Economic Warfare: Risks and Responses
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Economic Warfare: Risks and Responses Analysis of Twenty-First Century Risks in Light of the Recent Market Collapse Kevin D. Freeman, CFA Cross Consulting and Services, LLC Originally published June 2009 The views and conclusions contained in this document are those of the author and should not be interpreted as necessarily representing the official policies, either expressed or implied, of the Government. The report was originally published under contractual arrangement with a sub- contractor of the Department of Defense Irregular Warfare Support Program (IWSP) per contractual arrangement between the sub-contractor and Cross Consulting and Services, LLC. Per that contract, ―IWS(P) may use the work product and reports in related government support efforts with proper attribution.‖ This copy is provided to IWSP with full permission to distribute to the Financial Crisis Inquiry Commission for their review and inquiry. The author and Cross Consulting and Services, LLC retain copyright and other intellectual property rights. Kevin D. Freeman, CFA Cross Consulting and Services, LLC Tel: 866-737-2728 Fax: 877-201-2637 E-mail: [email protected] Economic Warfare: Risks and Responses Executive Summary Serious risks to the global economic system were exposed by the crisis of 2008, raising legitimate questions regarding the cause of the turmoil. An estimated $50 trillion of global wealth evaporated in the crisis with more than a quarter of that loss suffered by the United States and her citizens. A number of potential causative factors exist, including sub-prime real estate loans, a housing bubble, excessive leverage, and a failed regulatory system. Beyond these, however, the risks of financial terrorism and/or economic warfare also must be considered. The stakes are simply too high for these potential triggers to be ignored. The Obama administration‘s recent call for greater financial regulation stipulates to the facts that hedge fund activity has been virtually unregulated and that dark-pool trading, Credit Default Swaps, and naked short selling provide tremendous vulnerabilities in the system. This report concurs with these concerns as recently outlined by the heads of the SEC, US Treasury, and Federal Reserve and provides supporting data. Beyond that, this report exposes the fact that these vulnerabilities are subject to exploitation not only by greedy capitalists seeking profit but also by financial terrorists, intent on destroying the American financial system. From a historical perspective, there are numerous examples of financial attacks on specific companies and industries both for economic and non-economic reasons. In addition, there are other examples of financial attacks conducted against individual nations both for economic and non-economic reasons. Based on this awareness, the economic collapse of 2008 must be critically examined to determine the possibility that a financial attack took place as well as an assessment of future risks. The purpose of this report is to consider the implications of financial terrorism and/or economic warfare and to identify and realistically list prospective threats to U.S. economic security from a means, motive, and opportunity perspective. The preliminary conclusions of the research suggest that, without question, there were actors who had the motive to harm the U.S. economy. These motives can be categorized as both economic and non-economic. In addition, these same actors have clearly demonstrated the means to carry out such an attack. Finally, the opportunity was clearly present given the existing economic condition and regulatory framework in operation. The hypothesis under consideration is that a three-phased attack is underway with two of those phases completed to date. The first phase was a speculative run-up in oil prices that generated as much as $2 trillion of excess wealth for oil-producing nations, filling the coffers of Sovereign Wealth Funds, especially those that follow Shariah Compliant Finance. This phase appears to have begun in 2007 and lasted through June 2008. Page - 1 - Economic Warfare: Risks and Responses The rapid run-up in oil prices made the value of OPEC oil in the ground roughly $137 trillion (based on $125/barrel oil) virtually equal to the value of all other world financial assets, including every share of stock, every bond, every private company, all government and corporate debt, and the entire world‘s bank deposits. That means that the proven OPEC reserves were valued at almost three times the total market capitalization of every company on the planet traded in all 27 global stock markets. The second phase appears to have begun in 2008 with a series of bear raids targeting U.S. financial services firms that appeared to be systemically significant. An initial bear raid against Bear Stearns was successful in forcing the firm to near bankruptcy. It was acquired by JP Morgan Chase and the systemic risk was averted briefly. Similar bear raids were conducted against various other firms during the summer, each ending in an acquisition. The attacks continued until the outright failure of Lehman Brothers in mid-September. This created a system-wide crisis, caused the collapse of the credit markets, and nearly collapsed the global financial system. The bear raids were perpetrated by naked short selling and manipulation of credit default swaps, both of which were virtually unregulated. The short selling was actually enhanced by recent regulatory changes including rescission of the uptick rule and loopholes such as ―the Madoff exemption.‖ While substantial, unusual trading activity can be identified, the source of the bear raids has not been traceable to date due to serious transparency gaps for hedge funds, trading pools, sponsored access, and sovereign wealth funds. What can be demonstrated, however, is that two relatively small broker dealers emerged virtually overnight to trade ―trillions of dollars worth of U.S. blue chip companies. They are the number one traders in all financial companies that collapsed or are now financially supported by the U.S. government. Trading by the firms has grown exponentially while the markets have lost trillions of dollars in value.‖1 The risk of a Phase Three has quickly emerged, suggesting a potential direct economic attack on the U.S. Treasury and U.S. dollar. Such an event has already been discussed by finance ministers in major emerging market nations such as China and Russia as well as Iran and the Arab states. A focused effort to collapse the dollar by dumping Treasury bonds has grave implications including the possibility of a downgrading of U.S. debt forcing rapidly rising interest rates and a collapse of the American economy. In short, a bear raid against the U.S. financial system remains possible and may even be likely. Phase Two may have concluded with the brief market rebound that was supported by an emerging regulatory response calling for greater transparency across the board. Efforts including regulation of credit default swaps and proposed oversight of previously Page - 2 - Economic Warfare: Risks and Responses unmonitored trading activity, as well as Federal support of systemically vital institutions. But, we remain left with the critical unanswered questions of who and how? The recent seizure of $134 billion face value in supposedly counterfeit U.S. Federal Reserve bonds underscores the reality of the economic threat. This may be as significant as the Japanese radio intercepts were before December 1941. Immediate consideration of the issues outlined in this report is vital. Further study is essential and prospective responses must be crafted to address future risks. Finally, there are legitimate questions about the performance of the regulatory regime and Wall Street institutions. Implications that these parties have been complicit or otherwise co-opted cannot be ruled out. Therefore, it is strongly recommended that this study and any task-force response be conducted outside of traditional Washington and Wall Street circles. Page - 3 - Economic Warfare: Risks and Responses TABLE OF CONTENTS Executive Summary ...................................................................................................... - 0 - TABLE OF CONTENTS ............................................................................................. - 4 - Introduction ................................................................................................................... - 6 - Background and Timeline of Events ........................................................................... - 7 - Global Economic Peak ............................................................................................ - 7 - The Housing Bubble ............................................................................................... - 7 - Oil Price Spike ........................................................................................................ - 8 - Bear Stearns Collapse ........................................................................................... - 10 - The Collapse of Fannie and Freddie ..................................................................... - 10 - The Events of September 2008 ............................................................................. - 11 - Understanding the Potential Factors behind the Crisis ......................................... - 11 - Hypotheses for Consideration .................................................................................... - 14 - The