Analysis: Elections could pressure Pentagon spending

WASHINGTON Tue Oct 12, 2010 5:55pm EDT

The F-35 Lightning II, also known as the Joint Strike Fighter (JSF), is shown in this March 2010 file photograph. REUTERS/Lockheed Martin Corp/Handout

The F-35 Lightning II, also known as the Joint Strike Fighter (JSF), is shown in this March 2010 file photograph.

Credit: Reuters/Lockheed Martin Corp/Handout

WASHINGTON (Reuters) - Significant Republican gains in the November 2 congressional elections could fuel pressure to cut U.S. weapons funding, despite a huge push by top Pentagon officials to keep the defense budget stable.

"The grim reality is that the midterm elections are going to have a significant impact in terms of accelerating the contraction in defense funding," said Jim McAleese, a Virginia-based defense consultant.

Deputy Defense Secretary William Lynn tried to reassure Wall Street analysts at a closed-door meeting this month that the Pentagon could keep buying new arms and meet personnel costs by trimming $100 billion over five years from overhead and low-priority programs.

Lynn said the Pentagon could even buy more weapons if contractors can find a way to cut unit costs.

But he acknowledged growing pressure on defense spending from a presidential deficit-reduction panel, the Tea Party movement, and the upcoming elections, said McAleese, who attended the meeting.

U.S. defense contractors like Lockheed Martin Corp (LMT.N), Boeing Co (BA.N), Northrop Grumman Corp (NOC.N) and Raytheon Co (RTN.N), which have significant order backlogs on their books, may not be hurt immediately, but smaller companies and service providers could see orders decline, as could companies that are heavily focused on the war in Afghanistan, analysts say.

REAL PRESSURE EXPECTED

"We don't see spending falling off a cliff, but we expect real pressure," agreed one senior defense industry executive, who was not authorized to speak on the record.

He said that with U.S. troops at war overseas, neither Democrats nor Republicans will likely try to cut defense spending dramatically. But he echoed concerns that some Tea Party candidates, in particular, appear less wedded to military spending than more traditional Republican candidates, creating a level of uncertainty not seen in many years.

"We don't see any great scenarios out there, frankly," said the executive.

Chief of Naval Operations Admiral Gary Roughead on Tuesday voiced concern about mounting budget pressures but said the Pentagon's efficiency drive was already paying off.

He said the Navy had exceeded its $24 billion target for cutting costs over the next five years, identifying about $28 billion in savings through multiyear procurement agreements and changes in overhead structures.

Air Force Chief of Staff General Norton Schwartz said his service had also met its goal of cutting $28 billion in costs, saying the current budget environment meant the service had to be "more versatile and efficient in everything we undertake."

Despite progress on cost savings, if the Republicans win 39 seats and take control of the House of Representatives, they will believe they have a mandate for an aggressive deficit-reduction plan that could well include cuts to weapons programs, McAleese said.

Even if Democrats retain control of the House, they will feel compelled to show their muscle in cutting wasteful spending, and White House officials will be strengthened in their resolve to cut programs and find more savings, he said.

"It will set off a cost-cutting race between the Republicans and Democrats in Congress to demonstrate their ability and commitment to reducing deficits," said McAleese.

Later this week, a bipartisan group of more than 50 senators and House lawmakers, including Representative Ron Paul of Texas, a Republican favored by Tea Party supporters, plans to call for major cuts in the defense budget as part of an effort to reduce the federal deficit and national debt.

But enacting cuts could be virtually impossible in a split and paralyzed Congress, Rob Stallard, an analyst with RBC Capital Markets, wrote in a note on Tuesday.

FREEZE OR CUTS IN BUDGET SEEN LIKELY

Defense Secretary Robert Gates has vowed to continue expanding the defense budget by 1 percent each year, after inflation, but the White House could push for cuts once Gates retires next year, the senior defense industry executive said.

"As soon as he's gone, we believe that (1 percent) deal goes out the window," said the executive. "To be honest, we aren't expecting a 1 percent increase in the topline (budget). We expect a freeze or even slight reduction in the future."

Across the industry, companies are already scrambling to secure additional revenue sources through acquisitions or moves into adjacent markets such as homeland security.

One key issue facing lawmakers after the elections is whether to keep funding a second engine for the F-35 fighter -- a program the White House and Gates have been trying to kill for years.

General Electric (GE.N) and Britain's Rolls Royce (RR.L) say they need just $1.8 billion to finish developing their engine under a program launched by Congress in 1996. The program was aimed at ensuring competition for the engine built by United Technologies Corp (UTX.N) unit Pratt & Whitney that powers early versions of the F-35.

GE and Rolls Royce argue that competition driven by the program will save taxpayers $20 billion in the longer term. But Gates says the Pentagon cannot afford the program and has vowed to recommend a presidential veto.

Richard Aboulafia, analyst with the Teal Group, said the Pentagon's affordability drive and growing political pressure to rein in yawning federal deficits mean the GE-Rolls Royce engine program could be cut this year.