Crisis in Lebanon Anatomy of a Financial Collapse James Rickards August 2020 FOUNDATION FOR DEFENSE OF DEMOCRACIES FOUNDATION Crisis in Lebanon Anatomy of a Financial Collapse James Rickards August 2020 FDD PRESS A division of the FOUNDATION FOR DEFENSE OF DEMOCRACIES Washington, DC Crisis in Lebanon: Anatomy of a Financial Collapse Table of Contents FOREWORD ......................................................................................................................................... 4 INTRODUCTION ................................................................................................................................ 6 LEBANON’S UNRAVELING ............................................................................................................... 8 BANQUE DU LIBAN – THE CENTRAL BANK OF LEBANON ..................................................... 9 LEBANESE COMMERCIAL BANKS .................................................................................................. 12 THE NONVIABLE BANKS .................................................................................................................. 14 THE VIABLE BANKS ........................................................................................................................... 17 EUROBONDS AND EXTERNAL DEBT ............................................................................................ 20 GOLD ..................................................................................................................................................... 23 THE SYSTEM: HEZBOLLAH’S INTERNATIONAL CRIMINAL NETWORK .............................. 25 RESCUE PLANS .................................................................................................................................... 27 COMMENTS AND ALTERNATIVES TO THE IMF PLAN .............................................................. 30 FORECAST ............................................................................................................................................ 34 CONCLUSION ..................................................................................................................................... 37 APPENDIX 1: THE LEBANESE EXCHANGE RATE CRISIS ........................................................... 38 APPENDIX 2: THE 14 BANKS ............................................................................................................. 41 Crisis in Lebanon: Anatomy of a Financial Collapse Foreword “facilitated the flow of U.S. dollar-denominated funds Hezbollah used to bankroll its operations in Iraq.” These Lebanon is unraveling. Last year’s massive public operations killed Americans. This introduces liabilities, protests over the government’s inability to collect trash potentially in the form of liens on bailout funds, the or provide other key services now seem like a minor donor community cannot ignore. A banking sector problem. The COVID-19 pandemic has all but wiped purge and overhaul is urgently needed. out already falling remittances from the Lebanese diaspora. With its economy in a tailspin, the government What Mr. Rickards does not note explicitly is that missed a payment on a $1.2 billion eurobond in March Hezbollah physically controls chunks of Lebanese and effectively defaulted on all outstanding eurobond territory – the Bekaa Valley, southern Lebanon, and a obligations, including an additional $2.7 billion of Beirut suburb known as Dahiyeh. The group maintains payments due in April and June. a missile arsenal larger than that of any European country in NATO. Iran furnished Hezbollah with The International Monetary Fund (IMF), World more than 150,000 rockets that threaten its southern Bank, and others are working to assess the problem and neighbor, Israel. And Hezbollah’s recent acquisition offer solutions. But with Lebanon, it will not be easy. of precision-guided munitions from Iran threatens to The Foundation for Defense of Democracies (FDD) devastate Israel’s civilian areas, prompting Jerusalem commissioned renowned economist James Rickards to openly mull preemptive strikes. The risk of another to assess the challenges and damage. Mr. Rickards, ruinous Lebanon war triggered by Hezbollah is an who is an advisor to FDD’s Center on Economic and additional red flag for donors. Why finance a country Financial Power and has advised governments and that will be flattened shortly thereafter in a predictable banks on past bailouts, spent more than four months – and avoidable – war? studying Lebanon’s economic implosion. He makes it clear that this crisis will be an enduring one. There is also the question of how much cash Lebanon needs. Using an unofficial exchange rate of 4,000 First, Lebanon has a Hezbollah problem. Hezbollah Lebanese pounds to the dollar, Mr. Rickards finds controls the health ministry and is the majority partner that the amount of fresh money needed to stabilize in the current coalition. It is designated as a terrorist Lebanon’s banking sector is a whopping $67 billion. group by the United States, the United Kingdom, That does not include $22 billion in losses incurred by Germany, the Netherlands, Canada, the Arab League, Lebanon’s central bank, the Banque du Liban (BdL). the Gulf Cooperation Council, and several Latin Nor does it include anticipated net losses of $4.2 American countries. International donors cannot in billion or more from defaulted eurobonds that are now good faith bail out a government controlled by a terrorist the subject of restructuring negotiations. The total cost group that answers to the Islamic Republic of Iran, the of a bailout would thus exceed $93 billion. But, as Mr. world’s leading state sponsor of terrorism, according to Rickards acknowledges, even that figure is probably a both Democratic and Republican administrations. lowball, as the real exchange rate is pushing 9,000 or higher as of this writing. A direct consequence of Hezbollah’s political control is that Lebanon’s financial system is rife with corruption, Lebanon may be in a $100 billion hole. And that is money laundering, drug smuggling, and other illicit without public infrastructure and other needs. For finance. As a result, many of Lebanon’s most important context, the IMF’s largest-ever bailout was $57 billion financial institutions are in the crosshairs of a lawsuit in for Argentina in 2018. the United States: Bartlett v. Société Générale de Banque au Liban S.A.L. (SGBL), et al. The complaint alleges that Mr. Rickards is unambiguous about how Lebanon these banks provided financial services to Hezbollah and accrued this staggering debt. It was a Ponzi scheme. Banks took foreign currency deposits from Lebanese Page 4 Crisis in Lebanon: Anatomy of a Financial Collapse Anti-government protesters in Beirut, Lebanon, on May 30, 2020. (Photo by Marwan Naamani/picture alliance via Getty Images) customers at home and the Lebanese diaspora, is approximately $16.5 billion. It is not $93 billion, including from Hezbollah’s drug smuggling and other but it is a start. illicit operations. The banks used these deposits to make their own deposits with the BdL. The BdL used Where Lebanon goes from here is anyone’s guess. these funds for government spending, such as imports Under the grip of Hezbollah (and, by extension, the and interest payments – all at favorable exchange rates Islamic Republic of Iran), beset with corruption and that defied the realities of a country that generates little political dysfunction, saddled with staggering debt, foreign currency and has no exports to speak of. The inundated with Syrian refugees, and struggling amidst entire financial system, led by the BdL, assured the the COVID-19 pandemic, huge challenges lie ahead. Lebanese people that their dollar and pound deposits But, as Mr. Rickards warns, a simple bailout is not the were safe, even as the system crumbled. answer – even if one were feasible. An overhaul of the system is needed. Anything less risks transferring billions The Lebanese government knew what was happening. to a global terrorist organization and perpetuating one Those atop the system perpetuated the fraud. Today, of the largest Ponzi schemes in history. those same people are asking for help. Mr. Rickards does not say how the political elite should be held accountable. But he does imply how Lebanon can Mark Dubowitz subsidize at least part of its own bailout: gold. Chief Executive, FDD Lebanon held an astonishing 286.8 metric tons of gold in its official reserve as of May 2020. This ranks Lebanon as the 20th-largest holder of gold Jonathan Schanzer among countries reporting to the IMF. At $1,800 per Senior Vice President for Research, ounce (the market price as of June 30, 2020), that FDD Page 5 Crisis in Lebanon: Anatomy of a Financial Collapse Introduction bad to worse). A sense of calm returns. The rescue deal is unwound with a nice profit for the rescuer and a Lebanon is in acute financial distress. Over the past lesson learned for the debtor. 200 years, responsible parties have developed a playbook for dealing with such distress and reviving Landmark financial crises of the past 125 years include the injured entity. My training and experience leave me the Panic of 1907, the stock exchange shutdowns at the well-acquainted with this playbook and its application start of World War I, the stock market crash of 1929, the to specific cases. Unfortunately, Lebanon is uniquely UK banking crisis of 1931, the U.S. bank run in 1933, unsuited for a playbook-style rescue. Lebanon may the