Spring/Summer 2014
Number 26

Book Review - Warriors in Gray Suits

Mark Dubowitz and Annie Fixler

Juan Zarate, Treasury’s War: The Unleashing of a New Era of Financial Warfare (PublicAffairs, 2013), 512 pp. $29.99.

Economic sanctions are now the default instrument of coercive statecraft for confronting challenges to the international order. When Russian President Vladimir Putin invaded Crimea this winter, Barack Obama turned to his “favorite noncombatant command” at the U.S. Treasury Department to design targeted sanctions to increase the costs of Russian revanchism.

The president likes sanctions; he does not like to couple his diplomacy with military force. Unlike America’s adversaries in Tehran, Damascus, or Moscow, Obama doesn’t kill while he negotiates. Instead, he believes that there should be a clear sequence of engagement: diplomacy, sanctions, more diplomacy, perhaps more sanctions, and only after all peaceful alternatives are exhausted, the possibility of force—a possibility that the Administration is loath to entertain even in hypotheticals.

So financial warfare has become the president’s weapon of choice against Iran’s Ali Khamenei, Syria’s Bashar al-Assad, and now Russia’s Vladimir Putin as these men threaten to unwind the nuclear nonproliferation regime, transform Syria into a jihadist state in the heart of the Middle East, and upend Europe’s peaceful post-Cold War order. For these financial warfare tools, the president can thank his predecessor George W. Bush and a small band of financial warriors who, after 9/11, established Treasury as a pivotal national security player, expanded its effectiveness through the war against al-Qaeda, and provided Obama a powerful, albeit still limited, instrument of American power.

To understand how this was done, we can thank Juan Zarate for his indispensable book Treasury’s War: The Unleashing of a New Era of Financial Warfare, which describes how a small group of Treasury officials transformed blunt state-based embargoes into smart sanctions that leveraged the power of the U.S. dollar to isolate rogue actors, from terrorists to nuclear proliferators to arms dealers to Russian oligarchs. Zarate, who led this team as the first ever Assistant Secretary of the Treasury for Terrorist Financing and Financial Crimes, and who later served as a “silent partner” to his successors as deputy national security advisor for combating terrorism, details the innovation that transformed financial tools into key instruments of national security.

In the wake of 9/11, as part of the resulting all-out offensive against al-Qaeda, Zarate and his colleagues designed financial tools that treated reputation as a currency in an environment in which companies cannot afford the risk of being associated with bad actors. The rules of this new world were straightforward: you can do business with the United States or you can do business with rogue actors. You can choose, but you can’t do both. And if you choose the latter, prepare to be excommunicated by the global financial community.

The system created a “virtuous cycle of self-isolation by suspect financial actors,” explains Zarate. As rogue actors became more isolated, they engaged in more suspicious behavior to evade restrictions. And the more suspicious behavior they engaged in, the more they found themselves isolated from financial networks. The approach was based on persuading private sector players—principally financial institutions—to act in their own self-interest to avoid unnecessary business and reputational risk.

The message about the risks of doing business with rogue regimes like Iran and North Korea was conveyed in global boardrooms as Treasury officials—especially the first ever Undersecretary for Terrorism and Financial Intelligence, Stuart Levey—traveled around Europe and Asia. As Zarate explains: “Levey’s job was to stage the financial assault on Iran’s banks and its financial system—in large part by demonstrating to CEOs and compliance officers around the world that the risk of doing business with Iran was too high.”

This six-year effort reached its height in 2012 and early 2013. Levey (and later his successor David Cohen) and colleagues persuaded scores of foreign banks to restrict Iranian access to global financial markets. Treasury’s efforts were strengthened significantly by the bipartisan passage of multiple pieces of congressional legislation between 2010 and 2013; these congressional measures hammered Iran’s financial, energy, shipping, insurance, precious metals, and industrial trade, including a successful effort, initially opposed by the Obama administration, to target’s Iran’s economic lifeline, its crude oil exports.

Further punished by a European oil embargo and EU sanctions that restricted access to what had been its largest commercial and financial markets, by 2012 Iran was in a severe recession. In 2013, these economic difficulties led to the election of President Hassan Rouhani, who campaigned on the promise of resolving international concerns over Iran’s nuclear program in exchange for relief from punishing economic sanctions.

At the heart of efforts against Iran and other illicit actors was an obscure agency, the Office of Foreign Assets Control (OFAC), which Zarate describes as “perhaps the most powerful yet unknown agency in the U.S. government” prior to the rebirth of Treasury as a national security player. OFAC is in charge of U.S. sanctions programs and has the ability to unilaterally isolate illicit actors by cutting them off from the U.S. financial system.

OFAC’s power was complemented by the Financial Action Task Force (FATF), whose focus on the classic money-laundering schemes of drug cartels and organized crime was retooled to build international standards surrounding terrorist financing and proliferation. Treasury also developed its own intelligence agency, the Office of Intelligence and Analysis (OIA). While the smallest agency in the U.S. government’s intelligence behemoth, OIA punches well above its weight, unraveling illicit financial networks and providing evidence for thousands of designations.

After 9/11, Section 311 of the PATRIOT Act gave Treasury new authorities to designate entities as locations of “primary money-laundering concern.” While a Section 311 regulation advises only U.S. banks to end relationships with the designated entity and requires no action by foreign banks, the effect is a stark public indictment. While the United States does not order any asset freezes, financial institutions around the world freeze assets and close accounts in reaction to a 311 declaration that a bank is financially radioactive.

Early designations against entities in Burma, Northern Cyprus, Belarus, and Syria paved the way for the most dramatic use of “the 311” as part of a full-scale, multifaceted pressure campaign against North Korea that culminated in the designation of Banco Delta Asia (BDA). The rationale was clear: designation of a bank that the North Korean regime was using to evade sanctions and engage in illicit activities would spur the private sector to dump Pyongyang like a toxic asset. The designation in September 2005 “unleashed financial furies the likes of which the regime had never experienced” and “set powerful shock waves into motion across the banking world,” Zarate notes. Within days, North Korean accounts and transactions were frozen or blocked in banking capitals around the world—notably including Beijing.

But, as Zarate explains, for those whose priority was securing a nuclear deal with North Korea at all costs, Treasury’s actions worked too well. Not fully understanding what Treasury had done, these officials initiated an interagency war that undermined the leverage that Treasury had provided. Facing a North Korean negotiating team that refused to make any progress before money was transferred, the State Department became North Korea’s agent, advocating for the release of funds rather than forcing Pyongyang to alter its behavior. The North Koreans ultimately persevered, and the United States missed a significant opportunity to force Pyongyang to clean up its illicit activities, including its counterfeit racket. In the process, Washington undermined its own credibility as a protector of the global financial system.

The United States has never again had the kind of leverage against North Korea as it did at that moment—an important lesson as Washington calibrates sanctions relief alongside nuclear negotiations with Iran.

Today, hopeful that the negotiating track publicly launched with Iran in Geneva last fall will yield dividends, the Obama administration is claiming that escalating financial pressure will undermine rather than enhance negotiations. As a result, it has blocked broad, bipartisan Congressional legislation that would have imposed additional sanctions if Iran didn’t promptly and on acceptable terms reach a comprehensive nuclear deal. Meanwhile, although the Administration claims that the dollar value of sanctions relief provided as part of the “Joint Plan of Action” is limited, the decision to suspend sanctions on key sectors of Iran’s economy risks reducing the pressure on Tehran. Today, with sanctions pressure de-escalating, market psychology is shifting from “fear” to “greed,” as international companies position to get ahead of their competitors to find ways to re-enter the Iranian market. According to recent estimates from the World Bank and the IMF, the Iranian economy is experiencing a modest albeit fragile recovery.

This limited recovery helps Iran in the negotiations over its nuclear program. Although the Iranian economy cannot fully recover while the toughest sanctions remain in place, Iranian negotiating leverage doesn’t depend on a full economic recovery but on reversing the steep sanctions-induced recession that Iran experienced in 2012 and the first half of 2013, and avoiding an even more severe economic crisis. Thus, a change from a sanctions-induced economic free-fall to a Geneva-assisted recovery, however modest, will reduce U.S. negotiating leverage, making it more difficult to conclude a deal that prevents an Iranian pathway to a bomb.

The sanctions architecture may be eroded further still if the White House cannot vigorously defend it or, as in the North Korea case, moves too quickly to offer irreversible sanctions relief in exchange for reversible and temporary nuclear concessions. European companies may be hesitant to test the bounds of Western sanctions relief but, as recent sanctions-busting evidence suggests, Russian, Chinese, and Turkish companies may not be so cautious. Banco Delta Asia serves as a lesson that a State Department “single-mindedly fixated on getting a deal at all costs,” can too quickly throw away critical financial leverage without understanding that it can be “impossible to put the genie fully back into the bottle,” once sanctions-induced pressure is relieved.

Even when an administration is resolute, financial warfare alone may not work. As the Treasury Department has secured its preeminence at the national security table, there is a temptation to believe that no matter how complex the threat, Treasury can “just sanction something.” But as we have seen in Syria, financial sanctions are not always an adequate response to stop evil men from doing evil things. Sometimes the only effective response is the application of America military force, either directly or by arming people willing to fight to stop the slaughter.

While financial sanctions will remain a powerful coercive tool of American statecraft, they can only be effective if combined with other instruments of American power, including more credible presidential bellicosity. The warriors in gray suits are America’s preeminent financial combatants, and Juan Zarate’s book is a richly deserved celebration of their unsung successes—and an essential guide to how their financial power can be most effectively used.

Mark Dubowitz is executive director of the Foundation for Defense of Democracies and leads FDD’s projects on sanctions and nonproliferation. Annie Fixler is the director of public affairs at The Dershowitz Group.