It's a recipe for disaster. | Source: MANDEL NGAN / AFP
- The Treasury is planning to become an investor in defense companies the government does business with.
- The deal will create an ethical issue when the DOD awards contracts in the future.
- Government ownership of private businesses is a dangerous precedent that could change the industry forever.
As the fallout from the novel coronavirus continues to add up in sectors across the U.S. economy, the Treasury and the Federal Reserve have been quick to hand out financial aid and bailout packages to keep financial markets functioning. But the latest industry relief offered by Treasury Secretary Steve Mnuchin raises some serious ethical questions.
The Treasury has set aside a $17 billion pool to support defense contractors, and other firms deemed essential to national security. In exchange for the funds, Mnuchin will require receiving firms to offer the government an equity stake in their business.
That could take several forms, including warrants, which allow the holder to buy shares at an agreed-upon price. Regardless of how it’s offered, the deal would give the government a financial interest in the companies it hires for defense contracts.
The Dangers of Treasury Relief and Equity Investment
On the surface, the relief package is unremarkable. It closely mimics the aid Mnuchin has offered to airlines in exchange for an investment option. Even in that case, many argued there are ethical concerns. The government, after all, is responsible for regulating airlines.
The waters are muddy when it comes to government involvement in private industry, and it opens the door for corruption and questionable decision making.
And those issues are just scratching the surface. In the case of airlines, there’s a tenuous link between the government and its investment. In the case of defense contractors and other security firms, the link is direct. The government itself is their customer and now, under the terms of this deal, one of their owners.
The Treasury’s Tie-Up With Defense is a Conflict of Interest
The Federal Government is largely responsible for defense contractors’ success or failure so the agreement raises serious conflict-of-interest questions. For example, in 5 years time when defense companies are bidding on a contract, the government may be inclined to go with the provider in which it owns stock rather than the one offering the best product or pricing.
Department of Defense contracts are extremely lucrative. They not only offer a guaranteed long-term revenue stream, but they also tend to lead to future partnerships. That’s why contractors like Lockheed Martin (NYSE:LMT) are considered safe bets even in times of economic hardship. A relationship with the DOD is, in many ways, a ‘golden ticket’ of sorts.
Contract Battles Could be Influenced
That was evident last year when Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) battled for an extremely lucrative DOD cloud computing contract. When MSFT emerged victoriously, it sent the firm’s share price markedly higher. Microsoft would not only benefit from the 10 years’ worth of revenue that the contract offered, but its cloud business was also elevated in the eyes of prospective customers.
But the government’s ability to make or break a company by doling out defense contracts is a touchy subject. Many called the Microsoft contract into question because of Donald Trump’s ongoing feud with Amazon owner Jeff Bezos. It’s impossible to tell whether or not that feud influenced the deal, but many, including Bezos himself, believe it did.
Now imagine that the Treasury has a financial stake in Microsoft as well. It blurs the lines even further between whether the DOD is making the right choice.
Government Control Erodes Trust
The nature of the coronavirus pandemic has necessitated quick aid packages, which, in many cases, turn out to be flawed. This particular defense bailout opens the door for some very shady dealings in the future.
Despite the government’s ongoing criticism of state-run Chinese firms and their lack of transparency, the Treasury is moving to create the same culture in the U.S. Government involvement through direct ownership is dangerous, it could have far-reaching consequences that change the industry dynamics forever.
Disclaimer: As of this writing Laura Hoy did not hold a position in any of the aforementioned securities.
