all the risk on the private sector.
These priorities are utter nonsense. If executed, they would tighten the grip of the Death Spiral. Whoever put these words in the mouth the Deputy Secretary of Defense has done him and the taxpayers—a great disservice. Let me explain.
Firstly, the idea of a stable environment is nutty. Dead matter is stable, living matter is unstable. Dinosaurs died because they could not cope with an unstable environment. Stability of budgets is the refuge of the central planner, because removing uncertainty makes planning trivial. Even worse, the false god of stability tempts the unimaginative mind into thinking he can organize the world from the top down by freezing nature's dynamics and fitting the world to his formulaic needs and ambitions. But what makes this proposal truly absurd is the fact that the prospect for instability is greater now than ever before, in part, because central planners squandered the window of opportunity handed to them by the end of the Cold War.
Rather than rationalizing the budget to a post cold war reality, our central planners in the assumed they could pack their plans with new, higher cost cold-war legacy weapons, like the F-22 fighter (ironically named the Raptor, after a dinosaur-like, extinct bird believed by paleontologists to have been a predator), the Crusader self-propelled howitzer, and the new attack submarine. The defense budget is now pregnant with gobs of cold-war predators on the taxpayer's dollars, whose budgetary requirements are programmed to explode in the middle of the next decade (even if there are no more cost overruns), just when the budgetary pressures of the aging baby boomers also will begin to explode.
If Pentagon planners were truly interested in stability, they would not have planted the seeds of a domestic political war that will pit the aged and infirm against the special interests of the military industrial congressional complex.
Secondly, the idea that multi-year contracts will make for a more stable acquisition process is patently absurd, given the fact that current procurement programs will not produce enough new weapons to modernize the force and are not be fully funded, particularly if one accounts for the inevitable cost overruns Multi-year contracts lock in long-term commitments. That makes it contractually difficult for the government to adjust to changing conditions, because they extend the time period for which the government in contractually liable for the impact of changes. This protects the contractor against the uncertainties of change by placing the burden on the government and, by extension, the taxpayer. Moreover, multi-year contracting would lock the government into an even tighter straight jacket, just when it needs greater flexibility to make the hard decisions and policy changes needed to pull out of the death spiral without starting a civil war with the old people.
Thirdly, the idea that contractors bear ALL the risk in the cost plus economy of the military industrial congressional complex is preposterous. Congress and the Pentagon have a long history of bailing out, subsidizing, or protecting the defense industry, going back at least to ship of line the program that began in 1816 [see Comment #147] not to mention the recent policy of subsidizing mergers and golden parachutes for executives (based on the promises of future efficiencies and savings that have not materialized), while the contractors laid off production workers and white collar engineers.
If Mr. Hamre wants three good priorities, I have a better idea:
The Pentagon is about to start its second Quadrennial Defense Review. The first was a complete fiasco, whose only effect was to tighten the spin and increase the speed of descent into the Spiral of Death. Decision makers now have a second chance. If Mr. Hamre's advisors want to direct him to three problems that might help the taxpayers and soldiers rather than the special interests, they might want to consider recommending a QDR that (1) cleans up the books as a first priority based on the assumption that one needs reliable information to make sound decisions, (2) rationalizes and protects force structure and readiness, and (3) assembles a modernization program that can actually modernize the force without starting a civil war with the aging baby boomers.
This plan might have two additional benefits:
First, if his advisors directed the attention of the Deputy Secretary to real problems, they would not have to spend their time writing silly speeches to analysts on Wall Street, who are not listening, because they already smell the stench of decay.
Second, if decision makers focused on real problems, then the public affairs flacks might understand that the military is about soldiers and service, not stock prices, and we might even end up with an Armed Forces Day poster that celebrates people instead of weapons.
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