Don’t Let the Pentagon Become the Next Enron

Remember Enron and Lehman Brothers, the energy and financial giants that seemed immune to immutable principles of fiscal health? Reality caught up to their poor assumptions and unsound business practices, and their collapses caused tremors around the globe. Today, the Defense Department is in alarmingly similar straits—except that the stakes are far higher.

Since the end of World War II, America’s ability to project military power has helped stabilize the world order and protect access to the global commons, fostering an era of unprecedented economic growth and prosperity. Unfortunately, DOD is becoming so constrained by poor fiscal and modernization policy that it threatens the United States’ ability to lead globally. If the nation should become unwilling or unable to fund a military that can remain globally present, the effects on global stability would be similar to that of the failure of financial giants and mainstays on the world’s economy: devastating.

Like Enron, which infamously used off-balance-sheet financing to conceal enormous debt, DOD’s recent budgets fail to account for the increasingly urgent need to replace or upgrade various aging and expensive weapons. For many years, these purchases have been put off to make current budgets and five-year plans look affordable—in effect, ignoring an enormous debt that is getting ready to come due. The implications of this modernization "bow wave" are spelled out in a recent report by Todd Harrison, my colleague at the Center for Strategic and International Studies: several of these programs, primarily in the Navy and Air Force, are slated to arrive at or near their peak years of funding requirements in 2020. Mr. Harrison estimates that funding for major acquisition programs would need to increase by up to 23 percent (adjusting for inflation) from 2015 to the peak of the wave in 2022. In terms of the overall defense budget, DOD would need the budget caps set by the Budget Control Act of 2011 to be raised by a total of about $130 billion between 2017 and 2021, when the caps are set to expire.

The longer this situation remains unaddressed, the more likely that the remaining options will be bad and worse. The question is whether DOD and its Congressional overseers will continue to operate this way. Will lawmakers begin providing the DOD a budget that allows more responsible modernization practices? Congress cannot simply allow themselves and DOD to remain complicit in business as usual—the status quo assumes far too great a risk. They must act responsibly now to avert the impending crash of the wave.  Beginning an honest and transparent dialogue with DOD and the executive branch that reconciles resources and national security strategy is one recommendation. 

Look as well at Lehman Brothers, which borrowed four times as much money as its stock was worth to buy up tens of thousands of mortgages. When its assumptions about the value of those mortgages proved wrong, it vanished, along with many billions of dollars. In roughly similar fashion, DOD makes assumptions about cost savings, then borrows against these expected savings–in effect, creating leverage. Similar assumptions are made about inflation, interest rates, foreign currency exchange rates, and energy costs. Of course, financial planning requires assumptions. But far too often, DOD planners unwisely assume improbably favorable conditions. The Army’s current five-year plan, for example, assumes that foreign-currency fluctuations will save the service some $450 million in fiscal 2017; also, that low inflation in non-pay, non-fuel purchases will save $2.2 billion across the FYDP. It’s a reasonable guess that such optimism pervades the planning assumptions of other services and DOD itself, to the tune of billions of dollars each year. And when such savings fail to materialize, the Pentagon generally fails to adjust well, to the detriment of its programs, people, and readiness.

Unlike Enron or Lehman Brothers, the Defense Department is, in fact, too big to fail. It cannot declare bankruptcy and allow its stakeholders to pursue other investment options. Until these problems are resolved, DOD will gradually be forced to do less, delay or cut programs, reduce readiness, and assume greater strategic and operational risk. The implications for national security and by extension the world order of which the U.S. is largely a guarantor are too important to ignore.

It is time for a serious analysis of DOD’s budgeting practices, painful as it may be. DOD leaders must act responsibly to develop a comprehensive fiscal strategy. Congress must act boldly to strike a Simpson-Bowles or similar deal and return to budgets that are not at best only one-year deals. Our national security, our ability to lead globally, and indeed the stability of the global postwar order depend on it.