European Affairs

On a bigger scale, the worry—one completely shared by the leading governments in the European Union—was Iran’s continued defiance of the international community in pursuing what many experts suspect is a nascent nuclear weapons program. At the United Nations in September 2006, Iran’s president Mahmoud Ahmadinejad acted triumphantly, scoffing at the threat of Security Council sanctions and brazening it out with international opinion with repeated Holocaust denials.

As U.S. officials were considering ways to reverse a tide which seemed to be raising Iranian fortunes, Stuart Levy, the Treasury Department’s counter-terrorism and financial intelligence chief, kept coming back to the Iranian budget and a nine-digit item (representing a multi-million figure in dollars). Post 9/11 changes in the rules applied to the global financial system have made it easier to identify and trace terrorism funding— and invoke rules designed to cut it off. Levy had a pretty good idea where that budget line item led: he is the point man in a U.S. multi-agency initiative to coordinate the collection, declassification and dissemination of intelligence on the myriad financing streams supporting terrorism.

Following an often-torturous trail of disguised transactions, Levy found that $50 million had been transferred from Iran’s state-owned Bank Saderat through a London subsidiary to one of the bank’s branch offices in Beirut, where the money was distributed to an organization identified in U.S. eyes as being controlled by the Lebanese Shiite group Hezbollah, which is considered a terrorist group by the U.S. government. Under the USA Patriot Act of 2002, foreign banks engaged in terrorist-related money laundering can be cut off from the U.S. private-sector financial system. Last September the Treasury Department announced it was cutting off Bank Saderat’s access to the U.S. financial system.

This was the first step in what has become a weapon of economic strangulation in the overall U.S. strategy for isolating Iran. It has proved to be, what the military calls “a force multiplier”— meaning each step enhances parallel measures. It is also open to escalation, and what happened since has given U.S. officials far greater confidence in the coercive effect of this economic isolation. European financial institutions, clearly with backing from their national governments, have moved in concert with the U.S. banking community, to impose impediments on particular Iranian entities, causing a chilling effect on Tehran’s ability to operate in today’s international financial markets.

In media coverage, the military dimension of the U.S. strategy to pressure Iran has received great attention, and considerable notice was paid to the unanimous decisions reached last December, after often-fractious negotiations, by the UN Security Council to impose international sanctions on Iran. It was hailed as a political success for the international community. In practice, arguably the most formidable weapon—in Tehran’s eyes, where it counts—has been a growing trend for U.S. and European financial institutions to impose their own “sanctions” in the form of a freeze on their dealings with Iranian entities that can be linked to terrorist funding—not just as investors but even as banks and brokers in transactions. The campaign, quietly initiated by the U.S. and prodded by Levy, threatens to slowly constrict the lifeblood of the Iranian economy.

These “bilateral” sanctions seem to be biting deeper than the panoply of multilateral sanctions adopted by the Security Council last December. They are also adding momentum to the U.S.-led push for further steps. In February, a meeting in London of the five permanent members of the Security Council (plus Germany) seemed to set the stage for further sanctions and a tightening of the economic noose.

The Bush administration seems to know what it is doing. “Our Treasury Department has designated several Iranian banks that are prohibited from doing business in dollars or with American financial institutions, and we’re increasingly seeing nervousness in the international banking community in terms of doing business with Iran. “We’re actively encouraging that trend,” according to U.S. Undersecretary of State Nicholas Burns. He cited evidence from inside Iran that the economic squeeze has sparked serious concern and dissension. “We’re convinced the cost to Iran of its isolation will become so destructive to their economic potential that they will eventually have to come to the [negotiating] table.”

This renewed confidence in the power of economic isolation is largely the result of an unexpected phenomenon. After 9/11, U.S. officials discovered that the global network of multinational banks and lending institutions, whether afraid of running afoul of international banking regulations and the U.S. Treasury Department, or else motivated by good corporate citizenship, often acted more proactively than foreign governments in cutting off terrorist funding. That realization helped spark a strategy of putting the financial squeeze on Iran.

That the global banking system could provide unexpectedly powerful leverage not only on terrorist organizations but also on regimes with terrorist links has also become evident in the past few years. Last year the militant Palestinian group, Hamas, for instance, found that it was facing unanticipated problems after it was voted into office in the Palestinian territories. Because Hamas refused to amend its charter calling for Israel’s destruction and is designated as a terrorist organization by the United States and the European Union, Western nations were obligated to cut off foreign aid to the Palestinian government. What really surprised many observers, however, was that even Arab banks refused to transfer funds to the Palestinian Authority that had been donated by Arab governments. The resultant financial squeeze was so severe for the Palestinian Authority that last December Palestinian Prime Minister Ismail Haniyeh tried to smuggle suitcases containing $35 million in cash from Egypt to Gaza. (He was caught in the process.)

As a strategy for dealing with rogue entities, the “horizontal escalation” of a financial squeeze has an impressive-looking precedent in the case of North Korea. While the international community was mounting a drive to get Pyongyang to back away from its nuclear weapons program in 2005, Washington tightened the screws on a different front, unrelated in appearance but actually part of the same nest of concerns about causing pain to the “Hermit Kingdom.” [Similarly, in September that year, the U.S.

Treasury accused a bank in Chinese-rule Macao, the Banco Delta Asia, of being a “willing pawn” in the laundering of counterfeit U.S. currency from North Korea. “The allegations against the bank were levied under a provision of the Patriot Act which authorizes an administrative procedure that limits banks’ access to evidence of the accusations about terrorist-related funding that can allow the United States to freeze a foreign bank out of the U.S. financial system.”]

In practice, the U.S. charges led to the freezing of $25million in U.S.-based accounts linked to North Korea. Beyond that, what really hurt Pyongyang, experts say, was the informal financial embargo that followed. With Western institutions falling into line in restricting any transactions linked to North Korea, the pinch seemed to hit a nerve in the North Korean leadership. In February 2007, North Korea returned to the six-party talks and seemed to reach a deal on halting the country’s nuclear weapons program in exchange for concessions that included a relaxation of financial pressures.

The power of this approach to North Korea, combining financial coercion with diplomatic engagement, gradually gained a wider hearing among administration officials as they wrestled with the problem of how to gain leverage with Iran. “When we were looking at the Iran situation last fall, we definitely considered the lessons of North Korea, Hamas and terror financing in general, notably just how valuable a partner the private sector can be in amplifying the effects of our own financial measures,” Levy said in an interview.

“We started by briefing financial institutions around the world about how Iran was using the international financial system to fund terrorism and pursue its nuclear program. We showed how Tehran sought out financial institutions willing to obscure Iran’s involvement in transactions, and in general act in an opaque manner that threatened the transparency and integrity of the international system. And we left it to those institutions to do their own calculation of the risks of doing business with such a regime,” he said.

As part of its diplomatic effort to ratchet up pressure on Iran, Washington worked successfully to get unanimous approval in the Security Council last December. Resolution 1737 requires states to deny Iran any financial assistance related to its nuclear and missile programs. While not as stringent as U.S. officials had hoped, the resolution—and the political signal of its unanimous support, including from Russia and China—had several major political advantages: it kept the U.S. and its European allies strongly aligned on the issue; it produced a common front, even on limited terms, as Tehran was faced with condemnation from all the major powers; and it afforded political support for the bilateral crackdowns that private-sector entities started to impose in the major financial centers in the U.S. and the EU.

Acting on that resolution in January, the administration designated Iran’s state-owned Bank Sepah as the “financial lynchpin” of Iran’s missile procurement network, freezing many of its assets and cutting it off from the global banking network. In February, the U.S. Treasury likewise designated three Iranian companies as supporters of Iran’s proliferation of weapons of mass destruction, and it named a Lebanon-based construction company, Jihad al-Bina, as a wholly-owned subsidiary of Hezbollah.

Once again, however, it was the independent actions of many private banks and global financial institutions that arguably had the greater impact. Days after Treasury sanctioned Iran’s Bank Sepah, for instance, Germany’s second-largest bank, Commerzbank, announced that it would stop handling dollar transactions for all Iranian clients. Many other private European banks followed suit. For its part, the European Union announced that it will soon unveil a new regulation aimed at enforcing the U.N. resolution on Iran by freezing the assets of organizations and individuals associated with Iran’s nuclear and missile programs—action that in some cases goes even further than required by the resolution.

Despite Iran’s abundant oil revenues, there are signs that the international economic squeeze is beginning to pinch. Iranian leaders have publicly acknowledged that they are failing to find the international investments needed for the nation’s oil industry. Perhaps coincidentally but perhaps not, in February Russia announced that it was slowing work on Iran’s nearly-completed Bushehr nuclear power plant because Iran was late in making its $25 million monthly payments. Russia reportedly turned down a request by an Iranian bank that it take euros rather than dollars in payment. Iran was also counting on increasingly reluctant international banks to fund a $16 billion project to increase its oil-refining capacity and help reduce gasoline imports that cost the Tehran government more than $6 billion a year.

Meanwhile, Iranian voters angry about rising prices and high unemployment dealt Ahmadinejad an embarrassing setback in local elections in December, trouncing his allies running for office. Two conservative newspapers associated with Iran’s supreme leader Grand Ayatollah Ali Khameini openly criticized Ahmadinejad’s unyielding and confrontational approach for provoking the unanimous U.N. resolution.

Despite Ahmadinejad’s continued unyielding rhetoric, other Iranian officials have recently indicated a willingness to return to the negotiating table over Iran’s nuclear program. According to experts at the United Nations, for instance, Iran’s top national security official Ali Larijani has recently written to the head of the International Atomic Energy Agency (IAEA), the U.N.’s nuclear watchdog, saying that he was ready to restart negotiations on Iran’s nuclear program. Iran also agreed in March to take part in multilateral talks with the United States and other nations over the future of neighboring Iraq—a meeting that was the first time in years that Iranian and U.S. officials had publicly taken part in political negotiations of any sort.

“I think economic measures taken by the European governments and many large banks who are refusing to grant loans or [make] transfer payments in dollars to Iran are forcing people in Tehran to think twice,” said Bruno Pellaud, former deputy director of the IAEA, speaking recently at a conference hosted by the New America Foundation. The trade volume between Germany and Iran, he said, had dropped by one third just in the past year. “In the past Iran used to ignore U.S. economic sanctions because they could always strike deals with Europe. Now I think this squeeze on capital is beginning to have an impact.”

For the U.S. Treasury’s Mr. Levy, the wider lesson is the power of a newly-impressive one-two punch: gradual economic coercion applied in tandem with patient diplomacy. “I think what we’re seeing is that the more political isolation we bring to bear on these countries, the more likely the private sector is to act in a complementary fashion, and it becomes a mutually-supportive process of increasing political and economic pressure,” he said.

For Levy, “the question now is how long Iran will continue to act in a way that increases its isolation on both fronts.” In Tehran’s thinking, there must be some consideration being given to the fact that, so far, the Transatlantic, publicprivate front seems to be united in tightening the screws.


This article was published in European Affairs: Volume number 8, Issue number 1 in the Spring of 2007.