- The Washington Times - Monday, February 28, 2011

Evidence outlined in a Pentagon contractor report suggests that financial subversion carried out by unknown parties, such as terrorists or hostile nations, contributed to the 2008 economic crash by covertly using vulnerabilities in the U.S. financial system.

The unclassified 2009 report “Economic Warfare: Risks and Responses” by financial analyst Kevin D. Freeman, a copy of which was obtained by The Washington Times, states that “a three-phased attack was planned and is in the process against the United States economy.”

While economic analysts and a final report from the federal government’s Financial Crisis Inquiry Commission blame the crash on such economic factors as high-risk mortgage lending practices and poor federal regulation and supervision, the Pentagon contractor adds a new element: “outside forces,” a factor the commission did not examine.

“There is sufficient justification to question whether outside forces triggered, capitalized upon or magnified the economic difficulties of 2008,” the report says, explaining that those domestic economic factors would have caused a “normal downturn” but not the “near collapse” of the global economic system that took place.

Suspects include financial enemies in Middle Eastern states, Islamic terrorists, hostile members of the Chinese military, or government and organized crime groups in Russia, Venezuela or Iran. Chinese military officials publicly have suggested using economic warfare against the U.S.

In an interview with The Times, Mr. Freeman said his report provided enough theoretical evidence for an economic warfare attack that further forensic study was warranted.

“The new battle space is the economy,” he said. “We spend hundreds of billions of dollars on weapons systems each year. But a relatively small amount of money focused against our financial markets through leveraged derivatives or cyber efforts can result in trillions of dollars in losses. And, the perpetrators can remain undiscovered.

“This is the equivalent of box cutters on an airplane,” Mr. Freeman said.

Paul Bracken, a Yale University professor who has studied economic warfare, said he saw “no convincing evidence that ‘outside forces’ colluded to bring about the 2008 crisis.”

“There were outside players in the market” for unregulated credit default swaps, Mr. Bracken said in an e-mail. “Foreign banks and hedge funds play the shorts all the time too. But suggestions of an organized targeted attack for strategic reasons don’t seem to me to be plausible.”

Regardless of the report’s findings, U.S. officials and outside analysts said the Pentagon, the Treasury Department and U.S. intelligence agencies are not aggressively studying the threats to the United States posed by economic warfare and financial terrorism.

“Nobody wants to go there,” one official said.

A copy of the report also was provided to the recently concluded Financial Crisis Inquiry Commission, but the commission also declined to address the possibility of economic warfare in its final report.

Officials, who spoke on the condition of anonymity, said senior Pentagon policymakers, including Michael Vickers, an assistant defense secretary in charge of special operations, blocked further study, saying the Pentagon was not the appropriate agency to assess economic warfare and financial terrorism risks.

Mr. Vickers declined to be interviewed but, through a spokesman, said he did not say economic warfare was not an area for the Pentagon to study, and that he did not block further study.

Mr. Vickers is awaiting Senate confirmation on his promotion to be undersecretary of defense for intelligence.

Despite his skepticism of the report, Mr. Bracken agreed that financial warfare needs to be studied, and he noted that the U.S. government is only starting to address the issue.

“We are in an era like the 1950s where technological innovation is transforming the tools of coercion and war,” he said. “We tend not to see this, and look at information warfare, financial warfare, precision strike, [weapons of mass destruction], etc. as separate silos. It’s their parallel co-evolution that leads to interesting options, like counter-elite targeting. And no one is really looking at this in an overall ‘systems’ way. Diplomacy is way behind here.”

Mr. Freeman wrote the report for the Pentagon’s Irregular Warfare Support Program, part of the Combating Terrorism Technical Support Office, which examines unconventional warfare scenarios.

“The preponderance of evidence that cannot be easily dismissed demands a thorough and immediate study be commenced,” the report says. “Ignoring the likelihood of this very real threat ensures a catastrophic event.”

The report concluded that the evidence of an attack is strong enough that “financial terrorism may have cost the global economy as much as $50 trillion.”

Because of secrecy surrounding global banking and finance, finding the exact identities of the attackers will be difficult.

But U.S. opponents in Russia who could wage economic warfare include elements of the former KGB intelligence and political police who regard the economy as a “logical extension of the Cold War,” the report says.

Asked by The Times who he thought to be the most likely behind the financial attacks, Mr. Freeman said: “Unfortunately, the two major strategic threats, radical jihadists and the Chinese, are among the best positioned in the economic battle space.”

Also, the report lists as suspects advocates of Islamic law, who have publicly called for opposition to capitalism as a way to promote what they regard as the superiority of Islam.

Further Pentagon Low Intensity Conflict office research into possible economic warfare or financial terrorism being behind the economic collapse by the Pentagon’s Special Operations and was blocked, Mr. Freeman said.

The Pentagon report states that the evidence of financial subversion revealed that the first two phases of an attack on the U.S. economy took place from 2007 to 2009 and “based on recent global market activity, it appears that the predicted Phase III may be underway right now.”

The report states that federal authorities must further investigate two significant events in the months leading up to the financial crisis.

The first phase of the economic attack, the report said, was the escalation of oil prices by speculators from 2007 to mid-2008 that coincided with the housing finance crisis.

In the second phase, the stock market collapsed by what the report called a “bear raid” from unidentified sources on Bear Stearns, Lehman Brothers and other Wall Street firms.

“This produced a complete collapse in credit availability and almost started a global depression,” Mr. Freeman said.

The third phase is what Mr. Freeman states in the report was the main source of the economic system’s vulnerability. “We have taken on massive public debt as the government was the only party who could access capital markets in late 2008 and early 2009,” he said, placing the U.S. dollar’s global reserve currency status at grave risk.

“This is the ‘end game’ if the goal is to destroy America,” Mr. Freeman said, noting that in his view China’s military “has been advocating the potential for an economic attack on the U.S. for 12 years or longer as evidenced by the publication of the book Unrestricted Warfare in 1999.”

Additional evidence provided by Mr. Freeman includes the statement in 2008 by Treasury Secretary Henry M. Paulson Jr. that the Russians had approached the Chinese with a plan to dump its holdings of bonds by the federally backed mortgage companies Fannie Mae and Freddie Mac.

Among the financial instruments that may have been used in the economic warfare scenario are credit default swaps, unregulated and untraceable contracts by which a buyer pays the seller a fee and in exchange is paid off in a bond or a loan. The report said credit default swaps are “ideal bear-raid tools” and “have the power to determine the financial viability of companies.”

Another economic warfare tool that was linked in the report to the 2008 crash is what is called “naked short-selling” of stock, defined as short-selling financial shares without borrowing them.

The report said that 30 percent to 70 percent of the decline in stock share values for two companies that were attacked, Bear Stearns and Lehman Brothers, were results of failed trades from naked short-selling.

The collapse in September 2008 of Lehman Brothers, the fourth-largest U.S. investment bank, was the most significant event in the crash, causing an immediate credit freeze and stock market crash, the report says.

In a section of who was behind the collapse, the report says determining the actors is difficult because of banking and financial trading secrecy.

“The reality of the situation today is that foreign-based hedge funds perpetrating bear raid strategies could do so virtually unmonitored and unregulated on behalf of enemies of the United States,” the report says.

“Only recently have defense and intelligence agencies begun to consider this very real possibility of what amounts to financial terrorism and-or economic warfare.”

As for Chinese involvement in economic sabotage, the decline in the world economy may have hurt Beijing through a decline in purchases of Chinese goods.

Treasury spokeswoman Marti Adams had no immediate comment on the report but said her department’s views on the causes of the economic crash were well known.