Monday, February 14, 2011

Monopsony

Guambat learned a new word today from the erudite New York Times. Monopsony. It's "a single buyer with life-or-death power over its vendors".

Think government contracting. Think Pentagon. Read this article:

From Pentagon, a Buy Rating on Contractors
In economic terms, the Pentagon is a “ monopsony,” a single buyer with life-or-death power over its vendors. If the Pentagon wants the military industry to be healthy and profitable, it can pretty much ensure that outcome.

Monopsony or not, why should the Pentagon be talking up the stocks, even implicitly, of the companies it buys from? Why was Mr. Carter going out of his way to talk to investors and analysts? Didn’t he have more important things to do?

The answer, I eventually learned, has to do with something that happened a very long time ago, and goes under the category of “Be careful what you wish for.” Let’s just say that banking isn’t the only industry where the government has allowed a handful of companies to become too big to fail.
The article tells us that back in 1993, government officials invited defense industry executives to a "Last Supper" where they were told they would need to start merging to cut down on the costs of overhead being passed on to the government buyers.
The Last Supper has become part of the lore of the military industry — though partly that’s because Mr. Aspin’s prediction about tighter Pentagon budgets turned out to be so wrong. “On the day George W. Bush took office,” said Loren B. Thompson, a well-known military consultant, “defense spending was around $300 billion.”

Today it is more than double that amount, around $700 billion. The wars in Iraq and Afghanistan — not to mention the Pentagon’s voracious appetite for expensive weapons systems, and the lack of competition among the remaining contractors — have been a gold mine for the Big Five.

Not surprisingly, for most of the first decade of the 21st century, the stocks of these companies soared. But after peaking in 2008, they came crashing back to earth. Which, for the Pentagon, has turned out to be a problem. These companies need access to the capital markets, which is more difficult when their stocks are down. And the Pentagon simply can’t allow them get into serious financial difficulty; there are just too few of them. “What we can’t afford from the defense perspective is a sick industry,” said Jacques S. Gansler, a former procurement official for the Pentagon who teaches at the University of Maryland.

Recognizing that leaner times lay ahead, Defense Secretary Robert M. Gates made a speech last May acknowledging that Pentagon budgets were unlikely to rise substantially any time soon, and laid out a plan to create new efficiencies and increased competition among the companies.

taxpayers and shareholders are decidedly not in alignment: the tougher the Pentagon gets with its contractors, the better it is for taxpayers and the worse it is for shareholders. And yet it can’t get too tough, because if it is, the companies will start running into financial trouble, which means the stocks will sink even further and the companies will start to have trouble raising capital.

This is the bind created by the Last Supper.

Now can you see why the Pentagon has taken to talking up the industry to the investment community? With one side of its mouth, the Pentagon is saying it is going to be more tough-minded in its approach to military contractors than ever before. But with the other side of its mouth, it is telling investors not to worry: the profits will be there, no matter what.

The sidling up to investors actually began last October, when the deputy defense secretary, William J. Lynn III, held a private meeting for about a dozen Wall Street analysts, laying out the Pentagon’s cost-cutting plans in astonishing detail. Indeed, according to Reuters, which uncovered the meeting, the analysts were sworn to secrecy. Although this would seem to violate, at the least, the spirit of transparency that Americans expect of market participants, notes of the meeting became public only after Reuters exposed it. (A military consultant named James McAleese published his notes on his Web site a few days after the Reuters story broke.)

Whatever the ethics of this meeting — and the Pentagon insists that nothing new was divulged during the session — it appears to have had an effect. If you look at the stock charts of the Big Five, you’ll see that they all started to rise around October. Imagine that.

Guambat is reminded of another word: symbiosis.

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1 Comments:

Anonymous Banker Boy said...

Holy bill of rights, Procurement Man!

14 February 2011 4:14:00 pm GMT+10  

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