UPDATE 2-Pentagon warns on big U.S. defense cuts

Wed Apr 13, 2011 8:12pm EDT

* Obama aims to save $400 billion in security spending

* Arms makers' stocks sell off

* Gates has warned against deep cuts (Adds stock market impact, quotes, analysis)

By Missy Ryan and Jim Wolf

WASHINGTON, April 13 (Reuters) - The United States may have to scrap some military missions and trim troop levels if President Barack Obama sticks with his goal of saving $400 billion on security spending over a 10-year period, the Pentagon said on Wednesday.

Arms makers' shares sold off after Obama made a speech on the budget deficit in which he called, in effect, for holding growth in the Pentagon's core budget, excluding war costs, below inflation through 2023, starting in fiscal 2013.

The squeeze on the Pentagon's budget, which has roughly doubled since 2001, is part of a larger drive to cut the U.S. budget deficit by $4 trillion over the 10-year period.

Standard & Poor's aerospace and defense index declined 0.9 percent on Wednesday, underperforming the S & P 500 index, which closed up .02 percent. Lockheed Martin Corp (LMT.N), the Pentagon's No. 1 supplier by sales, dropped 2.6 percent to close at $80.37 on the New York Stock Exchange.

"It's not just a math exercise which is 'cut $400 billion'," said Geoff Morrell, the Pentagon press secretary. "It's 'let's review our roles and our missions and see what we can forgo, or pare down, in this age of fiscal constraint, where we are all collectively trying to work with the deficit problem.'"

Analysts said a selloff of arms makers' shares was an overreaction.

"We think that a flat defense budget" (excluding overseas contingency operations such as Iraq and Afghanistan) "is what investors and the defense industry already expect," said Rob Stallard of RBC Capital Markets.

"We think the knee-jerk selling in response to today's headlines has created an opportune entry point for our preferred defense names, notably Raytheon Co (RTN.N) and General Dynamics Corp (GD.N)," he added in a note to clients.

The Pentagon has been tightening its belt in the hope of warding off deep cuts amid the concern over budget deficits.

Defense Secretary Robert Gates already had eliminated or scaled back more than 20 troubled or "excess" weapons programs since April 2009. Last June he ordered the military to come up with more than $100 billion in overhead savings over five years, which could be reinvested in higher priority programs.

The chairmen of Obama's deficit commission as well as a Bipartisan Policy Center Debt Reduction Task Force each had called for cuts in projected military spending of up to $1 trillion over 10 years, far more than Obama proposed.

OBAMA'S GOAL

The core Pentagon budget is now about $530 billion, roughly $10 billion less than Gates said was critical when the Obama administration sent Congress its spending plan for 2012.

The Defense Department could easily meet Obama's goal -- which amounts to saving an average of about $40 billion a year -- without jeopardizing the U.S. military's global dominance, said Gordon Adams, a senior White House official for national security budgets from 1993 to 1997.

"It's fundamentally trivial," he said. "This is stuff a comptroller can do while playing with his prayer beads." He suggested it would mean shrinking the force "a bit," trimming and deferring some hardware purchases and finding more efficient ways to handle operations and maintenance spending.

But Mackenzie Eaglen, a national security analyst at the conservative Heritage Foundation, said the world was not getting any safer and the U.S. bill would come due.

"The need to modernize the inventory of all the services is not going away and that bill will simply grow larger the longer policymakers defer modernization," she said.

The Republican chairman of the House of Representatives Armed Services Committee, Howard McKeon, said he had "grave concerns" about spending reductions while the U.S. military was involved in Iraq, Afghanistan and Libya.

The Defense Department accounts for roughly 20 percent of U.S. federal spending and roughly half of discretionary, non-mandated spending.

Gates said in January the United States planned to cut $78 billion in defense spending over five years, including a reduction of up to 47,000 troops. That came on top of the $100 billion cost-savings drive that Gates kicked off last year.

"My greatest fear is that in economic tough times that people will see the defense budget as the place to solve the nation's deficit problems," Gates said last August. (Reporting by Missy Ryan, Phil Stewart and Jim Wolf; editing by Christopher Wilson)

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