Mr. Chairman, it is a privilege to appear before the committee today on an issue area that will, in my view, represent one of our principal U.S. national security concerns for the balance of this decade and the 21st century. The high-velocity, arcane world of global finance, specifically with regard to the private equity and debt markets, has never before, in peacetime, come into serious focus from a national security perspective. The ever-more sophisticated venues in which foreign governments -- particularly those considered emerging markets like China and Russia -- and related enterprises fund themselves and their global activities have resulted in a growth industry for potentially debilitating new challenges to our nation's vital security interests. Mr. Chairman, passage of your bill, S. 13 1 5, -- now sponsored in the House by Representative Gerry Solomon -- would prove of historic significance in helping the Congress and the U.S. security community curtail the both ironic and dangerous phenomenon of the American people unwittingly helping to finance the activities of foreign governments and entities which contravene their fundamental security interests and belief systems.
Mr. Chairman, I come to this opportunity to testify before the committee with more than twenty years of experience examining the national security dimensions of East-West financial flows. Over the past dozen years, I have been President and CEO of RWR, Inc., a small Washington-based consulting firm specializing in what I term, "national interest" projects and transactions internationally. Prior to forming the firm in September 1985, 1 served as Senior Director of International Economic Affairs at the Reagan National Security Council (3/82-9/85). During nearly two years of this period, I also served as Executive Secretary of the Senior Interdepartmental Group-International Economic Policy, the Cabinet-level body which reported through the National Security Advisor to the President. Before coming to government, I was a Vice President in the International Department of the Chase Manhattan Bank with responsibilities for the bank's loan portfolio in the Soviet Union, Eastern Europe and Yugoslavia. During a portion of this period, I had the privilege of serving as a staff assistant to former Chase Chairman, David Rockefeller.
Consistent with your invitation letter to appear today, I intend to review briefly: 1) the evolving borrowing activities of the former Soviet Union on Western markets; 2) the important financial and political benefits gained by foreign governments through participation in our debt and equity markets; 3) the major reasons why the American people's concern over certain foreign government entities will increase significantly; 4) the growing presence of Russia and China in these markets; and 5) coordinated actions which could be taken by the Congress, the Executive Branch and private U.S. market participants to help address the formidable national security risks attendant to global bad actors entering our markets -- while avoiding capital controls and other potential disruptions to the free flow of capital into and out of the United States.
Before going into why, in my judgement, these relatively new security-related problems in our debt and equity markets will be a matter of concern to a great many Americans across the political spectrum, it is instructive to look briefly at how the former Soviet Union funded itself and the bulk of its nefarious overseas activities. The same pattern is relevant to understanding the path of China's funding efforts and that of several other sovereign borrowers over past two decades.
The Soviets made substantial use of so-called "balance-of-payments" or general purpose loans beginning in about the mid-1970's, most often arranged by syndicates of Western banks. Each syndicated loan made hundreds of millions of dollars in untied, undisciplined cash available to Moscow with no questions asked about where the money was going or how it was being used. General purpose borrowing was a bit expensive, but could be easily diverted by the Kremlin, in multi-billion dollar sums annually, to fund purposes often inimical to vital U.S. and Western security interests. (1) As there were no hard currency-generating projects, self-liquidating energy deals or hard currency savings from import substitution underpinning these loans, it was all but inevitable that the USSR would eventually overextend itself, given only about $30-40 billion in total annual hard currency income. To put this income level in perspective, it was about one-third of the annual revenues of one American company like General Motors or Exxon.
To help whittle down its interest rates, in the late 1970's Moscow had the idea of double financing one of its largest natural gas pipeline projects, the 1,700-mile Orenburg gas deal constructed to deliver gas from the Orenburg deposits in the Caucasus to the West European gas grid. Although the Soviet-controlled International Investment Bank went to the Eurodollar market for some $2.2 billion in Western bank credits (in four separate syndicates) ostensibly to fund the purchase of wide-diameter pipe, compressors, turbines and other Western equipment needed for the project, in fact, these required imports were actually paid for in natural gas barter arrangements with the supplier countries. This double-financing gambit saved Moscow as much as one-quarter point off its normal market interest rate, as lenders in the West properly perceived project financing as a better risk than balance-of-payment loans.
It was also during this twenty-year window that Moscow broke the code on how to transform so-called interbank deposits -- that is, the short-term deposits banks routinely make with each other to earn money on excess cash and help facilitate money transfers -- into non- transparent, medium-term loans. Similar to the practices of the Bank of Commerce and Credit International (BCCI) in later years, the Soviet Union possessed a network of subsidiary banks in Western capitals (which still exists today) purposely incorporated as legal entities of those countries (e.g. Moscow Narodny Bank in London is legally a British bank). The primary mission or business of these subsidiary banks was to deal in the interbank and foreign exchange markets, with the former ultimately serving as a kind of off-the-books roughly $ 1 0 billion reserve checking account. In short, billions of dollars in Western bank deposits in Soviet-owned banks -repeatedly rolled over at maturity dates -- were used to finance activities harmful to Western security interests. (2)
The ultimate prize for Moscow, however, was access to the American bond market. Fortunately, the Soviet Union never attained this prize, although it did float some $1.8 billion in bonds in various G-7 capitals. What the Soviet Union was after -- and Russia has now secured -- in gaining access to our bond market are the following important, national security-relevant benefits:
The fact that our government and major commercial banks recently participated in the multilateral twenty-five year rescheduling of some $100 billion in defaulted Soviet debt owed to Western governments and banks should remind the Committee of those in Western governments and markets who dismissed years of earlier warnings that Moscow's creditworthiness was in serious doubt and, indeed, unsustainable.
In answer to the question "Why should average Americans care?" it is worth recalling that American taxpayers lost to "reschedulings" billions of dollars in government-guaranteed credits to both the U.S.S.R. and Iraq. In addition, there is some lingering irritation among the American people over the misuse of the Treasury Department's very short-term Exchange Stabilization Fund to help structure a medium-term bail-out of Mexico during its peso crisis. New concerns over the U.S. taxpayer dimension of the current bail-outs underway in South East Asia (via direct U.S. official credits and contributions to IMF emergency loans) are in the news today. For these and other reasons, average American investors are paying more attention than ever to where their dollars are going and how they are being used by foreign government borrowers. The internet, and information revolution more generally, have given expression to this intensified interest.
In fact, the combination of economic, social and political consciousness in the shaping of U.S. investor portfolios -- by both fund managers and individuals -- is nothing new in the markets. In the former case, large institutional investors like the California Public Employee Retirement System (CALPERS) not only eschewed holding South African paper in their portfolio during the period of Nelson Mandela's incarceration, but at least in some cases, even holding the bonds and stocks of countries and companies who did business with South Africa. This kind of discipline is also usual for investors in various "green" funds which invest in only environmentally-sound enterprises and activities.
Accordingly, we can increasingly expect Americans to choose their foreign investments based, in part, on their belief systems and scrutinize the "small print" concerning which foreign government-related enterprises are appropriate contributions to their portfolios. To help illustrate this trend, the following scenarios could unfold, affecting interest groups in this country outside the financial and national security communities: (4)
Consider the stakes in the current Gazprom bond/Eximbank drama that were subjects of powerful Senate Banking Committee hearings last week (October 30, 1997).(5) Committee Chairman Alfonse D'Amato made the key point at the outset of the hearings that it was the Clinton Administration -- in the person of former Under Secretary of State for Policy, Peter Tarnoff -- which supplied the following analysis to the same Committee in November 1995, "A straight line links Iran's oil income and its ability to sponsor terrorism, build weapons of mass destruction and acquire sophisticated armaments. Any government or private company that helps Iran to expand its oil must accept that it is contributing to this menace." (Emphasis added.) Clearly, financing, among other forms of "help," is alluded to in this statement.
The most immediate national security challenge posed by the Total/Gazprom/Petronas consortium proceeding with its $2 billion contract with Tehran to develop the off-shore South Pars natural gas deposits is, in the bipartisan view of the Committee, that the revenues flowing to Iran from this deal will help facilitate, and even accelerate, Iran's long-range ballistic missile and nuclear weapons programs. With the Iranian Shahad-3 and Shahad-4 missiles as little as eighteen months away from coming on line -- the latter with a range of some 1,250 miles, enabling it to strike Tel Aviv and Western Europe -- the roughly $1.75 billion in combined U.S. taxpayer and private investor funds scheduled to be made available to Gazprom in the coming months is seen by several Senators as a bridge too far. Indeed, it is unusual to have such a dramatic interdiction effort by members of Congress and, among others, the Jewish community of this country.
To make matters worse, the backdrop of this violation of the Iran-Libyan Sanctions Act by France, Russia and Malaysia (as these firms are intimately tied to their respective governments) is particularly ominous in the following ways:
Although it remains unclear at this writing if the extraordinary statements made by Senators on both sides of the aisle during the October 30th Senate Banking Committee hearings (6) will translate into significant diminution of U.S. commercial bank disbursements to Gazprom suppliers under the $750 million Eximbank loan guarantee program or the company's billion-dollar bond offering, one thing is clear: The Congress increasingly recognizes the serious national security dimensions attendant to certain Russian, Chinese and other foreign bond offerings and equity issues on U.S. capital markets.
Naturally, the dramatic market events of the past ten days -- and the catalytic role of Asian governments -- have focused the attention of the American people on our debt and equity markets perhaps as never before. An important reason for this is the sharp increase in the participation of small investors in the U.S. stock market in particular, where reportedly some 40% of our adult population is now engaged. With the Asian "miracle" at least temporarily in disrepair, the public would be well-served by a close examination of the scope of involvement of Chinese government-related enterprises in our markets. Chinese government-controlled enterprises have issued roughly eighty bonds on global markets since 1988, nearly forty of which were denominated in U.S. dollars. The bulk of these dollar-denominated bonds were floated on the U.S. bond market. (Japan is the other G-7 nation with substantial Chinese paper in its markets.) (7)
According to year-end 1996 statistics, China has issued about $6.75 billion in dollar denominated bonds, the bulk of this amount in the U.S. market. Although there are over a dozen different Chinese state borrowers involved in our bond market, it is interesting to note that just three borrowers-- the government of the People's Republic of China (borrowing under its own name), China International Trust and Investment Corporation (CITIC) and the Bank of China -- make up roughly 65-70% of this total (some $4.4 B). Specifically, the PRC has an estimated $2.7 billion in dollar-denominated bonds outstanding, while CITIC has about $800 million and Bank of China an estimated $850 million.
At least one or two of these Chinese government-controlled borrowers on the American bond market have backgrounds which raise legitimate national security questions. Take, for example, the large Chinese "red chip," CITIC, with some $23 billion in total assets. This important financial and industrial conglomerate is chaired by Wang Jun, the controversial arms dealer who met with President Clinton at a coffee klatche on February 6, 1996. Wang Jun is also chairman of Poly Technologies, a large company reportedly dealing in arms sales (among other activities). Poly Technologies was allegedly involved in the scheme to smuggle some 2,000 AK-47 assault rifles to West Coast street gangs and planned future lethal arms sales (including shoulder-launched surface to air missiles). Fortunately, the FBI interdicted this first shipment.
When U.S. media attention focused on Wang Jun's session with the President, Mr. Clinton termed the meeting "clearly inappropriate." Indeed, today Wang Jun reportedly cannot obtain a visa to visit this country. Given these circumstances it seems fair to ask some questions:
Consider the Bank of China and its role as the banking intermediary for payments to Arkansas restauranteur Charlie Trie, accused of illegal campaign donations in the 1996 elections and under investigation for possible other felonies, including espionage. It could be that the Bank of China was only performing a normal banking function and not part of any illegal activity. Nevertheless, it is interesting to note that the Federal Reserve has not acted for some two years on the Bank of China's request to open a branch in San Francisco, reportedly because of concern over abuses allegedly involving the bank. The question is: Is it not prudent to take a closer look at the Bank of China when it comes to New York for its next dollar-denominated bond offering?
Finally, when the borrower is the People's Republic of China, where did the estimated $2.7 billion in bond proceeds ultimately end up? Hopefully, a portion of these funds did not find their way to help fund the new DF-31 mobile ICBM, the new JL-2 submarine launched ICBM or other sophisticated, world-class military systems, which will be targeted at the United States and our assets overseas. Many Americans with human rights and other concerns may also seek to ensure that PRC bond offerings are not funding, for example, enterprises involved in suppressing individual freedoms.
The purpose here is not to cast aspersions on all Chinese borrowers or fund-raisers in our markets, or to propose the suspension of any borrowers or equity issuers on the basis of what we know today. It is rather to affirm, Mr. Chairman, that greater security-related disclosure and screening is urgently required if we are to build a more cooperative and sustainable bilateral relationship with China.
Most U.S. market players, frankly, view the notion of achieving enhanced national security-related surveillance of these markets as an anti-free market activity doomed to fail. Some understand, however, that it is not a matter of if but when a major geopolitical incident occurs which will focus the wrong kind of public attention on the U.S. corporate suppliers andfinders involved with such a foreign client. For example, when a weapon of mass destruction is fired on a ballistic missile in anger, it is easy to imagine the intensity of the recriminations that would be directed at those who may be seen to have helped make that heinous act possible. (8)
In the case of such a tragedy, with possibly tens of thousands of casualties, will U.S. investment banks and others want to face the onslaught of potential Congressional and media attention alone? Alternatively, would such U.S. firms prefer pointing to a good faith partnership with appropriate Executive Branch agencies and congressional committees? Perhaps these U.S. government agencies and committees could backstop the internal efforts made by these firms originally to "snakecheck" the foreign borrower or equity issuer who later committed, or was implicated, in a global crime. With some twenty countries, according to the CIA, currently expected to acquire weapons of mass destruction and ballistic missile delivery systems by the turn of the century, this scenario is not farfetched.
Even if this chilly prospect seems remote to some on Wall Street, consider some of the new, unsavory cadre of potential U.S. investment bank "customers" which could end up being legitimatized through access to our capital markets and most prestigious firms -- not to mention the immense financial and political benefits of same: proliferators, terrorist-sponsoring nations and groups, national military establishments, intelligence and technology-theft front companies, organized crime syndicates, drug cartels, arms smugglers and money launderers.
Should investment banks and other capital market participants wish to tackle this admittedly complex problem internally -- acknowledging that no perfect system can be constructed -- it would certainly go a long way toward advancing this country's security interests. After all, what would be wrong with explaining to prospective customers and the marketplace that the firm is now persuaded that subtle penetration of our markets by undesirable foreign government-related fund-raisers (who are not what they purport to be in prospectuses) is already underway? This kind of additional, security-related due diligence is now warranted.
Instituting new types of disclosure to create appropriate investor transparency at the front- end of these prospective offerings by foreign fund-raisers could make an incalculable difference in curtailing opportunities for those covertly dedicated to undermining U.S. and other democratic interests. The alternative would be to stand by and watch the American people innocently funding -- through their pension funds, mutual funds and other means -- those who would directly or indirectly harm this country and their deeply held values.
Mr. Chairman, I believe we all want to see China, Russia and other emerging market participants make steady gains in the direction of free markets, democratic-institution building, human rights, religious freedom and a civilized, benign foreign policy. There are certainly genuine merits to most of the openings created by the U.S. and global business communities in these countries, particularly the devolving of authority away from the state and toward the entrepreneurial individual. Nevertheless, we are not going to achieve these common goals and successfully bring China, Russia and others into Western political institutions and financial and trading systems in the absence of adequate discipline, transparency and conditionality with regard to U.S. financing of prospective adversaries or those who would aid and abet them. Such discipline and transparency are clearly inadequate today.
At the end of the day, I believe it all comes down to sustainability. When respected U.S. foreign policy figures characterize those in Congress and elsewhere who would seek to impose some modicum of security-minded disclosure, transparency and discipline on foreign entrants to our markets as reckless and counterproductive, they are, in my view, promoting an unsustainable and potentially dangerous U.S. policy.
Mr. Chairman, an appropriate balance must be struck between U.S. capital markets and our national security. Practically none of the public or private sector professionals I have spoken to with respect to this major, emerging national security challenge over the past decade had any interest in unnecessarily disadvantaging U.S. firms and driving business offshore, often to foreign competitors. Equally strong, however, was the sentiment that continuing to ignore this burgeoning, foreign government-sponsored use of our capital markets by wrong-doers in the guise of normal market participants was simply intolerable.
I am confident that you and most of your Senate colleagues on the Banking Committee have already chosen -- in hopefully rare circumstances -- which set of considerations must ultimately prevail. The U.S. Markets Security Act is an indispensable first step in putting into place a sensible monitoring or screening process which seeks to protect, in a non-disruptive, prudent fashion, the national security interests of the United States against an increasingly sophisticated array of global bad actors. As called for in this historic legislation, our allies, catalyzed by G-7 action under U.S. leadership, should also proceed with formulating similar market surveillance mechanisms as the affected security concerns are, more often than not, common ones. The mere creation of an Office of National Security at the SEC would send an important signal to would-be or actual bad actors seeking funding from the American people. Without any proposed capital controls or explicit enforcement measures, the U.S. Markets Security Act of 1997 contains a clear message: The relevant Committees of the Congress -- including Banking, Foreign Relations and Intelligence -- are now watching, even if most in the Executive Branch and the markets remain perilously dismissive of this complicated 21st century security challenge for this country and our allies.
Regrettably, the prospect of potentially devastating consequences stemming from largely unchecked foreign access to our markets will only expand from here, barring the passage of S. 1315 or a similar bill which institutes security-minded disclosure and transparency to inform and benefit U. S. investors, particularly those not on Wall Street. Fortunately, leadership is coming from the Congress on this family of financial issues, including Senators D'AMATO, Brownback, McConnell, Mack (who introduced S. 1083 on July 29, 1997), Kyl, Bennett and Dodd. In the House, Representative Solomon is taking the lead in support of these new reporting requirements.
Should we fail to step up to this new national security monitoring effort at the federal level on a balanced, carefully-crafted basis, there is little doubt that it will be taken on at the state and municipal levels in a blunter manner which would likely prove more chilling to our highly successful capital markets. Make no mistake, Mr. Chairman, this public policy concern has potentially powerful grass roots elements.' Once informed, the American people will not sign on to foreign government-related debt and equity issues of just any stripe or be successfully wooed by those who view passive introduction of some of this nation's foremost security concerns into the already existing disclosure requirements of our capital markets as extraneous and unwanted intervention.
Thank you for this opportunity.
(1) Interestingly, the Russian government has long argued that the country's powerful mafia consolidated its grip due, in part, to easy access to unconditioned Western credits during the Gorbachev era,
(2) For more on this subject see my op-ed prepared for the Washington Post entitled "Moscow's Shell Game, " June 22, 1986.
(3) I would like to submit for the record a paper I prepared for an Executive Branch interagency gathering on Feb. 21, 1997 entitled "Financial Sanctions: How Might They Be Used Against Proliferators?" sponsored by the Non-Proliferation Policy Education Center.
(4) Although proliferation should be properly considered a "national security" concern, I nonetheless included a brief sub-section on this pressing issue which cuts across potentially all of these interest groups
(5) In fact, Gazprom's $1 billion convertible bond offering scheduled for next month will likely be followed by some $5 billion or more in additional bond offerings on world markets in the next couple of years -- including the American bond market -- to help finance the estimated $45 billion price-tag for the long-delayed second strand of the 3,600-mile Siberian gas pipeline from the Yamal Peninsula to the West European gas grid. This is the same second strand that was killed in 1982-83 by President Reagan's resolve not to permit this vast, two-strand project to go forward while Moscow was massing troops on the Polish border and sponsoring martial law in that country. The hard currency cost to the Kremlin of the resulting two year delay in completion of the first strand of the pipeline project and the now fifteen-year delay in the completion of the second strand was as much as $8-12 billion annually (depending on demand) during a period when total Soviet hard currency income was only about $32 billion a year.
Unfortunately for Gazprom, the U.S. financial markets represents, according to some reports, 60% or more of its global borrowing capacity. This could mean that any substantial reduction in access to the U.S. bond and commercial bank markets could leave the company with a $2-3 billion short-fall in its hard currency funding requirements for the second strand. Clearly, the Russian government, and its surrogate Gazprom, did not make the connection between participating in the Total consortium with Tehran and possible damage to its bond offering in the U.S. in basically the same time-frame. Similarly, the Chinese government may not, as yet, have connected the dots between the precedential Congressional challenge to the Gazprom bond and its own robust expansion plans for Chinese government-controlled enterprises in the U.S. capital markets.
(6) Mr. Chairman, I would like to submit for the record of these hearings a paper produced by the William J. Casey Institute of the Center for Security Policy entitled "Sen. D'Amato's Committee Serves Notice On Those Who Aid And Abet U.S. Adversaries: No Fund-Raising On American Markets' (No. 97-C 1 61, 3 0 October 1997).
(7) China has also issued bonds in Hong Kong dollars, Swiss Francs and, more recently, Deutschemarks.
(8) In this connection, it is useful to remember the appropriate criticism of the Bush Administration's pre-war support for Saddam Hussein, better known as the Iraqgate scandal.
(9) Achieving some understanding of the way these new financial security issues resonate at
the grassroots level was greatly advanced by many "kitchen table" discussions with Dan Davis,
M.P.A. He will be missed.
Home | Menu | Links | Info | Chairman's Page