Financial Terrorism

Could A Global Financial Crash be Deliberately Engineered?

As the world economy limps out of its worst crisis since the Great Depression, we are left wondering how it happened and whether it could happen again. While attention has naturally focused on the causes and events surrounding the 2008-09 global financial crisis, this essay explores the intriguing possibility that we might suffer a similar crisis, not because of another accidental conflagration, but as a result of a deliberately engineered financial crash. But who would want to engineer such a catastrophe? How would they do it? And how can we prevent them?


The current global financial crisis has been extraordinarily costly. Although the shock’s epicenter was the United States and other advanced economies, there was no “decoupling”—even emerging market and developing countries, where banks were not holding toxic assets, felt the reverberations through real and financial linkages. For the first time since World War II, the global economy actually contracted. A crisis that had started narrowly in the US subprime mortgage market soon engulfed the banking systems in the United States and Europe, eventually transmuting into significant sovereign debt problems in a number of advanced economies. The recovery, while underway, is lackluster and jobless—a double dip cannot yet be ruled out. There are so many dimensions to this crisis that putting a simple dollar figure to its cost is difficult, but one metric is the loss of world GDP due to the crisis. A comparison of the International Monetary Fund (IMF)’s World Economic Outlook projections as of April 2008 for world GDP over the next five years to the corresponding projection as of April 2010, yields a cumulative difference that amounts to a staggering US$60 trillion—the equivalent of more than 100 percent of annual world GDP. Beyond dollar figures, a tragic stylized fact about economic crises is that they often result in sharp increases in suicide rates in the desperation of losing jobs and homes and life-savings. Financial crises do not just cost livelihoods, they cost lives.


The crisis has naturally elicited many explanations and theories about its root causes that encompass everything from Marxist interpretations of modern class struggle, to the political expediency of providing cheap credit to the undereducated, the effects of global imbalances, excessively low policy interest rates, and the lack of sufficient financial regulation. Clearly, there was a complex confluence of events that produced this accident. But what if, next time, it is no accident, but rather the result of deliberate malice?


A first question is whether this is even remotely possible. A recent account, Nineteenth Street, NW, describes one possible scenario, in which the perpetrators use an off-shore hedge fund to launch a series of speculative attacks. These attacks initially focus on already weak currencies or markets—perhaps the overvalued currency of an emerging market country or, in the case of a major currency, an overextended sovereign debtor. As the perpetrators succeed in their initial speculative attacks, not only do they gain additional capital to launch their next attack, they also induce other (innocent, profit-motivated) investors to join the bandwagon of the next speculative attack. Naturally, the more money betting against a currency, the more likely it is to succumb to the speculative attack. Eventually, given the interconnectedness of the global financial system, these cascading crises culminate in a global financial crash—costing trillions of dollars, and millions their jobs, homes, and life-savings.


The scenario is purely fictional. But is it plausible? There is no doubt that speculative attacks are possible—George Soros proved as much when he successfully attacked the British pound in 1992 (despite the Bank of England’s potentially “infinite” backing from the Bundesbank under the Very Short-Term Facility). During the 1997/98 East Asian crisis, Dr. Mahathir Bin Mohamad, then Prime Minister of Malaysia, famously accused hedge funds taking speculative positions against the currency of being the “highway men” of finance, though the role of deliberate speculative attacks (as opposed to investors rushing for the exit when it became apparent that the currency was going to collapse) in other crises is less clear. What does seem clear is that if there are fundamental economic and financial weaknesses, and if markets are already jittery, then a determined attack by well-heeled and well-informed speculators has a good chance of success.


And these days markets are extraordinarily jittery. On May 6, the Dow spontaneously fell by almost 1000 points in the space of an hour. What is interesting about this “flash crash” incident is that it was initially blamed on just such an “interconnectedness” phenomenon: riots in Athens over the Greek government’s fiscal adjustment program leading to concerns about the euro, implying a (relative) strengthening of the dollar that would choke off the nascent recovery, and therefore hitting the US stock market. This initial story turned out to be wrong (though such concerns were surely a contributing factor); nor was it a “fat finger” problem—a trader mistakenly entering billions instead of millions—in fact, it is still not clear what happened. (Interestingly, the preliminary report by the Securities and Exchange Commission notes “we have found no evidence that these events were triggered by “fat finger” errors, computer hacking, or terrorist activity, although we cannot completely rule out these possibilities”; emphasis added.) Suffice it to say that the market became illiquid and prone to excessive volatility—whereas, prior to the 2008 financial crisis, market specialists would have jumped in to arbitrage prices, now they stood on the sidelines, even withdrawing liquidity. The jitteriness was also reflected in the VIX (the Chicago Board of Options Exchange SPX Volatility Index)—the “fear index”— which, at its peak on May 6, 2010,  jumped more than 60% to reach 40.26: a level not seen since the turbulent days of late-2008 and early 2009.


In this environment of market turbulence and heightened uncertainty, deliberate attempts to destabilize markets through speculative attacks or otherwise are more likely to gain traction. And we have already used up much of the policy space for coping with crises: interest rates are at historical lows, and the Federal Reserve has expanded its balance sheet massively. In the event of another massive market disruption, and consequent economic downturn, what more could the Federal Reserve do?


Granted that it is at least theoretically possible to deliberately engineer a financial crash—and that such a crash would be extremely costly in its impact—who would want to commit such an act? Three types of groups come to mind: callous criminals, political extremists, or anarchists/fanatics. For purely criminal groups, the intent would not be to inflict damage on the world economy—it would simply be to manipulate markets in order to make money; any fallout from the speculative attacks would be incidental. For political extremists, the motivation would be more mixed, with the primary objective being to threaten greater damage if certain demands are not met, while any money earned in the speculative attacks would either provide additional capital for the next round of speculative attacks or finance other acts of terrorism. For such groups, the challenge would be to calibrate the scale of the initial “demonstration” crisis so that they are taken seriously, but do not cause so much damage that they cannot plausibly threaten to do worse if their demands are not met. Finally, for the anarchists and fanatics, the primary purpose would be to inflict damage on the modern, capitalist global economy—with any money made in successful speculative attacks being incidental to this purpose. Presumably, such groups would not be concerned that the crisis could spin out of control—their goal would be to maximize damage to the global financial markets and economy.



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Whether any group intent on deliberately engineering a financial crash would also have the (considerable) expertise and financial resources required is an open question. But it is a tail risk we can ill-afford to ignore. The bad news is that protecting ourselves from such (politically- or criminally-minded) terrorism will not be easy because of the many forms that an “attack” could take. The good news is that all of the measures that help make our financial markets and economy more resilient to any form of crisis, also helps protect us from deliberately-engineered crashes.



Current efforts to strengthen the financial sector—and the global monetary and financial system—are therefore also integral to better protecting ourselves against financial terrorism. At the personal level, this means ensuring that households are not overextended on credit cards, mortgages, or other personal debt. At the national level, it means ensuring that financial institutions hold adequate capital and do not engage in recklessly risky behavior. In the United States, the recently-passed Financial Sector Reform Bill, which seeks to address both these issues, is obviously an important start—yet there are literally hundreds of regulations that still need to be specified, implemented, and enforced.


The international dimension is no less critical. Regulation around the world needs to be beefed up—but in a way that does not stifle financial innovation or lead to regulatory arbitrage (financial transactions all migrating to the least-regulated market). The Basle Committee has just penned agreement on a common definition and standard for banks’ capital requirements—essential for preventing regulatory arbitrage, and for minimizing the risk that a crisis in a weakly-regulated jurisdiction spreads through cross-border exposures to infect markets globally.


While the United States was the epicenter of the current crisis, spreading globally through financial and real linkages, next time it may be the other way around. For this reason, a sort of “global financial sprinkler system”—that would help governments ward off speculative attacks and douse incipient crises before they can spread—is required. Rudiments of such a system were put in place by the International Monetary Fund (IMF) as the crisis unfolded in late-2008 and early 2009. In addition to rapidly ramping up its traditional lending to countries afflicted by the crisis, the IMF introduced several new facilities—including the Short-term Liquidity Facility (SLF), the Flexible Credit Line (FCL), and most recently the Precautionary Credit Line (PCL). The purpose of these new facilities is to provide contingent, but rapidly disbursing financing to governments battling financial crises, thereby give markets confidence, which could even obviate the need to actually disburse the resources. In other words, the very knowledge that the governments had these financial resources at hand if necessary, might itself help ward off speculative attacks (or a rush for the exit by nervous investors). These measures, together the Federal Reserves’ swap lines with the European Central Bank (ECB) and few select emerging market economies, were probably instrumental in preventing the global financial crisis from turning into a global Great Depression.


Since prevention is always better than cure, the IMF (together with the Financial Stability Board) has also introduced its “Early Warning Exercise”—metaphorically, an early warning “radar screen” intended to identify vulnerabilities before they can erupt into crisis (For descriptions of the Early Warning Exercise, see “IMF-FSB Early Warning Exercise” IMF Fact Sheet (available at; and  Atish R. Ghosh, Jonathan D. Ostry, and Natalia Tamirisa. “Anticipating the. Next Crisis: What can Early Warning Systems be Expected to Deliver?” Finance and Development, September 2009).


The premise is that financial crises represent the confluence of an underlying financial vulnerability and a specific crisis trigger. (This description of crises as being the result of an underlying vulnerability plus a specific trigger fits nicely most financial crises; see Atish Ghosh and others, “IMF Support and Crisis Prevention,” Occasional Paper 262, Washington DC: International Monetary Fund.) While the underlying vulnerability usually takes the form of a balance sheet mismatch (too little capital; unhedged foreign currency exposure; or maturity mismatches), the event that actually triggers the crisis may take many different forms: domestic or external; economic or political (including, presumably, deliberate action by terrorists or criminal elements). Because the specific trigger is very hard—if not impossible—to predict, crisis prevention efforts are better directed at addressing the underlying vulnerabilities. Quite simply, if there are no vulnerabilities, then a “triggering event” (deliberate or accidental) will have nothing to ignite, and will just fizzle out instead.


Starting from this premise, the Early Warning Exercise seeks to identify vulnerabilities that could precipitate global or systemic crises. The Exercise draws on a wide range of analytical tools, market information, and expert opinions. A key goal is to “connect the dots”—that is, understand how shocks in one country or market could spread across the global financial system. The findings are communicated confidentially to finance ministers and central bank governors in order that they may take prompt preventive and correction actions, especially those that require international cooperation and coordination.


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The global financial crash, which originated in the advanced economies but spread quickly to emerging market and developing countries, was a painful reminder about our vulnerability to financial and economic crisis. It turns out that deliberate enemy action was not necessary: greed, hubris, and a lack of financial oversight was enough. How much worse might it have been if deliberately engineered? With the world economy still struggling to regain its footing after the current crisis, we cannot afford to find out. Increasing our resilience to financial crises therefore needs to be a global priority. The three elements outlined here—national reforms of financial sectors; a global financial “sprinkler system” to help douse incipient crises; and early warning efforts to identify dangerous vulnerabilities—are surely steps in the right direction.


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Rex Ghosh is Chief, Systemic Issues Division International Monetary Fund; the views expressed in this article are those of the author and should not be attributed to the IMF, its Executive Board, or its management. He holds a BA and a PhD from Harvard University, and a MSc from Oxford University, and is the author of Nineteenth Street NW (, a thriller about financial terrorism and a global market crash.


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