[Congressional Record Volume 142, Number 105 (Wednesday, July 17, 1996)]
[Extensions of Remarks]
[Pages E1307-E1308]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




                              MERGER MANIA

                                 ______
                                 

                        HON. JOHN J. DUNCAN, JR.

                              of tennessee

                    in the house of representatives

                        Wednesday, July 17, 1996

  Mr. DUNCAN. Mr. Speaker, the U.S. Government should not be paying 
millions in taxpayers' funds to help defray the costs of corporate 
mergers in the defense industry. I would like to call to the attention 
of my colleagues and other readers of the Record the following article 
from the Brookings Review:

                [From the Brookings Review, Summer 1996]

                              Merger Mania

                         (By Lawrence J. Korb)

       McDonnell Douglas, Martin Marietta, Ling-Temco-Vaught 
     (LTV). As the telltale compound names signal, mergers and 
     acquisitions have long been a staple of the U.S. defense 
     industry. But since the Clinton administration took office in 
     1992, the number of mergers has increased dramatically.
       In 1991, military mergers were valued at some $300 million. 
     By 1993, the value had climbed to $14.2 billion. It will top 
     $20 billion in 1996. In 1993 Martin Marietta purchased 
     General Electric's defense division and General Dynamics' 
     space division. At about the same time Lockheed purchased 
     General Dynamics' aircraft division, while Loral purchased 
     LTV, Ford Aerospace, and Unisys. Then in 1994 Lockheed merged 
     with Martin to become Lockheed Martin, and a year later 
     Lockheed Martin purchased Loral to produce a $30 billion 
     giant known as Lockheed Martin Loral, which now controls 40 
     percent of the Pentagon's procurement budget.
       During this same period, Northrop outbid Martin for the 
     Grumman aircraft company, and the new company in turn bought 
     the defense division of Westinghouse. On a somewhat smaller 
     scale, Hughes bought General Dynamics' missile division and 
     Raytheon purchase E-Systems. Among the true defense giants, 
     only McDonnell Douglas has not yet made a major purchase.
       Spokesmen for the defense industry cite two reasons for 
     this sudden rush of mergers. First, merger mania is sweeping 
     U.S. industry generally. Second, with the end of the Cold 
     War, defense spending has fallen so dramatically that excess 
     capacity in the defense industry can be eliminated only 
     through consolidation. As Norman Augustine of Lockheed Martin 
     has observed, for the defense industry this is 1929.
       Superficially these reasons seem quite plausible. Merger 
     mania has certainly hit many areas of American industry, such 
     as banking and communications. In 1992 Chemical Bank merged 
     with Manufacturers Hanover, and in 1995 they combined with 
     Chase Manhattan to form a single company. In the past year, 
     Time, which had merged with Warner Communications in 1990, 
     purchased Turner Broadcasting; Capital Cities/ABC merged with 
     Pacific Telesis; and Bell Atlantic merged with NYNEX.
       And defense spending has indeed fallen since the end of the 
     Cold War. In current dollars, projected defense spending for 
     fiscal year 1997 is about 40 percent below that of a decade 
     ago, and procurement spending is about one-third what it was 
     at its peak in the 1980s.
       But what industry spokesmen fail to note is that the 
     decline in defense expenditures has been greatly exaggerated 
     and that, unlike the private-sector restructuring, the 
     government is subsidizing defense mergers.
       Remember the $600 toilet seats and the $500 hammers that 
     had taxpayers up in arms during the mid-1980s? Today's 
     subsidized mergers are going to make them look like bargains. 
     The outrageously priced toilet seats and hammers were the 
     result of defense companies taking advantage of a loophole in 
     acquisition regulations. This time, the taxpayers are being 
     fleeced at the hands of the Pentagon's civilian leadership, 
     whose secret reinterpretation of the regulations has rained 
     hundreds of millions of dollars upon the defense industry. To 
     date the Pentagon has received 30 requests for reimbursement 
     for restructuring. Lockheed Martin alone expects to receive 
     at least $1 billion to complete its merger.


                           How Did It Happen?

       In July 1993, John M. Deutch, then the undersecretary of 
     defense for acquisition, responded to pressure on his boss, 
     William Perry, from the chief executive officers of Martin 
     Marietta, Lockheed, Loral, and Hughes by deciding to allow 
     defense companies to bill the Pentagon for the costs of 
     mergers and acquisitions. According to Deutch, who has since 
     been promoted to deputy secretary of defense and then to 
     director of Central Intelligence, the move was not a policy 
     change but a clarification of existing policy. In Deutch's 
     view, not only was the clarification necessary to promote the 
     rational downsizing of the defense industry, it would also 
     save taxpayers billions in the long run.
       Deutch is wrong on all three counts. This is a major policy 
     change. It is not necessary. And it will not save money.
       A commonsense reading of the Federal Acquisition 
     Regulations (FAR) would lead a reasonable person to conclude 
     that organization costs are not allowable. The regulations 
     state that since the government is not concerned with the 
     form of the contractor's organization, such expenditures are 
     not necessary for or allowable to government contracts. 
     Indeed, during the Bush administration, the Defense Contract 
     Management Agency (DCMA) rejected a request by the Hughes 
     Aircraft Corporation to be reimbursed for $112 million in 
     costs resulting from its acquisition of General Dynamics' 
     missile division. As far back as the Nixon administration, 
     during the post-Vietnam drawdown of defense spending, which 
     was as severe as the current drawdown, the Defense Department 
     rejected a similar request from General Dynamics.
       But on July 21, 1993, Deutch wrote a memorandum stating 
     that restructuring costs are indeed allowable and thus 
     reimbursable under federal procurement law. Because Deutch 
     regarded the memo as merely a clarification of existing 
     policy, he saw no need for a public announcement. Indeed, he 
     did not discuss his ``clarification'' with the military 
     services or Congress or even inform them of it. Congress 
     found out about it accidentally nine months after the memo 
     was written when Martin Marietta tried to recoup from the 
     Pentagon about $60 million of the $208 million it paid for 
     General Dynamics' space division. A somewhat astonished 
     Senator Sam Nunn (D-GA), then chairman of the Senate Armed 
     Services Committee, remarked, ``Why pay Martin Marietta [60] 
     million?''
       Deutch's position that he was merely clarifying rather than 
     making policy is not supported by anyone, even those who 
     favor the change. The procurement experts in his own 
     department disagreed vehemently. On June 17, 1993, the career 
     professionals at DCMA told him that the history of the FAR 
     argues against making the nonrecurring organization costs 
     associated with restructuring costs allowable and noted that 
     they had disallowed these costs in the past.
       The DCMA position was also supported by Don Yockey, the 
     undersecretary of defense for acquisition in the Bush 
     administration; the Aerospace Industries Association (AIA), 
     the trade association for aerospace companies; the American 
     Bar Association's Section on Public Contract Law; and the 
     American Law Division of the Congressional Research Service.
       Yockey, who was Deutch's immediate predecessor as 
     procurement czar and who is both a retired military officer 
     and former defense industry executive, argued in a July 13, 
     1994, letter to the professional staff of the House Armed 
     Services Committee that by definition, structure means 
     organization, and that the FAR does not allow the 
     reimbursement of organization costs. Indeed, it was Yockey 
     himself who told DCMA to reject Hughes' request for 
     reimbursement for its purchase of General Dynamics' missile 
     division.
       In a September 28, 1993, letter to Eleanor Spector, the 
     director of defense procurement, Leroy Haugh, vice president 
     of procurement and finance of AIA, stated that the Deutch 
     memo constituted a significant policy decision and an 
     important policy change. Therefore, Haugh asked Spector to 
     promptly publish notice of this policy change in the Federal 
     Register and to consider amending the regulations. In a May 
     3, 1994, letter to Deutch, Donald J. Kinlin, the chair of the 
     ABA Section on Public Contract law, urged Deutch to modify 
     the FAR since at the time it did not reflect the changes made 
     in Deutch's July 1993 memorandum. What is significant about 
     the AIA and ABA positions is that both groups support 
     Deutch's change.
       Finally in a June 8, 1994, memorandum John R. Luckey, 
     legislative attorney for the Congressional Research Service, 
     stated that while former amendment of the FAR could make 
     restructuring costs allowable, the argument that they are 
     allowable under the current regulations appears to contradict 
     their plain meaning. In Luckey's opinion, Deutch's position 
     is based on semantics, not legality.
       In short, the political leadership of the Clinton defense 
     department made a significant policy change that as a minimum 
     should have been published in the Federal Register and, as 
     Secretary Perry later admitted, cleared in advance with 
     Congress.


                       the substance of the issue

       This end run around the administrative and legislative 
     processes by the Pentagon is unprecedented, but even more 
     important is whether the Defense Department and the taxpayers 
     should be giving the defense industry a windfall by allowing 
     a write-off of substantial parts of restructuring costs. For 
     four reasons, the answer to that question should be an 
     emphatic ``No.''
       First, like Mark Twain's death, the decline of the defense 
     industry in this country has

[[Page E1308]]

     been greatly exaggerated. As Pentagon and industry officials 
     endlessly point out, defense spending in general, and 
     procurement spending in particular, have declined over the 
     past decade. They note that between fiscal year 1985 and 
     fiscal year 1995, the defense budget declined 30 percent in 
     real terms and procurement spending fell 60 percent. But that 
     comparison ignores the fact that between fiscal year 1980 and 
     fiscal year 1985, the defense budget grew 55 percent and the 
     procurement budget grew a whopping 116 percent. Defense 
     spending in real terms is still at about its Cold War 
     average, and the defense budget for fiscal year 1996 was 
     higher than it was for fiscal year 1980. In inflation-
     adjusted dollars, Bill Clinton spent about $30 billion more 
     on defense in 1995 than Richard Nixon did in 1975 to confront 
     Soviet Communist expansionism. Using fiscal year 1985, the 
     height of the Reagan buildup, as a base year distorts the 
     picture. It would be like comparing spending in the Korean 
     and Vietnam wars to the level of World War II and concluding 
     we did not spend enough in Korea and Vietnam. Moreover, 
     procurement spending will rise 40 percent over the next five 
     years, and the Pentagon is now soliciting bids for the $750 
     billion joint strike fighter program.
       Similarly, while defense employment has fallen 25 percent 
     over the past eight years, it grew 30 percent in the five 
     years before that. More people work in the defense sector now 
     than at any time in the decade of the 1970s. Moreover, much 
     of the decline in the defense industry is attributable to the 
     reengineering or slimming down that is sweeping all American 
     industries, even those with an increasing customer base.
       Finally, if one adds the $266 billion worth of U.S. arms 
     sold around the world since 1990 (a scandal in itself) to the 
     $300 billion in purchases by the Defense Department, American 
     defense industry sales are still at historic highs. Defense 
     is still a profitable business--which explains why defense 
     stocks are still quite high despite the jeremiads of industry 
     spokesmen. Over the past year Lockheed Martin stock has 
     increased 48 percent in value. Northrop Grumman is up 50 
     percent and McDonnell Douglas a whopping 80 percent.
       Second, taxpayer subsidization is no more necessary today 
     to promote acquisitions and mergers than it has even been. 
     Just about every major defense company today is the product 
     of a merger, some of them decades old. For example, General 
     Dynamics acquired Chrysler's tank division in the early 
     1980s, and McDonnell acquired the Douglas Aircraft Company in 
     the late 1960s. Even today in the supposed ``bull market,'' 
     plenty of bidders vie for the available companies. Three 
     years ago, several companies engaged in a fierce bidding war 
     for LTV. And Northrop outbid Martin Marietta for Grumman. It 
     is hard to believe that if taxpayer subsidies were not 
     available, companies would not buy available assets if it 
     made good business sense. If they paid a little less for 
     their acquisitions, the taxpayers rather than the 
     stockholders would benefit. In the bidding war for Grumman, 
     both Martin and Northrop offered significantly more than 
     market value, thus giving Grumman's shareholders a financial 
     bonanza of $22 a share (a bonus of nearly 40 percent). 
     Raytheon paid a share (a bonus of nearly 40 percent). 
     Raytheon paid a similar premium to acquire E-Systems in April 
     1995. Should the government allow Northrop's and Raytheon's 
     stockholders to reap a similar bonanza by subsidizing those 
     sales?
       Over the past five years, William Anders, the former CEO of 
     General Dynamics, made himself and his stockholders a fortune 
     by selling parts of his company to Hughes, Martin, and 
     Lockheed. Since 1991 General Dynamics' stock increased 550 
     percent and the company has stashed away $1 billion. Should 
     we also help the stockholders and executives of the buying 
     companies? Did defense companies offer the taxpayers a rebate 
     during the boom years of the 1980s when their profits reached 
     unprecedented levels?
       Third, the Defense Department has no business encouraging 
     or shaping the restructuring of defense industry, or as 
     Deutch puts it, ``promoting the rational downsizing of the 
     defense industry.'' Who is to determine what is rational? A 
     government bureaucrat or the market? While government 
     shouldn't discourage restructuring, it should stay at arm's 
     length. If the deal does not make good business sense, the 
     company will not proceed, as Martin did not when the price 
     for Grumman became too high. Moreover, might not these 
     mergers create megacompanies that will reduce competition and 
     may be very difficult for the political system to control? 
     The Lockheed Martin Loral giant, for example, is larger than 
     the Marine Corps. With facilities in nearly every state and 
     200,000 people on its payroll, its political clout is 
     enormous. And it presents problems over and above its sheer 
     size. For example, Loral sells high-tech components to 
     McDonnell Douglas for its plane, which is competing with 
     Lockheed Martin for the $750 billion joint strike fighter 
     program. How can Loral be a partner in promoting the 
     McDonnell Douglas plane against the Lockheed Martin entry?
       Fourth, past history indicates that these mergers end up 
     costing rather than saving the government money. Both the 
     General Accounting Office and the Department of Defense 
     Inspector General have found no evidence to support 
     contentions by Deutch and defense industry officials that 
     previous mergers had saved the government money. Indeed, on 
     May 24, 1994, the Inspector General found that the claim of 
     Hughes Aircraft that its 1992 purchase of General Dynamics 
     missile division saved the Pentagon $600 million was 
     unverifiable. Moreover, under the Deutch clarification, 
     contractors can be reimbursed now for savings that are only 
     projected to occur in the distant future. And if these 
     savings do not occur as projected, how will the Pentagon get 
     its (our) money back?


                    bring back the merger watchdogs

       Mergers always have been and always will be a feature of 
     the U.S. defense industry. And the government has a role in 
     those mergers. But that role--as exemplified by the 
     successful 1992 Bush administration challenge of Alliant 
     Techsystem's proposed acquisition of Olin Corporation's 
     ammunition division--is to ensure that they preserve 
     sufficient competition to enable the Pentagon to get the best 
     price for the taxpayer. It is definitely not to increase 
     company profits and limit competition by subsidizing the 
     merger. Not only should the Defense Department abolish the 
     new merger subsidy, it should follow the lead of its 
     predecessors and scrutinize the anticompetitive aspects of 
     all future mergers.
                                                                    ____


                        Planning Future Defense

                        (By Thomas L. McNaugher)

       Quietly a new defense debate is taking shape, prompted by 
     widespread recognition that the stable budgets Republicans 
     and Democrats have promised the Defense Department cannot 
     keep current forces ready to fight while financing a major 
     round of weapons buying to replace the services' aging 
     arsenal.
       The problem here has been called the ``defense train 
     wreck,'' because it involves the impending collision of two 
     categories of defense spending. One train, already racing 
     down the track, is high spending on current readiness, enough 
     to keep U.S. forces prepared for two nearly-simultaneous 
     ``major regional contingencies,'' as outlined in the 1993 
     ``Bottom Up Review'' (BUR) of U.S. force requirements that 
     still governs Pentagon planning. The other train, looming on 
     the horizon, is a surge in spending on new weapons. We have 
     been able to forgo such spending for nearly a decade because 
     Reagan-era defense investments left military inventories 
     flush with new hardware. But those weapons are getting old 
     and need to be replaced or improved. Barring an unexpected 
     increase, the defense budget cannot afford both readiness and 
     weaponry. Something has to give.
       Although this debate probably won't pick up until after 
     this fall's elections, early positioning in the debate 
     suggests that U.S. forces may get smaller to accommodate more 
     weapons procurement. Indeed, Secretary of Defense William 
     Perry has said as much recently, although he appears to have 
     only modest force cuts in mind. Senator John McCain (R-AZ), a 
     prominent congressional voice on defense, would go much 
     further. In a recent letter to his colleagues, McCain 
     lamented ``the alarming practice of postponing essential 
     modernization programs'' and suggested that the nation plan 
     to meet just one major contingency while aggressively 
     modernizing its weaponry to produce high-tech forces able to 
     deliver firepower from long range with minimal ground force 
     commitment.
       Whether or not this is the right answer, it's the wrong way 
     to frame the issues. Visualizing procurement spending as a 
     co-equal ``train'' in this collision amounts to treating the 
     future as if we knew it. Procurement spending amounts to 
     long-range planning, after all, since it buys weapons that 
     won't even enter our force posture, in some cases, for a 
     decade or more. At a time when Pentagon briefings routinely 
     begin with the adage that ``the only constant today is 
     change,'' one is justified in asking why we are committing so 
     much money to new weapons that will be with us for decades to 
     come.
       The answer lies less in a vision of the future than in 
     habits and commitments linked to the past. We got used to 
     treating the future like an advanced version of the present 
     during the Cold War, when Soviet forces provided a well-
     understood, slowly advancing focal point for long-range 
     planning. We are still doing that, even in the absence of any 
     firm vision of the future. Even the discussion of current 
     readiness bears witness to Cold War concepts of risk that no 
     longer capture the realities of what our forces are doing.
       This is not meant as criticism. The BUR has served 
     admirably to maintain U.S.

                          ____________________