Mark-to-Market Pentagon Style

“Mark to Market” is (or was?) an accounting standard that required financial institutions to value their assets at their current market value. Thus a stock portfolio would be valued at an amount determined by the stock market, if the stock holder sold all his assets in that market. Last Spring, when the government was contemplating its plan to rescue the big banks, it settled on the idea of using taxpayer money to purchase or guarantee the so-called toxic assets of the large “investment” banks and their insurers (e.g., collateralized debt obligations and credit default swaps). The banks lobbied furiously against the mark to market rule, because the toxic assets could not be sold in a market that was frozen, and under the rule, they would be valued a fraction (somewhere between 0% and 60%) of their original purchase prices. Under mark to market, the banks would take a bath or even become insolvent. So, they concocted a new concept of “fair value,” which came close to reimbursing them at cost, thus implying the capitalist market was inherently unfair. The Federal Government ended up guaranteeing the debt at taxpayer expense, thus securing an American economic system that guarantees private profits at the expense of public losses for the privileged entities on Wall Street.

But don’t blame the banks for this kind of system. They are only doing what is natural when one is working with the best government money can buy. In fact, the American political economy has many ways of guaranteeing private profits with public subsidies of what should be private losses.

For example, the latest scam in the Military – Industrial – Congressional Complex (MICC) is the so-called “Buy to Budget” formula for the hugely expensive and deeply troubled F-35 Joint Strike Fighter.

This formula was just gleefully endorsed in an email recently sent to the F-35’s Stakeholders. The author, Charles T. Burbage, is the executive vice president of Lockheed Martin Aeronautics Company and general manager of the F-35 Joint Strike Fighter (JSF) Program Integration. Burbage is responsible for ensuring that all of the F-35’s requirements are fulfilled for both the program’s U.S. and its international customers, as well as its industrial partners around the world. And the email makes clear Burbage is licking his chops at the MICC’s latest coup.

It is pretty easy to understand why Burbage is so gleeful. Defense contractors operate in a “cost-plus” economy, where profits are a negotiated percentage of costs. If costs rise, profits rise. The Pentagon just approved another higher cost estimate for the F-35 and a reduced production quantity. That is clearly good, but Burbage is confident the future looks even rosier. The reasons for his confidence in Lockheed’s rosy scenario becomes clear when “Buy to Budget” is viewed in this context of the MICC’s political economy.

“Buy to Budget” increases the incentive to grow costs even faster and thereby increase profits even more over the long term. The rosy scenario results when costs continue to grow, and smaller numbers of F-35s will be purchased each future year, all financed within a given budget level. The lower F-35 production rates will exacerbate the aging crisis of the F-16s, A-10s, F-18s, and AV-8s that the F-35 is supposed to replace. But the average age of these airplanes is already far greater that they were designed for, so the political/bureaucratic pressure to increase the production rate of the F-35 will be enormous. Moreover, Burbage knows the Pentagon does not want any alternatives to the F-35. This rising political/bureaucratic pressure caused by the aging inventories will therefore lead to loud calls for higher F-35 budgets, and larger budgets will provide a larger space in which to “Buy to Budget” by jacking up costs further. Thus, the deadly cycle of cost growth, decreasing production rates, aging inventories, and higher profitability will reinforce itself again, in what is the political-economic equivalent of a perpetual motion machine.

At a program acquisition cost already exceeding $300 billion, and a total life cycle cost approaching one trillion dollars (which no doubt will include lots of follow-on maintenance contracts for Lockheed), the F-35 is solidly on track to be the all time record breaker in high cost programs, in which continual production cutbacks will finance a never ending honey pot for Lockheed. Moreover, the Pentagon just signaled its increased commitment to the importance of the program by elevating its government program manager (Burbage’s uniformed equivalent) to a two star to a three star general officer, in this case a vice admiral in the Navy — which means more high level meetings in bigger offices, more cocktail parties, and more of the pomp and circumstance that are the perks of working in the MICC, not to mention even greater high-powered efforts in the Pentagon to save face by continuing business as usual. That the F-35’s foreign partners like Great Britain and the Netherlands will help to foot the ever increasing bill is merely icing on the cake.

In the context of MICCs long-term survival, Burbage’s gleeful endorsement of “Buy to Budget” reaches back to the end of the Cold War confirms the farsighted wisdom displayed William Anders, former CEO of General Dynamics (note: GD at that time owned the Fort Worth factory where Burbage now works and the F-35 is produced). “Buy to Budget” is validation of the MICC business strategy that Anders spelled out in 1991. Anders decided that General Dynamics (and by extension the Fort Worth factory, which he subsequently sold to Lockheed) was not going to diversify business operations into the non-defense commercial manufacturing sector, even though the Cold War had just ended. Anders said his decision was to increase his concentration in defense activities (a view widely shared and resulted in increased oligopolization of the industry, in an orgy of Pac Man gobbling up of defense companies by other defense companies during the early 1990s. He said this decision to increase concentration was “not surprising,” because 80% of defense acquisitions in the non-defense sector failed. He then explained succinctly why these acquisitions are always so unsuccessful: “Defense industry management teams generally have little commercial experience and market savvy,” and “Most have been cost-plus and mil spec trained.” He concluded by saying, “In short, most don’t bring a competitive advantage to non-defense business,” and “Frankly, sword makers don’t make good and affordable plowshares.”[1]

Of course, what Anders did not say is that sword makers also do not make good affordable swords. But who cares when you live in a posh, post-cold-war marketplace like Burbage’s, where ever rising costs and profits are fueled by a user friendly Pentagon policy of “Buy to Budgets.”

Franklin “Chuck” Spinney is a former military analyst for the Pentagon. He currently lives on a sailboat in the Mediterranean and can be reached at chuck_spinney@mac.com

Notes.

[1] “Rationalizing America’s Defense Industry: Renewing Investor Support for the Defense Industrial Base and Safeguarding National Security,” Keynote Address, Defense Week 12th Annual Congress, 30 October 1991, page 13.

 

 

 

Franklin “Chuck” Spinney is a former military analyst for the Pentagon and a contributor to Hopeless: Barack Obama and the Politics of Illusion, published by AK Press. He be reached at chuck_spinney@mac.com

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