Economic Warfare: Risks and Responses by Kevin D. Freeman

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,

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IWS(P) may use the work product and reports in related government support efforts with proper attribution.

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This copy is provided to IWSP with full permission to distribute to the Financial CrisisInquiry Commission for their review and inquiry. The author and Cross Consulting and Services, LLC retain copyright and other intellectual property rights.

Kevin D. Freeman, CFACross Consulting and Services, LLCTel: 866-737-2728Fax: 877-201-2637E-mail: kevin@freemanglobal.net

Economic Warfare: Risks and Responses

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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 $50trillion of global wealth evaporated in the crisis with more than a quarter of thatloss suffered by the United States and her citizens.

A number of potential causative factors exist, including sub-prime real estate loans, ahousing bubble, excessive leverage, and a failed regulatory system.

Beyond these,however, the risks of financial terrorism and/or economic warfare also must beconsidered. 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 thesystem. This report concurs with these concerns as recently outlined by the heads of theSEC, US Treasury, and Federal Reserve and provides supporting data.

Beyond that, thisreport exposes the fact that these vulnerabilities are subject to exploitation not onlyby greedy capitalists seeking profit but also by financial terrorists, intent ondestroying the American financial system.

From a historical perspective, there are numerous examples of financial attacks onspecific companies and industries both for economic and non-economic reasons. Inaddition, there are other examples of financial attacks conducted against individualnations both for economic and non-economic reasons. Based on this awareness, theeconomic collapse of 2008 must be critically examined to determine the possibility that afinancial attack took place as well as an assessment of future risks.

The purpose of this report is to consider the implications of financial terrorismand/or economic warfare and to identify and realistically list prospective threats toU.S. economic security from a means, motive, and opportunity perspective.

The preliminary conclusions of the research suggest that, without question, there wereactors who had the motive to harm the U.S. economy. These motives can be categorizedas both economic and non-economic. In addition, these same actors have clearlydemonstrated the means to carry out such an attack. Finally, the opportunity was clearlypresent 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.

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The first phase was a speculative run-up in oil prices that generated as muchas $2 trillion of excess wealth for oil-producing nations, filling the coffers of Sovereign Wealth Funds, especially those that follow Shariah CompliantFinance.

This phase appears to have begun in 2007 and lasted through June 2008.

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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 otherworld 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 threetimes the total market capitalization of every company on the planet traded in all27 global stock markets.

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The second phase appears to have begun in 2008 with a series of bear raidstargeting U.S. financial services firms that appeared to be systemicallysignificant.

An initial bear raid against Bear Stearns was successful in forcing thefirm to near bankruptcy. It was acquired by JP Morgan Chase and the systemicrisk was averted briefly. Similar bear raids were conducted against various otherfirms during the summer, each ending in an acquisition. The attacks continueduntil the outright failure of Lehman Brothers in mid-September. This created asystem-wide crisis, caused the collapse of the credit markets, and nearly collapsedthe global financial system. The bear raids were perpetrated by naked short selling and manipulation of creditdefault swaps, both of which were virtually unregulated. The short selling wasactually 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 bearraids has not been traceable to date due to serious transparency gaps for hedgefunds, trading pools, sponsored access, and sovereign wealth funds. What can bedemonstrated, however, is that two relatively small broker dealers emergedvirtually 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 bythe firms has grown exponentially while the markets have lost trillions of dollars

in value.‖

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The risk of a Phase Three has quickly emerged, suggesting a potential directeconomic attack on the U.S. Treasury and U.S. dollar.

Such an event hasalready been discussed by finance ministers in major emerging market nationssuch as China and Russia as well as Iran and the Arab states. A focused effort tocollapse the dollar by dumping Treasury bonds has grave implications includingthe possibility of a downgrading of U.S. debt forcing rapidly rising interest ratesand 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 anemerging regulatory response calling for greater transparency across the board. Effortsincluding regulation of credit default swaps and proposed oversight of previously