Snozberry

I looks like the DoD isn't really cutting its budget - most all of its "cuts" are for spending that will occur in 2006-2011. Here's the scoop from the Defense News:

Defense News
January 10, 2005
Pg. 1

DoD Cuts Not What They Seem

Bulk of Reductions Don't Hit Until 2007 and Beyond

At first glance, Program Budget Decision 753, the budget document that leaked from the Pentagon Jan. 3, seems to presage a landscape littered with popular weapons programs crippled by billions of dollars in cuts.

An aircraft carrier would be retired, the F/A-22 stealth fighter program would be cut by one-third, fewer destroyers and submarines would be built, V-22 tilt-rotors and C-130J cargo plane programs would be curtailed.

But a closer look shows that many of these cuts don’t hit until 2007, 2008 or later. And at least some of the cuts that do hit in 2006 will be covered by a supplemental request to cover war costs totaling as much as $100 billion.

"Most of the cuts are in the out years," said an aide to a senior Republican on the Senate Armed Services Committee. For practical purposes, that means they can be restored to the budget later without actually affecting the targeted programs.

The sudden appearance of Program Budget Decision (PBD) 753, a 26-page spending plan dated Dec. 23 and marked "For Official Use Only," caused a furor on Capitol Hill, on Wall Street, and in defense industry boardrooms around the country.

This document will shape a White House 2006 budget request that is expected to total $418.1 billion, a senior Pentagon official said. The supplemental request will be on top of that.

The inevitability of the supplemental allows the Pentagon to keep growth in the Army budget below the rate of inflation. The 2006 budget request will seek only $98.6 billion, an increase of $1.4 billion over last year’s request to Congress. but roughly $3.7 billion less than the Defense Department’s initial 2006 budget projections for the service, according to draft budget documents reviewed by Defense News. Meanwhile, the Navy and Air Force shares would each grow by approximately $6 billion over the president’s 2005 budget submission, to $125.3 billion and $126.1 billion.

Of the $6 billion in cuts PBD 753 calls for in 2006, $2.4 billion — well less than half — comes from procurement, research and development accounts. The rest is in personnel and operations and maintenance — accounts that are easily rolled into the war supplemental.

The DoD leadership and the services are still working on the budget figures. The final version of the president’s defense budget request will go to Capitol Hill on Feb. 7, and Pentagon officials have been asked to keep the working budget figures under wraps until then.

"It is too early to be discussing figures," said Pentagon spokeswoman Marine Corps Lt. Col. Roseanne Lynch. "We are a nation at war and our first priority is to ensure our men and women in uniform have all they need to win."

She said the budget submission will adequately fund the military’s modernization initiatives.

Hill Reaction

But Senate and House members whose states and districts would suffer job losses were swift to denounce the proposed cuts. Meanwhile, congressional aides pored over the plan, searching for deeper meaning.

The 26-page document leaked from the Pentagon so swiftly that in a matter of hours on Jan. 3, paper and electronic copies of PBD 753 were in the hands of congressional staffers, journalists and defense analysts.

"This circulated very quickly — as opposed to things that this administration doesn’t want to get out," said an aide to a senior Democrat on the House Appropriations Committee.

Evidence of a well-planned leak prompted many to wonder why.

"They leaked it because they want to show that defense is paying its share," said a Democratic House Armed Services Committee staffer.

A plan that calls for big cuts in defense may be intended to pave the way for deep cuts in other programs, such as housing, veterans programs and support for national parks, he said.

"It gives the administration cover to take the milk out of school lunch programs," another Democratic staffer suggested.

President George W. Bush "wants to blow people’s socks off with the budget this year," said the Republican aide. "It’s going to be bare-bones to show that he’s serious about getting the deficit under control."

The president "set some unbelievable targets" for agencies to meet by paring their budgets for 2006, he said.

Bush has pledged to reduce the federal deficit, make tax cuts permanent and reform Social Security. But to do so while also paying for the war in Iraq will require substantial cuts in popular non-defense programs, the staffer said.

Dov Zakheim, the former Pentagon comptroller, now a partner at Booz Allen Hamilton, Fairfax, Va., sees the proposed cuts as a serious effort to scale back spending.

"I’ve no doubt the [Defense] department would not have taken on anything of this magnitude and would have resisted these cuts unless there was clear leadership from the White House," Zakheim said. "This marks a clear break from the last several years."

Though many of the program cuts identified in the PBD have been debated for a while — reducing the F/A-22 order and the number of aircraft carriers — external budget pressures forced the Pentagon to act, Zakheim said.

At the end of fiscal year 2004 in September, the U.S. federal budget deficit was $413 billion. According to projections by the Congressional Budget Office the deficit will stay above $300 billion each year through the end of the decade if the Bush administration makes the tax cuts permanent.

"It’s a clear reflection of budget realities," Zakheim said of the proposed cuts in defense spending. "I would not in any way dismiss these actions as a charade."

What ‘Cuts’ Means

PBD 753 calls for $6 billion in cuts in 2006 and $30 billion in cuts through 2011.

But the cuts are to previously projected increases in defense spending, not to the defense budget itself. With the cuts outlined for 2006, the military "would still be spending $12.5 billion more than they are in 2005," said the aide to the Appropriations Committee member.

After making the $6 billion in cuts called for by PBD 753, the 2006 defense budget would be about $418 billion, according to a draft version of other Pentagon budget documents. About $20 billion is earmarked for nuclear programs managed by the Department of Energy, pushing total spending for 2006 to $438 billion.

The 2005 defense budget contains $420.6 billion. The most eye-catching cuts outlined in PBD 753 don’t occur in 2006.

For example, there are no significant reductions to the F/A-22 until 2009. Then, by 2011, $10.5 billion would be cut from the program.

The Virginia-class submarine program receives a $64.3 million increase in 2006 before cutting begins in 2007. One submarine is deleted in 2009 and 2010, with $5.3 billion in cuts through 2011.

The Navy’s DD(X) destroyer program is untouched in 2006 and receives increases of $115 million in 2007 and $78 million in 2008 before cutting begins.

The LPD-17 amphibious ship program receives $140 million in 2006 and $285 million in 2007 before reductions begin in 2008. The tenth ship in the program — to be ordered in 2008 — is cut, along with $953 million through 2011. That could cap the total LPD-17 class buy at nine ships, assuming the ninth ship appears as expected in the 2006 budget request.

Cuts to the Air Force’s C-130J program are nearly offset by increases in the Marines’ refueling version of the aircraft in 2006. Deeper cuts — 20 planes and $1.5 billion — begin in 2007.

Even the aircraft carrier headed for retirement receives an increase of $134.3 million in 2006 before budget reductions of $1.2 billion set in 2007-11.

One reason for pushing most of the cuts to the out-years is that "it’s hard to cut things in the next fiscal year because so much spending is already in the pipeline in the form of advance procurement," said Christopher Hellman, director of the Project on Military Spending Oversight.

"You’re much better able to cut things that are further in the future." Of course, targeting future spending gives program supporters more time to organize a defense, he said.

Protecting Programs

On Capitol Hill, lawmakers were quick to defend programs where cuts would hurt their constituents.

On Jan. 4, the day Congress returned to session, while House and Senate members mingled in their respective chambers and new members were being sworn in, staffers who work for Sen. Bill Nelson, D-Fla., were already at work drafting legislation to block the carrier retirement.

Before day’s end, they produced a bill that would require the U.S. Navy to keep "not less than 12 operational aircraft carriers."

Nelson and other members of the Florida congressional delegation fear the doomed carrier is the USS John F. Kennedy, based in Mayport, Fla.

Meanwhile, Sens. Susan Collins and Olympia Snowe, both Republicans from Maine, decried plans to lop two DD(X) destroyers, which could jeopardize jobs at Maine’s Bath Iron Works shipyard.

Members of the Georgia congressional delegation, led by Sen. Saxby Chambliss, fired a letter to White House Chief of Staff Andrew Card decrying the proposed cuts to the F/A-22 and C-130J, which are built by Lockheed Martin in Marietta, Ga.

Counting on It

Defense industry officials are counting on that kind of congressional reaction to forestall the cuts.

"Our members have been strong supporters of the president’s defense program. These cuts took us by surprise," said John Douglass, president of the Aerospace Industries Association.

It is impossible to execute a strategy of pre-emption without air superiority, airlift and ships — the very programs the PBD proposes to cut, he said.

If the cuts are enacted, the industry impact would be significant, Douglass said.

But what’s likely to happen is that "Congress will take a hard look at this and make up their own minds about whether cuts of this type fit into the president’s overall program of fighting the war on terrorism," he said. In that case, relatively few cuts would be made.

Pete Steffes is less optimistic.

"It’s very likely that some of the cuts will occur," said Steffes, vice president for government policy at the National Defense Industry Association. War costs have made some acquisition spending cuts unavoidable.

"Republican hawks will want to put money back into these programs, but where are they going to get it from?" he asked.

For the defense industry the cuts would mean "not necessarily a downturn, but the beginning of major defense realignment," Steffes said.

"This not the death knell for the defense industry," said Hellman. "There is not a single program termination in the PBD. There are reductions and slowdowns."

Consider the situation that confronts Lockheed Martin, one of the companies that would be hit hardest if cuts outlined in the PBD were to be approved. Lochkeed’s F/A-22 and C-130J programs would be trimmed by $10.5 billion and $3.7 billon respectively. But Hellman notes the PBD does not touch Lockheed’s Joint Strike Fighter; at $200 billion, it is history’s most expensive weapon program.

Wall Street’s Take

This is why some Wall Street analysts are shrugging off the news, saying the proposed reductions may ultimately have little effect on arms makers.

For one thing, only $2.4 billion of the proposed $6 billion cuts in 2006 would come out of acquisition, research and development accounts. For another, officials at most major defense companies say they expect lawmakers to restore some of the more drastic reductions — certainly, before the bulk of the planned reductions begin in 2008 and beyond.

In a flurry of notes in the last few days, several analysts advised investors to buy defense company stocks, pointing out that post-election profit-taking and the news of budget cuts has already shaved 10 to 12 percent of many defense shares in recent weeks. Many analysts believe that defense companies will be fine in the long term — beyond 2009 — as budget pressures ease and programs on the chopping block survive.

But others say the proposed reductions could force U.S. defense giants to rethink their strategy, sell off poorly performing businesses, and diversify to make up for lost business.

"Is it realistic to believe that somehow money will be found to put Humpty Dumpty together again, or is this a harbinger of a serious fracture that will reshape the strategies of defense companies?" said Byron Callan, analyst at Merrill Lynch, New York.

The cost of fighting insurgents in Iraq, the pressure to cut federal budget deficits, and the billions of dollars it would cost to privatize Social Security are driving Pentagon budget cuts, Callan said.

Callan said defense company strategists are quietly planning for permanent cuts.

"Publicly, they have masked the angst and concern, but this will eventually change," he said.

Callan told his clients in a Jan. 6 note that defense giants might pursue more acquisitions, including non-defense ones; consolidate aircraft production lines, reduce shipbuilding capacity or join hands with non-U.S. firms. One possibility, Callan said: A Lockheed-Airbus team could offer Airbus’ A400M airlifter to the U.S. Air Force in place of Lockheed’s C-130J aircraft.

The short-term effect on small- and medium-sized defense companies that are seeking to sell themselves to bigger firms may not be so great either, said Paul Serotkin, president of Minuteman Ventures, a Boston-based investment banking firm that specializes in such companies. Simply being associated with a weapons program that is likely to be cut could depress valuation, Serotkin said.

Posted by reds at January 10, 2005 02:08 PM