Lebanon, Pity the Nation That Never Was Part III

Part III: How to Send a Country to Hell, Modern Finance in the Hands of Warlords

This is the last installment of a three-part series on Lebanon. In the opening lines of part one I quote the country’s  current President Michel Aoun begging the West for a financial bailout as the country was, in his words, going to hell. In part one, I also chronicled the country’s tribal history that was full of bloodshed and mistrust under five centuries of Ottoman repression. In part II, I explored its modern history as a republic created by the French, which threw its varying tribes into an era of chaos, civil war, and subjugation to regional powers that reflected the Arab stages of development of “the warrior archetype.”  In the last part of this series, I’ll take a closer look at the forces that have been at play for the last decade in Lebanon’s politics and its economy that led to the current existential crisis. Its noteworthy to point that since I started writing part I, the Lebanese currency has devalued by another 10% plunging a greater percentage of the population into poverty and famine, while its politicians continue to refuse to meet the demands for transparency made by the international community as a condition for aid.

Hariri

As part of the post-civil war reconstruction effort, Prime Minister Rafik Hariri set a new and modern course for Lebanon as a prosperous oasis on the Mediterranean. Foreign investment in the country reached new heights and most of it was coming from rich Arab Gulf states. His private foundation, backed by the Saudis sponsored thousands of young Lebanese students to study abroad with the condition they return home and contribute to the reconstruction effort and beyond. He strengthened the judiciary that clamped down on illegal drug trade. He underwrote projects that modernized Lebanon’s infrastructure from highways and roads to public hospitals and schools. He moved freely among world leaders. He made Lebanon a very attractive target for investors from all over the globe. He sought the advice of Lee Kuan Yew, the founder of modern-day Singapore on how to make Lebanon the Singapore of the Middle East. He erased the sectarian and religious barriers through his determination to bring prosperity to the entire country.  Hariri was a modern-day Phoenician who brought peace to Lebanon through prosperity.

All these expensive projects however, saddled Lebanon with an enormous amount of national debt and with Hariri’s assassination, the road to the continued prosperity of Lebanon became a bumpy one. While the years immediately after his death saw a reduction in the rate of increase of national debt, the huge capital inflows that he had attracted in the past began to dwindle. Money flowed into the country at a slower pace, but as long as it came in, fears about the resilience of the economy and the country’s ability to service its debt were tempered. Money flowed from tourism, foreign aid and remittance from the millions of Lebanese living abroad. But the biggest capital inflows remained those that came from the goodwill of Gulf Arab states that bankrolled the country’s operations by strengthening the reserves of its central bank and kept the holders of its international debt happy.

All was well and the big can of debt was kicked down the road until 2012 when things began to change. Hezbollah began to steer sectarian tensions after the US Treasury named it as a terrorist and criminal organization effecting its free movement of capital and funding from its allies like Iran. Hezbollah had also strong armed the Lebanese Parliament to amend the constitution which lowered its veto power to one-third. Lebanon and all its official acts were now effectively at the mercy of Hezbollah or any minority parliamentarian block that can stop anything from moving forward without a supermajority vote. The US designation came after the Arab Spring that descended much of the region, including neighboring Syria into chaos. During the Syrian civil war, Hezbollah fought on the side of the Assad regime which used chemical weapons against its own people. Both Syria and Hezbollah were allied with Iran, the Sunni world’s archenemy which also sent fighters to defend Assad showing in no uncertain terms who Hezbollah’s allies were and where its loyalties lie.

Iran by default had become the mouthpiece for the Shia Arabs and through its proxies like Hezbollah and Assad and the newly empowered Shia in Iraq, it sought to shift regional loyalties away from the mostly Sunni Gulf states.  After seeing Iran’s and Syria’s power grow through Hezbollah’s political and military influence on Lebanon, the Gulf states’ hopes for the country’s continued prosperity faded and they stopped their financial support for its central bank. Soon thereafter, tourism and investment in the private sector from the Gulf came to a slow halt as well. This loss of revenue resulted in budget deficits that outpaced GDP growth almost every year since. Throughout this chaos, Lebanon was without a president for more than two years until 2016 when a candidate that was acceptable to Hezbollah was confirmed, sealing the fate of the nation. It quickly became apparent that the new President, Michel Aoun was nothing more than a puppet of Hezbollah. Under his presidency, the most important national posts such as the Ministry of Finance went to Hezbollah politicians.

Financial Engineering in the Hands of Warlords

If there’s anyone to blame for Lebanon’s current financial mess, it’s not the head of its central bank as much as it is the Minister of finance, Hezbollah’s Ali Hassan Khalil who held the position for an unprecedented 6-year term. Before his party plunged the country into mayhem, Lebanon’s annual fiscal deficit was on a steady decline for almost a decade. This improved the country’s global credit rating and its ability to refinance its older debt at much lower rates.  Under Khalil’s care however, annual deficits grew back to near record levels, except this time the rich Arab states were not there to prop up the appearance of financial stability.

Lebanon GDP-Debt ratio

The US Treasury action that has effectively cutoff Hezbollah’s finances had become a major threat to its stability. Khalil turned his attention towards the country’s banking sector that had shown exceptional resilience since its founding.  If the country’s treasury could not be propped by Arab friends, then it will be propped by debt underwritten by the West and by deposits made by expatriates that were concealed in sexy packages that promised unimaginable returns. Surely for an institution that survived a two-decade civil war and saw Lebanon through reconstruction, selling government bonds to the world was not much of a challenge. Before Hezbollah took the over the reins, Lebanon’s bond rating was at B with a stable outlook. This allowed the head of Lebanon’s central bank, Riad Salame, the ability to issue debt and sell it on the international bond markets at reasonable rates.

Salame was well versed in the ways of modern finance. Before taking the post as central banker, he had been an investment banker with Merrill Lynch in Beirut and Paris. Since ascending to the position, he had been on the board of the IMF and many global banking organizations. He rose to global prominence in 2008 and became known as the genius banker who saved Lebanon from the effects of the 2008 financial crisis for not participating in the speculative financial instruments that brought the world to its knees. Hezbollah couldn’t have asked for a more perfect candidate to hide behind as they manipulated the country’s finances.

How the Scam Worked:

  1. Lebanon’s Ministry of Finance issued US denominated Eurobonds, which the central bank swapped for treasury bills denominated in Lebanese Pounds. The appearance of risk was muted as this move reduced the cost of debt service on old loans while alleviating the pressure on the devaluation of the Lebanese Pound which had been pegged at 1,500 to the dollar for decades.
  1. Lebanon’s banking secrecy laws allowed for impropriety behavior on the part of depositors or borrowers to be veiled behind a wall of secrecy. This provided the perfect cover for financial crimes.  Through financial engineering the methods of which are yet to be disclosed, the central bank found a new lifeline. Suddenly it empowered its member banks to offer high returns on dollar deposits. While saving accounts and CDs were returning less than 1% or 2% all over the world, dollar deposits in Lebanese banks were returning anywhere from 12 – 16%. The higher the deposit and the longer the term, the higher the return.  Rational evaluation of this phenomenon was thrown out the window as animal spirits and greed brought in Billions in hard currency to the strapped Lebanese economy and its government, and it was all justified by Salame credibility as a banking genius on the world stage.

This scam continued undetected for years until liquidity began to dry up in late 2019 when banks began to impose capital controls on their depositors. Shortly thereafter the government announced that it will be defaulting on its March 2020 Eurobond payment of $1.2 billion, the first government default of its kind in the country’s history. Efforts to renegotiate any debt required an audit of the central bank and full transparency on government spending. Hezbollah did not allow either of these things to happen. To them, this wasn’t about respecting modern institutions and the covenants that made the world economy function. It was all about revenge against the West for its actions, pure and simple. It was after this realization that the world woke up and recognize that Lebanon under Hezbollah only has the superfluous appearances of a functioning country. The Lebanese government had been running a nationally protected Ponzi scheme within its banking system for years.

This is when the modern world woke up to the fact that Lebanon cannot be held to the same standards of accountability that most sovereign nations adhere to. And under Hezbollah’s influence Lebanon’s fortunes and goodwill have been reversed. A year and half have passed since the default and the government still refuses to show its books risking the lives of its people and plunging half of its population below the poverty line. The country’s credit rating stands at D or SD which are both the lowest rating possible with only a dark outlook. Today, the Lebanese pound trades at more than 20,000 to the dollars, a 90% devaluation in purchasing power that has left many families hungry and destitute. The country has been without a government since the resignation of the last prime minister a day after the massive explosion that leveled half of Beirut. The IMF, the World Bank and Western donors are insisting on transparency from the country’s leaders, who refuse to agree to any such terms while their citizens stand in bread lines for hours only to realize that the Lebanese Pound has devalued even more just in the time they’ve been in line. As Hezbollah waits for Western bankers to blink, they continue to plunge Lebanon into a darker abyss with no workable end in sight.  Maybe this is what they and their masters in Tehran have wanted all along.

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Governance that Fits

On the cultural development scale of Spiral Dynamics, what the Beirut explosion, the Coronavirus and the banking crises have done to Lebanon is expose the essence of Modern-day values of the third level psychosocial system of development.  This form of feudalism dressed in an Armani suit is tricky if not outright dangerous. It uses the tools from higher modern values such as the power of global finance and a vacuous system of democracy to manipulate power and reinforce the feudalistic systems and keep it in place for the long term. Lebanon today remains a collection of loose sectarian tribes boasting of how great it is to be Lebanese without ever knowing what true nationalism is. Sadly, even as starvation knocks at many doors, most citizens refuse to acknowledge this failed stage of cultural development.  A true nation derives its values from seeing a bright future based on collaboration and inclusion, not from its deterministic and feudalistic past. It is the belief in an abstract concept of the institutions that treat everyone equally and afford equal opportunities. It transcends loyalty to the religious sect or the tribal Za’eem. It separates religion from state, and it empowers the institutions not the charismatic warlord or head of a certain religious sect.

SD Org structure

As I described in part I of this series, the transition from the third stage of development to the next stage where democracy begins, is the toughest transition in human history. It comes after everybody lays beaten and bloodied. That’s when the culture collectively acknowledges that there must be a better way as it begins to work toward building the foundation for institutions based on the rule of law. This becomes the corner stone of nations. Unfortunately, the window to build a new national platform for Lebanon has passed. It should have been the first priority in the Taif Agreement that ended the civil war. Mutual coexistence is essentially national reconciliation which never materialized. Sadly, without the needed dialog among the different tribes about what nationalism means to all Lebanese, the country defaulted back into the old sectarian divide with loyalties to regional powers, and local sectarian leaders, not the nation. The confluence of these 3 crises has descended Lebanon to unprecedented levels of despair. Conditions are even worse than they were during the two-decade civil war, which, in my opinion, has never ended. It only transformed into an armistice of angry tribes agreeing to disagree while they carve bigger and bigger pieces of the political pie to expand their feudalistic powers.

For a culture that loves rhetoric, no Lebanese will ever acknowledge that Lebanon was never a country. Pride runs deep in the heart of every Lebanese, including me. It must be that Phoenician blood that courses through our veins. But the Phoenicians were an enterprising civilization; a loose collection of city states, each with its own commerce God (Ba’el) and issues of governance never imposed the will of one city on another. Absent true national reconciliation, what awaits Lebanon is Balkanization. It’s future points to a loose collection of city-states based on sectarianism and commerce until such time as when the various tribes outgrow such design and believe in a greater common purpose for a true republic governed by the modern tools of democracy and absent the influence of so many outsiders.