“This is my truth—tell me yours.”
Reading Secret Weapon, Kevin Freeman’s treatise on financial terrorism, that quote by Welsh politician Aneurin Bevan repeatedly came to mind. The book highlights the author’s truth: 2008’s financial panic was the work of financial terrorists—and the next attack will make 2008 “look like a picnic.” And that view is backed up with hundreds of cited quotes and factoids. But in all 220 pages, there’s no one else’s truth and nary a dissenting fact—barely even a straw man set up with the purpose of knocking it down—leaving the reader with more questions than answers.
Make no mistake, the thesis is supported with great, earnest passion. Unfortunately, that passion begets the book’s rhetorical shortcomings.
The book starts, appropriately, with a question: Was the fall 2008 financial panic “the plan long threatened by Osama bin Laden to destroy our economy?” But where the scientific method would call for observation, analysis, testing and deduction, the book jumps to the conclusion—Yes!—and asks the reader to accept on faith the litany of assumptions, generalizations and suppositions proffered as support. If you already accept that Middle Eastern Sovereign Wealth Funds are terrorist covers, Sharia-compliant finance exists to enable “financial jihad,” China wants to destroy the US, derivatives are (as Warren Buffet put it) financial weapons of mass destruction and short selling is the primary reason stocks tanked that autumn, you’ll likely find the book persuasive. But if even one of those statements strikes you as xenophobic, overwrought or oversimplified, you’ll be left wanting for more hard evidence.
Even supposedly tangible evidence is framed subjectively. Take the China supposition—it largely rests on a 1999 book, Unrestricted Warfare, written by two high-ranking members of the Chinese Army and reportedly endorsed by some Communist party members. An information-age equivalent of Sun Tzu’s The Art of War, it theorizes on non-military ways to beat a superior opponent. None of the passages quoted even resembles an attack plan—the US is occasionally mentioned, but the context is philosophical. Yet the book claims the work “recommends economic warfare as a primary means of attacking the United States,” effectively characterizing it as China’s mission statement. Perhaps that’s because the source material was a version that added the non-canonical subtitle, “China’s Master Plan to Destroy America,” which was strikingly absent from the original work. But where’s the proof that’s the Chinese government’s aim? Who’s to say China’s pegged currency, tariffs and export-dumping are “economic warfare,” rather than plain old protectionism? Or its occasional sales of US Treasurys anything other than innocuous diversification? That’s a truth never explored.
Also unexplored is the counterfactual: Despite the book’s occasional claims America’s “enemies” are willing to suffer the inevitable financial consequences that would follow a US economic implosion, evidence overwhelmingly suggests this would be too bitter a pill. For example, the US accounted for roughly 21% of Chinese exports in 2011. In destroying our economy, China would lose fully one-fifth of its end market, likely hurting its own economy in the process—hardly a sensible move for a nation striving to be a global economic powerhouse.
Moreover, to assume China selling its US Treasury holdings en masse would destroy America’s balance sheet makes a fundamentally incorrect assumption about how capital markets function. If China sells a lot of debt at once, that would depress prices. In effect, China would be harming itself by forcing prices lower. And when bond prices fall, yields rise. And those higher yields would no doubt attract other investor who would happily buy debt instruments from the world’s deepest, most stable economy at elevated yields. That wouldn’t harm the US at all. Plus, while mass selling would be a short-term shock to yields, it would take years to materially impact borrowing costs since it wouldn’t affect payments on bonds already issued. China likely knows all this—which makes it an unlikely tactic.
A broader example of perilous assumption: Chapter Nine opens with the assertion, “Almost half the planet’s wealth was destroyed in the 2008 financial crisis.” And that’s supported by a quote from former IMF Managing Director Michel Camdessus: “This crisis is the first truly universal one in the history of humanity. No country escapes from it. It has not yet bottomed out.” QED? Hardly: Flip to the endnotes, and you find the quote was taken on March 8, 2009—exactly one day before the market, in fact, bottomed out. That’s a pretty material fact the reader would probably benefit from knowing. A balanced view would also acknowledge global stocks’ massive advance since then has helped bring back much of that supposedly “destroyed” wealth—the MSCI World Index has risen over 85% from the market trough and is closing in on the prior peak. And that real US and global GDP are already logging new highs. Near-term, markets are pretty darn volatile and economies grow in irregular fits and starts—that’s been true throughout history and isn’t evidence of a recent well-organized conspiracy.
The book takes particular aim at relatively newer investment vehicles. Newness can breed fear of the unfamiliar. But naturally, new innovations aren’t inherently bad—they’re often good. For example, the book purports Sharia-compliant financial products (SCF) exist merely to “enable Muslims to fulfill … financial jihad.” But what about the tens of millions of people who use SCF for perfectly innocent reasons—should they not have tools to invest in capital markets and manage risk? To my mind, any tool that democratizes Wall Street, allowing millions of people new access to the capital markets that have brought wealth to society over time, is inherently good.
The same goes for derivatives—even credit default swaps—and short selling. One may take Buffet’s “financial WMD” attribution at face value, but in reality, these tools are overwhelmingly used to manage financial risk—a perfectly unalarming goal. Overall and on average, they promote more efficient pricing, not market dislocations. Like anything else on this green earth, miscreants can use them nefariously. That’s the human condition. But to say their sheer existence is bad belies their many productive qualities. And to say credit default swaps (CDS) are inherently disruptive doesn’t square with reality. When Greece’s default triggered CDS in March, the final payout was a relatively tiny $2.5 billion (and banks’ net exposure only $3.2 billion), and markets largely yawned. In fact, even the Lehman CDS payout went substantially better than most expected—markets feared bank exposure in excess of $400 billion, but in reality net exposure was less than $10 billion, and financial Armageddon didn’t ensue.
And the book’s position that short sales were singlehandedly responsible for Bear Stearns’ and Lehman Brothers’ collapses is too narrow. Short-sellers didn’t pile on a perfectly healthy Bear Stearns in March 2008 for no apparent reason, driving the firm to oblivion. Bear Stearns, lest we forget, came under fire in mid-2007, when two overleveraged hedge funds collapsed. The event wreaked havoc on the investment bank’s balance sheet, and a flight of capital ensued—a classic run on the bank. In the end, “significantly deteriorated” liquidity exacerbated by fair-value accounting rule FAS 157, not short selling, wrought Bear Stearns’ demise. Lehman, too, ultimately failed for lack of liquidity—another victim of FAS 157’s deleterious balance sheet impact. Short sales were coincident, not causal.
And this is true, in our view, of every financial panic and bear market in history. The book purports short-selling “bear raids” were primary causes of previous crashes, including 1929, ignoring that each had their own fundamental causes. Limited space won’t let me discuss each and every historical panic, but here’s another way to measure short selling’s impact. If short selling truly had power to manipulate the market—if shorting automatically drove down share prices—there would be a visible group of investors who’ve gotten very rich through repeated short selling. History is peppered with one-time success stories, but only Jim Chanos comes to mind as someone who’s consistently made money on the short side of the market. The book offers Jesse Livermore’s short-sale profits in 1929 as evidence of the tool’s market-moving power—but Jesse Livermore died broke, killing himself. He couldn’t hold on to money, and he couldn’t repeat that incidental success once regulations got more teeth. A short sale is nothing more or less than a bet demand will fall—but demand rises more often than it falls, and even naked short-sellers tend to get squeezed more often than not.
Now, none of this is to say the book’s conclusion is impossible—it’s possible and even probable financial terrorists do exist. Yet even then, we’re likely not doomed. The US and global capital markets are huge and liquid. Even if financial terrorists seeking to harm our economy seemingly succeed in the very short term, the vast universe of ethical investors influences prices exponentially more over time—and in the long run, free markets thus tend to do what’s right for the greatest number of people.
Regardless of the cause, markets have always recovered and grown after even the most massive short-term disruptions. Lower prices attract buyers, demand rises, fundamentals take hold and markets recover, as the past three-plus years have taught us. Thus, whether you accept or question the truth in Secret Weapon, there’s ample reason for hope.