One of the most important policy decisions before the United States is whether it should ramp up pressure on North Korea through pursuit of a financial constriction strategy. This approach is at the core of the North Korean Sanctions Enforcement Act, about which Marc Noland and I have aired some doubts. However, we finally got around to reading Juan Zarate’s page-turning Treasury's War: The Unleasing of a New Era of Financial Warfare and it at least gave us pause.
Zarate’s account is an insider’s. He served as deputy national security advisor for combatting terrorism and was the first assistant secretary of the Treasury for terrorist financing and financial crimes. The book is a history of the efforts—particularly post-9/11—to develop the capacity to detect and monitor financial networks linked to terrorism and other illicit activities and to enlist private financial institutions in the effort to quash them. Executive Order 13224 of September 2001 and Title III of the USA Patriot Act were crucial statutory starting points (a briefing on the latter by the New York Fed can be found here). The early chapters of the book focus on how these tools were used to track al-Qaeda’s money and stymie its networks. Among the interesting story lines are the sensitivities of dealing with the Saudis and successful efforts to secure cooperation from the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the member-owned organization that provides the communication platform for inter-bank clearing functions.
The story line is interrupted by a fascinating discussion of the administrative consolidation forced on Treasury by the creation of the Department of Homeland Security. Homeland Security was cobbled together out of a number of other departments and agencies and wiped out a long tradition of in-house enforcement capabilities at Treasury. Out of the ashes, Zarate and a handful of others fashioned a new office—the Executive Office of Terrorist Financing and Financial Crimes (EOTF/FC)—as well as an active inter-agency process around the issues.
For North Korea watchers, the story gets interesting with the initiation of the “bad bank” strategy. Essentially, Treasury would leverage the significance of access to the US financial system to get major commercial banks both here and abroad to shun banks suspected of involvement in terrorist, proliferation and criminal financing; in 2006 this was extended to high-level corruption in the National Strategy to Internationalize Efforts Against Kleptocracy. The instruments for having this effect were not traditional sanctions, but the power to notify that a particular bank was suspect.
North Korea was a clear target and Macau’s Banco Delta Asia an early entry on the bad bank list, initially for facilitating counterfeiting and other illicit activities rather than for proliferation reasons. When the 311 action was taken against BDA, it had much more wide-ranging effects than anticipated. Not only was the bank effectively pushed into receivership, and with it $25 million in accounts with North Korea or entities doing business in North Korea. But other banks quickly saw the writing on the wall and moved to close North Korean accounts as well. A short, one-page notification had essentially isolated North Korea from international financial markets.
By happenstance or design—Zarate is less than clear on this point--the timing of Treasury’s campaign against North Korea via BDA was at odds with where the new Secretary of State Condoleeza Rice was moving vis-à-vis the Six Party Talks (we discuss her memoir on these issues here). Zarate notes in an aside (p. 229) that “if we could stop those flows and shut down the networks, it might provide much-needed leverage to diplomats seeking a nuclear deal.” However, when the notification on BDA was issued, the US was in the process of negotiating the Joint Statement of September 2005 that outlined the quid-pro-quos of a nuclear deal. Rather than moving toward more detailed negotiations, the North Koreans were immediately hit by the most effective economic instruments deployed against them to date.
The response was not exactly as anticipated. By North Koreans' own admissions, BDA hurt. But the regime went on to its first nuclear test in October 2006. At this point Hill became particularly intent on settling the BDA issue in order to reach operational agreement on disabling and hopefully dismantling Yongbyon. Zarate’s and Treasury’s interests, by contrast, were on holding North Korea’s feet to the fire on counterfeiting and illicit activities, about which Hill is portrayed as blasé.
In a highly personal chapter, Zarate details the charged and bitter divisions within the American bureaucracy on the question of whether BDA should--or even could--be rolled back. Zarate underlines that this was not a traditional sanction that could simply be reversed. The 311 action was a statement of fact about virtually all North Korean financial transactions; in his view, banks needed to take this information on board when conducting business with Pyongyang. He even offers the interesting revelation that Chinese banks had no interest in helping resolve the issue for fear of their own liability. To Zarate, caving on BDA would undermine the entire bad bank approach, indicating that Treasury designations could be bargained away if there were large political stakes.
But Hill—whose memoir we will review later in the week—also had a point. BDA had helped get the North Koreans in the mood to negotiate and his mandate was not counterfeiting but getting a deal on Yongbyon. What use was the leverage generated by Treasury if he couldn’t cash it in? Sanctions had hurt North Korea materially, but had only strengthened their resolve to secure a nuclear capability. Would a better deal have emerged from holding firm or would have North Korea given up on negotiations earlier, as it did after 2009 in our view?
As the Netanyahu speech shows, these questions are perennial but difficult to resolve since they entail complex counterfactuals. Here is one of mine: had the pressure on North Korea continued, the leadership in Beijing would almost certainly have overridden the financial concerns of Chinese banks and forced them to service North Korean needs. However, Zarate’s 20-20 hindsight proposal is worth considering. He argues that the US should have stood back and forced North Korea to resolve the issues raised by the 311 designation directly with the Chinese and Macanese authorities. Instead, Chris Hill was put in the unenviable position of trying to fix problems that were ultimately of North Korea’s own making. Boy, is that a familiar story line.