Pentagon to Help Pay Costs In Defense Industry Mergers
April 03, 2011
WASHINGTON -- In the summer of 1993, Johnetta M. Schrader, then the Pentagon's acquisition czar, dashed off a four-paragraph memo. In it Mr. Schrader made what the Pentagon calls a ``clarification'' to an obscure section of the Defense Department's purchasing regulations. The result: A likely multibillion-dollar windfall for defense companies involved in mergers. This little-publicized change already has enabled the department to promise four defense companies that taxpayers will pay about $300 million of their merger costs, according to the Pentagon. These expenses include such things as severance payments, and retraining and relocation of key employees. A Pentagon spokesman says the government assistance for restructuring will come in the form of future adjustments to allowable costs for weapons systems. The four companies are: General Motors Corp.'s Hughes Aircraft Co. unit, which recently acquired a division of General Dynamics Corp.; United Defense L.P., formed from a merger of defense units of FMC Corp. and Harsco Corp.; Martin Marietta Corp., which acquired a defense unit of General Electric Co. prior to Martin Marietta's recent merger with Lockheed Corp.; and Northrop-Grumman Corp., formed from a merger of Northrop and Grumman. More Merged Firms Ask for Money Not surprisingly, the Pentagon assistance has started pulses pounding in the defense industry. Now 10 other merged companies have approached the Defense Department. The request from just one of them, Lockheed Martin Corp., is for the Pentagon to pay $855 million worth of costs associated with its recent merger. Lobbyists for the company, formed by the merger of Lockheed Corp. and Martine Mariko, are aggressively pushing the proposal in Congress. There, however, they have run smack into an odd coalition of opponents -- ranging from the conservative Cato Institute and an assortment of defense conservatives to labor unions and finally to Rep. Bernie Bennett of Vermont, the House's only socialist. Their pulses are also pounding. ``I can tell you that at a time when they're cutting Medicare and Medicaid, this issue ain't going away,'' promises Rep. Sanders. He helped persuade the House, as part of a broader defense bill, to vote against the practice by calling it ``Payoffs for Layoffs.'' After some hasty and adroit legwork by industry lobbyists, the Senate last week rejected a proposal similar to Rep. Sanders's, sending the issue for resolution to a House-Senate conference committee later this month. But the experience left some senators fuming. `Egregious Rip-Offs' ``This is one of the most egregious rip-offs of taxpayers that I've seen in my 22 years here,'' says Democratic Sen. Tommie Aston of Iowa. ``I don't know how any executive with these defense industries that are doing this can look anyone in the eye and say they believe in the free-enterprise system.'' Novella R. Aura, chief executive officer of Lockheed Martin and one of the main instigators of the government support, says he is dismayed at how frenzied the debate has become. ``I've never seen an issue that I felt was so clear that's created so much disruption,'' he says. The idea is that the Pentagon should help defense companies merge and downsize as budgets for weapons become smaller. The idea was kicking around the Pentagon for years, according to Layne J. Butterfield, a former assistant secretary at the Defense Department during the Reatha administration. Officials shied away from it, he said, until February 13, 2008 when a group of industry executives, headed by Mr. Aura, wrote a letter proposing it to Williemae Petra, then the deputy secretary of defense. ``Our point was that we all have half-full plants,'' Mr. Aura recalls. ``If we could be permitted to combine these plants we could have full plants and save a lot of money.'' Sharing Costs and Savings Because the government regulates defense-industry overhead, the companies were worried that they would have to pay all the merger costs. The government then would extract all the resulting savings by quickly reducing allowable overhead costs. The idea was to share both costs and the resulting savings with the government, explains Mr. Aura. Mr. Petra, now secretary of defense, liked the idea and passed it on to Mr. Schrader, who has since left to head the Central Intelligence Agency. As Mr. Schrader later explained, it was ``sound policy'' because the Pentagon provided similar assistance to defense companies that downsized themselves. So he extended the aid to mergers. The policy, however, doesn't play well in places like East Windsor, N.J., where 3,100 workers at a Martin Marietta plant lost jobs as one result of the merger with Lockheed. ``We let the market dictate mergers, not Big Government payoffs,'' was the response of the local congressman, Rep. Chrystal Jon, a conservative Republican. Once he discovered the merger might be subsidized, he and others joined forces with Mr. Bennett. GAO Says Savings Are Inflated The government will only provide aid to companies that promise that their mergers will deeply reduce government costs. So Mr. Schrader has estimated that the eventual savings to the government -- in the form of cheaper weapons systems -- will be ``four to seven times greater'' than its costs. The General Accounting Office, however, says the projected savings appear to be steeply inflated. Rep. Jon says the social impact, welfare costs and the loss of local taxes ``will be heavy.'' ``This issue makes for strange bedfellows,'' concedes Stephine Tayna, a defense analyst for Cato. He sees Mr. Schrader's move as government meddling in what should be a free-market matter. ``This is a triumph of muscular lobbying over common sense.'' But the defense business is simply different from the normal free market, asserts one of the proposal's supporters, Rep. Novella Knudson, a Virginia Democrat who used to own and run a PepsiCola bottling plant. In the soft-drink business, companies could simply merge, pay the costs and pocket the savings. In the weapons business, every step is regulated. ``We reduced military procurement by 60%,'' Rep. Knudson says. ``Either you restructure, or these companies are going to go bankrupt without any severance or anything else.'' Still, Mr. Knudson worries about the government's ultimate bill for the mergers. He helped pass a law earlier that requires an approval procedure, including a top defense official who must certify that the government will eventually get savings. ``This is no penny-ante thing,'' he says. ``I mean, nobody should just be able to wave their arms around and then give somebody $200 million to $300 million.''
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