Bob Gates vs. Lockheed Martin

IT’S NO SECRET that Defense Secretary Robert Gates wants to close out production of the F-22. Gates has been a critic of the bells-and-whistles guys in the Pentagon, has argued against Cold War weapons systems, and in June fired the fighter jet’s most outspoken advocates—Air Force Secretary Michael Wynne and Chief of Staff T. Michael Moseley. The official reason for the firing was sloppy management that resulted in the failure to remove the nuclear warheads from cruise missiles attached to a bomber that flew from North Dakota to Louisiana. But Wynne had flouted Gates’ authority, saying that “any president would be damn happy to have more F-22s around if we had to get into a fight with China.” It was widely assumed within the defense community that the two men were let go, in part, because of their support for the F-22.

The F-22 was designed more than twenty years ago as a Cold War weapons platform. When the first prototype of the fighter rolled out of the hangar in 1997, the enemy it was designed to fight, the Soviet Union, had been gone for six years. The Air Force wanted 750 F-22s, but the disappearance of the Soviet Union (and economic reality) drove those numbers down to 438, then 381. Only 183 have been ordered, of which 123 have been delivered. Air Force brass insist that every plane on order is essential to the nation’s defense. It appears that twenty more planes will be delivered—unless production is stopped.

The F-22 is the most expensive fighter ever built, with a total price tag when research-and-development costs are taken into account, of approximately $350 million per plane. It has never flown a single combat mission. Two were lost in crashes, one during testing at Nellis Air Force Base in Nevada in 2004 and another on March 25 of this year near Andrews Air Force Base in Southern California, where it was flown by a Lockheed test pilot.

The fighter was designed to use stealth technology to penetrate radar and engage in aerial dogfights with Soviet fighters. It was to be retrofitted with air-to-ground weapons to make it more versatile. It is also tens of billions of dollars over budget, according Massachusetts Democratic Congressman John Tierney’s critique of the plan at a House committee hearing.

Does a critical mass of negatives, lack of relevance, the disapproval of Defense Secretary Gates, and a Pentagon budget that has to accommodate two wars and an increase in the number of troops mean that the F-22 won’t make the cut in the budget scheduled for release this month?

Not exactly.

Four days before Barack Obama took office, forty-four senators (representing both parties) signed a letter to the president-elect, warning him that even a fleet of 183 planes would be insufficient to counter potential threats. Four paragraphs into the letter, the senators made the argument that has dominated the F-22 debate as the economy contracted.

FULL EMPLOYMENT—”The F-22 program annually provides over $12 billion of economic activity to the national economy,” the senators wrote. “Over 25,000 Americans work for the 1,000-plus suppliers in 44 states that manufacture the F-22. Moreover, it is estimated that another 70,000 additional Americans indirectly owe their jobs to this program. As we face one of the most trying economic times in recent history it is critical to preserve existing high paying, specialized jobs that are critical to the nation’s defense.”

The day after Obama took the oath of office, 191 members of the House signed off on a similar letter. In fact, the House’s “$12 billion” paragraph was lifted directly from the letter signed by the senators—minus the redundant “another 70,000 additional.”

Texas Governor Rick Perry followed, with an argument about 95,000 jobs that will be lost if F-22 production is curtailed. Twelve other governors signed a similar letter.

Lockheed Martin, the principal contractor, has shifted the focus of its public-relations campaign from national security to economic stimulus. The national Machinists union has joined the campaign to save the F-22 and the jobs it provides in forty-four states.

How is one weapon manufactured in forty-four states? (And why were six states left out of the deal?) Twenty years ago, Pentagon analyst Chuck Spinney wrote a white paper entitled “Defense Power Games,” in which he described the “political engineering” of defense projects. Political engineering is the process of spreading the design and production of weapons systems across as many states (and Congressional districts) as possible, creating a large Congressional constituency for a weapons system.

Once a constituency is created, it’s cultivated. The four big contractors in the F-22 deal have provided $11.5 million in political contributions, according to the Center for Responsive Politics.

Lockheed Martin has aimed its retooled jobs and economic development campaign at Congress, with full-page ads in the Washington Post and posters in the D.C. Metro. The debate is no longer about national defense. It’s about jobs. F-22 proponents have become military Keynesians, focusing on the economic stimulus the continued production of the fighter jet would provide an economy mired in a recession.

It wasn’t always that way. Thomas Christie was the director of Operational Test and Evaluation when he retired from the Pentagon. In a phone interview, Christie recalled a defense contractor working on an Air Force project, who entered the office of Ronald Reagan’s Defense Secretary Caspar Weinberger with a chart that listed the jobs the program created.

“Weinberger blew his stack,” Christie said. “He said, ‘Get that out of here. I never want to see anything like that again.'”

It was more than a sense of propriety. Weinberger, Christie said, was offended by the notion that a weapons procurement and manufacturing program would be sold as a job creation program.

Pierre Sprey spent twenty years designing Air Force warplanes at the Pentagon, until he resigned in 1986. He’s an ardent critic of the F-22 but doesn’t think its opponents can stop it—even though President Obama has promised to cut out wasteful weapons programs and Defense Secretary Gates is gunning for the plane. Sprey predicts a budget decision that is not quite a decision, “stealing a little money out of the F-35 program to pump up the F-22 because they need it right now.”

“It will be an interesting display of the muscle of the military-industrial complex and the Congress and the zillions of subcontractors,” Sprey said in an interview. “Because it’s well-known that Gates really wants to cancel this son of a bitch. And, the OMB [Office of Management and Budget] wants to cancel it too. So here are two of the top-ranking civilian agencies involved that really want to cancel the son of a bitch. And the power of all this campaign money and everything else is such that they can’t.”

 

It’s the Economy, Connie

“The firestorm that has engulfed Secretary Geithner over the past two weeks is an appropriate discussion for Americans to have,” said Rep. Connie Mack in a March 26 press release. “The American people want leadership. They want to feel confident. Today on Capitol Hill, Secretary Geithner failed to deliver either.”

Nobody has ever suggested that the Republican Congressman from Florida is the brightest or most articulate member of Congress, and the firestorm that became a conversation has me wondering if he is writing his own press releases.

Mack was the first and most strident member of Congress to demand that Treasury Secretary Tim Geithner resign. But the Congressman’s timing was off. The March 23 stock market rally (500 points on the Dow Jones) in response to Geithner’s bank bailout plan allowed the Treasury secretary to ride out the engulfing firestorm.

That’s good news. And bad news.

Good because the volatile markets could only react negatively to the news that the Treasury secretary had resigned less than three months into Barack Obama’s term. Bad because Geithner’s optics are distorted by a career on Wall Street.

As president of the Federal Reserve Bank of New York, Geithner made his bones in the Financial District. He worked with his predecessor, Henry Paulson, on the AIG bailout. Geithner was also on the scene in September when Paulson decided to pull the plug on Lehman Brothers, the event that precipitated a collapse from which the world’s financial markets have yet to recover. He was in the room when Paulson planned the first bank bailout (the Troubled Assets Relief Program, or TARP) while George W. Bush was still in office.

All good on-the-job training.

But all Wall Street and no Main Street.

Geithner’s bank bailout sets out to repair Wall Street so the global system of finance can be made to hum again. It assumes that once markets are up and running as they were before Lehman was put down, the real economy will follow.

Financial systems are essential to economic recovery. But who are the winners and losers in Geithner’s toxic assets auction plan? That question is best answered by economists (rather than bankers).

“The Geithner plan is very badly flawed,” Nobel Prize winner Joseph Stiglitz told Reuters in an interview conducted at an international conference in Hong Kong, followed by a New York Times Op-Ed. “Quite frankly, this amounts to robbery of the American people. I don’t think it’s going to work because I think there’ll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer.”

In his New York Times column, Princeton economist (and Nobel Prizeman) Paul Krugman described the Geithner plan as “essentially a rehash of the Paulson plan.” Its fundamental flaw is the assumption that the bad assets on the banks’ books are “worth much, much more than anyone is willing to pay for them.”

According to Krugman, the government is lending money to private investors in order to drive up the prices of the bad assets on bank balance sheets. Krugman is particularly critical of the “one-way bet” created by the plan. If the asset values increase, the investors pocket most of the money. If asset values decrease, investors can walk away from the loans provided by the government.

THE BIGGEST LOSERS—Investors are exposed to very little loss because the government is lending them 85 percent of the purchase price of the securitized mortgages, in non-recourse loans secured only by the assets they’re buying from the banks. The government also buys half of the remaining 15 percent of each asset package, putting the taxpayer on the hook for 92.5 percent of every transaction.

“It may well succeed in giving the banks the opportunity to dump the bad assets,” University of Texas economics professor James K. Galbraith said in an interview with Yahoo’s online financial page, tech ticker. “But I think the most likely outcome is that those assets will realize massive losses, which will be charged to the Treasury and to FDIC and will fall on the FDIC.”

Galbraith said the plan assumes the troubled assets, mostly bad securitized loans, will recover their value. “The difficulty is that there really is no reason to believe that’s the case,” he said.

As Galbraith told the House Financial Services Committee in February, many of the mortgages the banks sold as securities are backed by documents that are missing or that show signs of misrepresentation or even fraud.

So the banks unload their bad assets at a smaller loss than they would realize if they had to write them down to their actual value. And the losses are transferred to the taxpayer.

“That to me is a serious problem,” Galbraith said.

It is almost impossible to find a respectable Keynesian economist who will support Geithner’s bank bailout plan. The best it gets is cautious and mixed reviews. On a conference call with investors and reporters, Christian Menegatti, an analyst for Nouriel Roubini’s RGE Monitor, said the plan might work for solvent banks but there are some banks that are “beyond the stage of rescue.” Like Galbraith, Stiglitz, and Krugman, Menegatti says that the plan includes a real downside for the taxpayer, who will be left holding the bag if the assets decrease in value.

Menegatti believes that the markets rallied on news of the Geithner plan because it includes no threat of nationalization of banks. “There’s no potential haircut for shareholders,” he said, “so the markets responded positively.”

So the loser is the taxpayer; the winners are the smart guys on Wall Street who created the recession.

Even if the best economic thinkers in the country are wrong, the banks are made whole, and the taxpayer doesn’t get too badly stiffed, it’s premature to uncork the Dom Pérignon.

Billionaire investor and philanthropist George Soros gives the Obama administration high marks in every area except recapitalization of banks. Soros believes that Obama missed a critical moment, shortly after his inauguration, when he could have said that the Bush administration’s bank bailout was badly executed and asked Congress for the money to do it right.

That would have entailed drawing a line over the bad assets of the failed banks, Soros said, and creating “new banks on top of the old banks.” The new banks could have been provided with new capital and new management, while the old capital could have been held to cover the old assets, which are still deteriorating and will continue to deteriorate for several years.

That moment and opportunity has passed, Soros said at a New America Foundation forum in Washington, D.C. The administration is left to piece its way through a financial crisis that is still unfolding.

And there will be at least one more shock to the system coming. “Expect commercial real estate to lose at least 30 percent of its value,” Soros said.

Financial institutions, and the Obama administration, will have to respond.

CORRECTION—A reader reminds us that in the March 15 issue, we somehow expelled Cornell from the Ivy League. Our apologies to Big Red students, faculty, and alumni.