A Second Look at Your Recent $717 Billion Investment

In the Congressional Budget Office’s (CBO) 2018 Budget and Economic Outlook report, the agency paints a bleak picture of the United States’ deteriorating financial position over the next decade.[i] The office’s projections forecast the United States hitting the trillion-dollar annual deficit figure in 2020 after which it is projected to grow, hitting 1.5 trillion by 2028. As this reality continues to near, it will be important to evaluate the efficiency and effectiveness of funds being deployed across the gamut of government services. With the recent passage of the 2019 defense bill (clocking in at $717 billion) it is time to take a closer look at the US government’s second largest annual expenditure.

The United States spends more on defense than the combined amount spent by the next 7 largest military spenders. At $717 billion, the 2019 bill represents 17 percent of last year’s federal budget. Under the bill, the Department of Defense’s budget will jump 12 percent from last year’s value.

Certainly, safety is something valued by all Americans. Nevertheless, it may be time to reflect on whether the hundreds of billions of dollars invested above and beyond what is being spent around the globe is something we as a country want to double down on.

Financial Reporting, Missing Money, and Accounting Systems

Since 1995 the Department of Defense (DOD) has earned itself a spot on the Government Accountability Office’s (GAO) list of high risk entities. High risk entities are identified as organizations whose serious financial management problems represent a threat to the federal government’s financial well-being. The GAO goes on to list the Department of Defense as one of three major impediments to the office being able to issue an opinion on the federal government’s financial statements. Within the government’s 2017 financial statements the GAO establishes that the impediments identified:

(1) hamper the federal government’s ability to reliably report a significant portion of its assets, liabilities, costs, and other related information;

(2) affect the federal government’s ability to reliably measure the full cost, as well as the financial and nonfinancial performance, of certain programs and activities;

(3) impair the federal government’s ability to adequately safeguard significant assets and properly record various transactions; and

(4) hinder the federal government from having reliable financial information to operate in an efficient and effective manner.

The GAO goes on to add that the DOD’s financial reporting deficiencies not only impact its ability to report on financial transactions and assets, but that the deficiencies also “affect its ability to make sound decisions on missions and operations.”

As with the private sector, government entities are required to undergo an annual audit of their financial statements. Since the US government’s first audit over 20 years ago, the Department of Defense has failed to produce a single set of auditable financial statements.

After decades of work, the department has announced it will undergo its first department wide audit of its consolidated financial statements for fiscal year 2018 (October 1st 2017 to September 30th 2018). Both the Government Accountability Office and the DOD’s own representatives acknowledge there are likely to be many findings and it will not be a clean audit.

Even though the DOD has never undergone a department-wide audit, several US defense organizations have been evaluated with mostly negative results. The army has been the subject of a myriad of financial misconduct findings. Scott Paltrow of Reuters wrote a fantastic article detailing examples of these areas of misconduct. (See selected narrative below)

“Because rules require that the Army’s numbers exactly match in monthly reports to the Treasury, the Army and the Defense Finance and Accounting Service must find a way to make them match. Their solution was to enter made-up numbers to make it appear falsely that the Army’s numbers do match. The report said that for March 2016, there were $1.9 billion in such “forced balance entries.”

For October 2015, the Army had 177,921 discrepancies. The monthly numbers rose steadily to 790,551 for June 2016. Army spokesman Wayne Hall said the number of discrepancies continued to increase in 2017.”[ii]

These accounting issues are not limited to the Army. The Navy, Airforce, and several other military agencies have reported similar if not more significant errors. These issues allow for fraud, the misuse of tax payer money, and can lead to situations wherein the government is unable to locate or account for heavy artillery and weaponry. It’s these kinds of issues that lead to headlines like the following.

While the events leading the military to this state are many and varied, one major driver includes the underlying software in place to support the department’s financial reporting efforts. The GAO and other military offices have voiced concerns surrounding the inability of the DOD’s financial systems to accurately report on financial outcomes.

In its article, “Unaccountable: The High Cost of the Pentagon’s Bad Bookkeeping,” Reuters reported on the hundreds of independent accounting systems that are “built ad hoc … some dating from the 1970s.” The article goes on to describe the systems as “riddled with errors and incapable of sharing accurate data.” The article spoke not only to the software but the antiquated error prone computers being utilized in the process.

While the United States struggles with basic reporting and asset management, emerging countries are leap frogging to new technologies and learning how to operate more efficiently. These countries do not have nuclear weapons operating off floppy disks. They do not have military schematics sitting on microfiche machines. And they are certainly not running critical enterprise software programs on Microsoft XP.

The current environment enables fraud, limits strategic decision making, and ensures a future of good money chasing bad. At some point we as a country cannot outspend the inefficiencies underlying the management of our money and assets.

Contractors

US defense contracts are big business to the tune of $320 billion in 2017. Within the DOD’s contracting process there are serious concerns surrounding limited competition, quality issues, and a general lack of oversite.

Competition — The qualification process to become a defense contractor is expensive and time intensive. The nature of the process deters leaner and more entrepreneurial firms from applying for consideration. Nevertheless, for those who have weathered the process, the reward is considerable.

The ability to receive such contracts represents a major, often unsurmountable, barrier to entry for competitors looking to enter the market. A barrier that existing contractors are extremely interested in protecting.

Defense contractors are further buffered from competitive forces as nearly half of the Department of Defense contracts awarded in 2017 were done so without a competitive, open-bidding process.[iii] As will be discussed later, in 2017 roughly 72 percent of contracts were structured without clauses designed to incentivize/punish poor contractor performance.

To further diminish competitive forces, defense contractors have picked up on a disturbing new trend. Those contractors developing new high-tech weapon systems have made big business out of designing complex support systems that ensure long-term contracts wherein no other viable competitor exists.[iv]

This trend was made apparent in the GAO’s October 2017 report entitled “F-35 Aircraft Sustainment: DOD Needs to Address Challenges Affecting Readiness and Cost Transparency.” Among the many problems identified the GAO report highlights the following issues.

• The report cited average part repair times of 172 days compared to the 60 to 90 day requirement established by the program. The DOD’s capabilities to repair F-35 parts at military depots are 6 years behind schedule.
• From January through August 7, 2017, F-35 aircrafts were unable to fly about 22 percent of the time due to parts shortages.
• Sustainment costs alone are estimated at $1.12 trillion over a 60-year life cycle.
• The DOD does not have the data it needs from the prime contractor to enable competition of future sustainment contracts or effectively negotiate performance-based contracts in the future. This includes the information necessary to ensure weapon system performance and support.
• Citing unexplained cost increases and difficulty tracking their requirements to contracts, the DOD does not understand how the costs they are being charged by the program office are linked to the capabilities they are receiving.

Despite all of these issues, the 2019 spending bill allocates $7.6 billion to fund the purchasing of an additional 77 F-35 aircrafts. The funds will go to Lockheed Martin, the same contractor that has failed all efforts to support the current fleet.

These contractors benefit from considerable levels of supplier power. They exist in an environment where they can lobby congress to push for new orders. They also benefit from a history of the US government defaulting to preferred vendors even when the organization has little or no experience in the area being contracted, or award contracts to organizations with a recorded history of producing poor results.

Quality and Waste — In a world of limited competitive forces, the pressure to innovate and perform is severely muted. In an attempt to address this market failure, policy makers have developed a host of regulations aimed at managing government contractors’ output quality. CFR, ISO, and NIST are a small subset of regulations designed to instruct agencies how to follow structured product development, testing, and change control processes.

Unfortunately, the enforcement and punishment for non-compliance is generally lacking. The result of lax enforcement has been embodied in headlines speaking to the tax payer dollars funneled into procuring, fixing, and maintaining fundamentally flawed goods.

A recent illustration of the issues related to defense contracting and poor quality is that of the three additional Littoral Combat Ships (LCS) funded in the $717 billion military spending bill. The bill requires the Navy to purchase all three ships despite several protests that two of the ships are not necessary. In fact, the Navy has wanted to pursue efforts to get away from using LCS ships altogether. The decision to move ahead despite protests was likely fueled by the lobbying efforts of government contractors Lockheed Martin, Austal USA, and Marinette Marine.

However, the more concerning plotline in this funding decision relates to the ship’s history of poor quality. The pentagon’s operational test and evaluation director has issued a report deeming the ship unreliable due to severe performance issues. The ship has a storied history of “cracked hulls, engine failures, unexpected rusting, software snafus, weapons glitches, and persistent criticism of how vulnerable they are to an attack.”[v] Over the 17 years spent building and repairing the Navy’s LCS fleet, this ship has racked up billions in cost overruns. Nevertheless, in 2019, $1.56 billion will be awarded to contractors to build three more ships with a proven history of failure.

Lockheed Martin’s ability to procure contracts in light of quality and safety failures does not end here. Also included in the bill are funds to build UH-60M Black Hawk utility helicopters, manufactured by Sikorsky (a unit of Lockheed Martin). A Pentagon inspector audit of the machine identified safety issues so severe they “required the unit commander to ground (restrict flying) those helicopters.” To avoid consequences of the safety issues “the unit commander did not always allow evaluators to finish the evaluation of additional helicopters because he did not want to ground more helicopters if additional safety problems were identified.”[vi]

These stories only begin to scratch the surface of the expensive quality and safety issues presented by defense contractors. A quick run down the list of preferred DOD vendors illustrates story after story of similar issues. These issues are costing US tax payers billions of dollars and are putting the lives of military personnel at risk.

Oversite — The poor oversight of government contracts falls largely into two buckets. First in the way government contracts are tracked and accounted for and second in the way they are paid out in light of quality commitments.

The Federal Procurement Data System (FPDS) is the database utilized by the government to track its contracts. As is a common theme, the data base was established in the 80’s, revamped in the early 2000’s and has yet to produce data quality to the satisfaction of regulatory bodies. Both the GAO and Inspector General of Commerce have expressed opinions regarding the poor data quality produced by the system. Ultimately the system allows for high level trend analysis, but individual queries to the data may render differing results.

This lack of visibility makes strategic acquisition and vendor selection extremely difficult. The GAO is rendered almost completely incapable of offering a solid opinion on whether the military is improving its ability to negotiate and spur better outcomes.

The inability to manage the “who and what” of contracts exacerbates the second issue related to the government’s ability to hold contractors to contract terms. This is of particular concern when it comes to managing incentive contracts.

In an effort to mitigate overpayment, poor quality, and missed deadlines, the DOD has taken efforts to implement and improve enforcement of incentive contracts. These contracts serve as a method of incentivizing low cost, on time execution of contracts. However, upon initial review, the GAO found that, in large part, these contracts were being paid out regardless of outcome. In 2005 the agency identified $8 billion worth of unearned fees being paid out. These contracts were in fact leading to heightened expenses.

After its first review, the department acted on GAO recommendations to try and improve the execution of its incentive contracts. While in later reviews the GAO determined that the contracts were improving from a structural perspective (with notable exceptions in both the Navy and Army), the DOD had such poor reporting functionality there was no way to assess the “effectiveness of incentives for improving contractor performance and achieving desired program outcomes.”

Conclusion

There is a fast approaching future wherein the United States will no longer be able to assert dominance by outspending its enemies. As other countries build their defense frameworks from the ground up, unencumbered by old technologies and outdated ways of doing things, they will continue to be more effective in deploying capital.

Several paradigm shifts must occur if the United States’ military is to remain relevant over the long term. We can no longer be content with the assumption that all government projects will be late and overbudget. We can no longer rely on an acquisition process that does not enforce quality or engender true competition. We can no longer afford the broken software and hardware systems that prohibit efficient operations. Data analytics and artificial intelligence are in no doubt the way of the future, and if the US government does not have the data quality and infrastructure to support this future it will continue to fall behind the competition.

It is time to seriously contemplate the special interest groups and bureaucracy that are supporting wasteful spending and systems that make the United States less safe.

[i] https://www.cbo.gov/publication/53781

[ii] https://www.reuters.com/article/us-usa-trump-pentagon/as-trump-seeks-defense-spending-boost-watchdogs-cite-faulty-pentagon-accounting-idUSKBN17F1PQ

[iii] https://datalab.usaspending.gov/competition-in-contracting.html

[iv] http://www.pogo.org/straus/issues/weapons/2017/defense-contractors-holding-the-pentagon-hostage-with-service-contracts.html

[v] https://www.publicintegrity.org/2016/07/05/19869/congress-funds-problematic-weapons-pentagon-does-not-want

[vi] https://taskandpurpose.com/black-hawk-army-training-problems/