Five ways the financial crisis makes things tougher for contractors

Guest column

1. Regulation ? in general ? is now in, with gusto, easing passage of more rules.

As a tide of bipartisan calls for regulation washes over financial institutions, more stringent rules and oversight are a certainty for Wall Street. In the government services business, those working to ward off the recent upward spiral in proposed and enacted regulations now look like the Dutch boy, with their fingers in a dike.

More regulation is in the air and water not just in Washington, D.C., but nationwide. The sloppy equation that profit-making equals greed rolls easily off the tongue, especially in an election year when the economy teeters on disaster and the government is short on funds. It doesn't help, too, that some executives look incompetent or in denial.

Yes, it's guilt by association for government contractors, with their reputations already clouded since the renewal of oversight, the inevitable high-visibility contract performance problems, some ethical lapses, and even a little corruption by a tiny fraction of firms.

So the ire directed at Wall Street readily wafts over the contracting industry where the ground was already plowed and ready to receive it. If the Wizards of Wall Street take a fall, why not the Wizards of Tysons Corner, deservedly or not?

Expect the economic crisis to lubricate the path to more laws and regulations concerning organizational and personal conflicts of interest, transparency of contract performance, the state of contractor finances, and even executive compensation. And the bar of overzealous government intrusion into sensitive and proprietary information will be moved lower. Just think of government contracting as kind of a public trust, and a congressman will see a reason to regulate in the current climate.

2. The bailout will infect the discretionary budget, snuffing growth in some areas.

After years of spending indiscipline and the war on terrorism, we will see some reversal of federal spending growth. But it won't cover the entitlement programs or the sacrosanct national and homeland security budgets?for now.

Funding for contracts centered outside those protected areas will suffer. The decline will show in the fiscal 2009 budget proposed by the new administration, expected by early April.

Both presidential candidates promise wiser spending and even tax cuts, but with the Wall Street bailout tab weighing on the national debt, funding cutbacks that contractors feel will surely be larger.

3. Financing for M&A deals will be constrained as "deleveraging" proceeds on Wall Street.

Many investment bankers will tell you that money can always be found for a good deal. But the credit crisis turned out to be more dire than expected and directly aimed at not only the sources of operating cash, but also longer-term funds. Simply put, much less will be available.

The larger (almost unregulated) private equity firms and hedge funds will always have an edge in raising funds. The commercial banks and the carcasses of the big investment banking houses will suffer cuts in leverage and thus anticipated profits.

One byproduct of deleveraging is that the private equity firms and hedge funds will retain relatively better capacity to make acquisitions in government contracting because they can more readily finance them. The ultimate question, though, is whether the industry can still grow sufficiently to remain attractive.

4. Small businesses will suffer a continuing credit pinch.

Government contractors are prodigious users of short-term credit lines if for no other reason than the government pays so slowly. However, just as home equity loans have tightened up or have even been called by some lenders, firms of all sizes will find it tougher to borrow.

Small businesses, always at the bottom of the risk pool, will be hit hardest. Not only is available credit constrained, but also lenders are becoming increasingly picky.

5. Boards of directors will be compelled to proactively surveil management.

In companies large and small, boards of directors have often been lethargic. They focus on governance and often act after the fact. In the financial services arena, where directors' fees are among the highest, many boards must have been asleep as toxic assets were concocted, grown, sold, or just accumulated. For example, where was Lehman Brothers' board when the firm started to bulk up on the incomprehensible mortgage-backed instruments?

It's no secret that many boards, even in the government services industry's leading firms, don't act vigorously to control risk. For example, privately owned Parsons Engineering's board let the company get in way over its head in Iraq, even when early business results were foreboding. Like many boards, it appeared to be in a "review" capacity rather than positioned to vet high-stakes decisions before they were made or executed.

Regulators, overseers and shareholders will expect boards to be more activist and skeptical with regard to such matters as bet-the-firm bid decisions, new-market plans, conflict-of-interest prevention, and the internal oversight of high-risk contract performance.

So, it's not a pretty picture when recession, and even an economic depression, are discussed in polite conversation. The good news is that the government services business has tended to be robust and insulated from many economic shocks. In relative terms, it still is.

Michael Lent ( is editor and publisher of Government Services Insider in Washington, D.C.,

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