Warren Buffett describes credit derivatives as “financial weapons of mass destruction.” George Soros identifies credit default swaps and unlimited short selling as instruments used to carry out the bear raid on Lehman Brothers that triggered the 2008 financial meltdown. Hedge fund billionaire Leon Cooperman insists that short selling should be restrained by reinstating the uptick rule and that limits should be placed on credit default swaps and high-frequency trading before it’s too late. John Mauldin, a best-selling author and online commentator for over a million readers, calls credit default swaps a continuing crisis and an incipient debacle. Jim Cramer of CNBC fame labels credit default swaps, high-frequency trading, and leveraged ETFs “dastardly devices.” Marc Cuban, another billionaire investor, equates high-frequency trading and leveraged ETFs with financial hacking, arguing that they have ruined the market.
These individuals—experts in financial markets from across the political spectrum—have each argued that many of today’s financial instruments are extremely dangerous. All seemingly agree with Mr. Buffett that they represent financial WMDs. There should be no doubt that these financial WMDs played a significant if not defining role in the near Armageddon of 2008-09 that wiped $50 trillion of global wealth from the planet’s balance sheet. Yet, three years later, we have done virtually nothing to understand let alone disarm them.
Worse still, as I argue in my new book Secret Weapon, these financial WMDs can be and have been exploited by rogue states and terrorists. A book published by the Chinese Army, “Unrestricted Warfare,” advocates using these financial instruments as new-concept weapons, contending that combining the terrorism tactics of Osama bin Laden with financial techniques ascribed to George Soros would produce a hyper-strategic weapon sufficient to topple Europe or even the United States. Worse still, such a weapon is stealthy, hidden in market obscurity and virtually untraceable when deployed. We still don’t know, for example, why the flash crash happened in May 2010 even though it wiped out almost one-tenth of the stock market’s value in minutes—imagine if the flash crash had lasted a few hours. For all our seeming sophistication, market authorities had no idea that the once-respected Bernie Madoff was actually running a $50 billion Ponzi scheme. The reality is that we have virtually no market transparency left. Our approach has been to fix problems on the finance markets after they surface, but with financial WMDs that would be too late.
Our nation’s sovereignty and future depend on healthy capital markets. Our enemies, however, have studied and understand the weaknesses in our system. Osama bin Laden boasted that al Qaeda knew the “cracks in the Western financial system like we know the lines in our own hands.” He witnessed the economic destruction caused by 9/11 and the devastation created by a collapsing financial system. Should it really surprise us that terrorists would want to exploit financial WMDs? Without market transparency, we must assume they are already doing so.
Following Muammar Gaddafi’s death, authorities uncovered some $200 billion in Western markets that the dictator had personally controlled. That’s four times the estimated wealth of Warren Buffett in the hands of a man who knowingly funneled money to al Qaeda. It was a shock to authorities who had earlier pegged his wealth at a fraction of that amount. Some of it was hidden in unusual places such as with accused Ponzi-schemer Allen Stanford, the funds having been pulled out just before the SEC had Stanford arrested. Gaddafi also had money with Goldman Sachs and a host of other financial companies—huge sums connected to him only after his death.
When bin Laden died, authorities reportedly found a document in his compound outlining a strategy to attack Europe’s economy. The date appears to coincide with the attacks on the Euro and sovereign debt. In 2009, New York District Attorney Robert Morgenthau uncovered billion-dollar money-laundering schemes by Iranian and Chinese suppliers using Western banks to acquire weapons.
Another threat emanates from huge sovereign wealth funds, some controlled by individuals or governments openly hostile toward the West. According to Hank Paulson, in 2008, “top level” Russian officials approached the Chinese with a plan to destabilize the American economy by dumping GSE (government sponsored entity) debt. While the Chinese did not participate, the Russians dumped over $65 billion of Fannie Mae and Freddie Mac securities. This is just the tip of the financial iceberg, where what we don’t know is far more dangerous than what we see on the surface.
The bottom line is this: weapons are no longer simply tanks, planes, boats, missiles, and guns. If Warren Buffett and the Chinese Army are right, financial instruments can be WMDs, too. Just as we make it a top priority to keep terrorists from acquiring nuclear bombs or chemical arsenals, so too the United States should be vigilant in preventing them from accessing financial WMDs. Unfortunately, although we’ve begun to grasp the risks of cyber-attacks, we are woefully behind in defending against financial weapons designed to appear as normal market activity. The problem is that most of our financial regulators cannot recognize malevolent activity because they do not acknowledge non-economic motivations—that terrorists may conduct trades not to make a buck, but with the sole purpose of harming the markets themselves. On the other side, defense experts understand warfare but do not comprehend how financial markets operate or how they can be exploited.
The phrase “the weapons of our warfare” comes from a Biblical verse that suggests the use of spiritual means such as prayer to combat evil. Until we begin to address the serious risks of financial WMDs and awaken to the harsh reality of financial terrorism, prayer may be our only option.