Could Terrorists Create a Market Crash?
Given their shared mid-September timing, it's not surprising that people are starting to wonder if a financial version of 9/11 that combines the worst elements of the Sept. 11 attacks and the 2008 financial meltdown is possible.
In fact, international economist Rex Ghosh has written a fictional account about just such an event, in which terrorists engineer a global financial crash. Ghosh's goal is to illustrate to a broader audience why efforts to safeguard the world's financial systems need to be improved and constantly monitored. He recently visited DailyFinance's offices to discuss his views.
"In the current environment where there is a lot of nervousness and lack of liquidity, an extremely volatile event clearly can happen on its own, and therefore, could probably be engineered to happen as well," says Ghosh, who has dealt with international financial crises for 15 years.
In his novel,Nineteenth Street, N.W., which was first published in 2008, a fictional terrorist group uses a hedge fund to make financial transactions that weaken several currencies, setting off a chain reaction that cripples the global financial system. While he doesn't believe it was intentional, a scenario similar to what took place this past summer -- when the Greek government battled a debt crisis that some analysts feared might threatened the stability of the euro -- could be engineered through speculative sales of debt securities. For this reason, addressing financial vulnerabilities must be taken seriously.
With such real-life events already threatening the global financial system, Ghosh says three elements make it possible that thieves and terrorists might try to engineer a financial crisis in the future:
Financing terrorism. Criminals routinely try to move money through the banking system undetected -- and terrorists do the same. Terrorist organizations have become more sophisticated since 9/11 and may attempt to use the markets to profit from a future financial crisis. The Securities and Exchange Commission investigated many suspicious trades that took place just prior to 9/11, such as the shorting of airline stocks that would have provided a financial windfall for someone with advance information.
"Part of what the SEC was looking at was whether Al Qaeda had basically attacked us physically and also profited from it to finance further operations," Ghosh says. "They concluded that it hadn't happened, but it could have."
Physical vulnerability of financial infrastructure. The physical attack on banking system buildings, ATMs and back-end systems has symbolic value to terrorists and can cause major economic disruptions. Crippling a nation's banking system with a physical or cyber attack would make its government vulnerable to takeover or collapse. After September 11th and after the Y2K scare, banks and other financial institutions have increased security efforts and have created back-up systems at alternate locations that will kick in if their main network went down. But the defensive efforts are far from perfect.
Lack of regulations guarding against financial crashes.Unchecked speculative activity in the financial markets has moved markets in the past and probably will in the future. Unregulated markets can be exploited by speculators and terrorists alike, so it's up to the markets to put safeguards that work in place. Since the 2008 financial crash, the U.S. and other nations have worked diligently at reducing their vulnerabilities to financial crises, whether they are engineered or the result of bad luck and/or the lack of regulation.
To that end, Ghosh points out that the International Monetary Fund and the Financial Stability Board conduct an early warning exercise twice a year to look for financial system vulnerabilities that can be transmitted across borders, such as identifying financial contagion that could be spread through bank holdings across different nations. There is also a coordinated effort across all major financial centers and major global economies to get a set of consistent rules in place on how much capital banks need to hold. Ghosh also believes this year's passage of the U.S. financial regulations bill was a step in the right direction.
However, recent events such as the May 6th "flash crash," in which the Dow Jones Industrial Average dropped 900 points in less than an hour, demonstrate how far the financial community still needs to go to protect the financial markets from financial crashes when fear and market volatility mix.
"The SEC is still trying to figure out what happened with the flash crash," says Ghosh, noting that the exact cause may not become clear for months or maybe years.
Given the difficulty of dealing with this threat, why write a novel that could give terrorists ideas?
"The book is fiction, not a blueprint," says Ghosh. "If the terrorists haven't noticed that we've had the biggest crash since the Great Depression, they're pretty dumb. But it doesn't pay to underestimate them -- that's why is so important to make our markets more resilient."