'Because that's where the money is': the U.S. government finds a way to hurt Kim Jong Il

National Review, June 25, 2007 by Mario Loyola

SINCE the stern warnings delivered in the "Axis of Evil" speech in 2002, North Korea and most other problem states have felt distinctly undeterred from doing much as they please. Five years on, it hardly seems as if the Bush administration will be remembered for excellence in the art of credible deterrence. But that may yet change, with the administration's discovery of a fabulous new weapon: the Department of the Treasury.

This story of serendipity begins early in 2002, as the administration set out to reformulate North Korea policy. "Appeasement was out," one former administration official explains. "The imperative was to change North Korea's behavior." For that, it was necessary to gain a better understanding of the sources of North Korean conduct. And the first question was how the ruling class of Pyongyang was living better than ever, even while North Korea was in utter economic ruin--in default on its debt and unable to borrow internationally. In particular, how was North Korea financing a trade deficit as high as $800 million a year without any access to the international capital markets?

Part of the answer was charity, but much of the answer was simply crime. "You can make some money selling missiles," the former official observes, "but do you have any idea what the profit margins on counterfeit cigarettes are?" The intelligence community presented a picture of criminal profit margins on a breathtaking scale: from drug traffic, illegal weapons sales, counterfeit "superdollars" so high-tech that they were virtually undetectable--the list went on and on.

Together with several officials of the Treasury--chiefly Juan Sarate and Daniel Glaser--State Department adviser David Asher and several of his colleagues formed a working group called the Illicit Activities Initiative to track North Korea's racketeering. As 2002 turned into 2003, the Treasury's Secret Service surged its resources into the investigation. The initiative mushroomed into a massive international effort, involving the Justice Department and hundreds of executive-branch officials, as well as over a dozen foreign governments. The Bush administration quickly gained an understanding of the vast network that supported Pyongyang's luxuries.

The North Korean regime is organized much like a mafia family; and like the mafia since Al Capone's time, its greatest vulnerability was finances. It was Sarate, currently a deputy national security adviser, who first came to grasp that an obscure provision of the Patriot Act--Section 311--could be used to target North Korea's criminal network at its weakest points, and at the same time unleash a potentially devastating cascade of problems for North Korea around the world.

Section 311 amended the Bank Secrecy Act by empowering the Treasury Department to designate suspect foreign banks as "institutions of primary money laundering concern." It could then require domestic U.S. banks to impose "special measures" in their dealings with those institutions, such as closure of "correspondent accounts." These fine surgical instruments, the deadliness of which is obscured by the impenetrable technical jargon used to describe them, are designed to cut the suspect institution off from the U.S. banking system.

The Treasury focused on a small Macau bank, Banco Delta Asia (BDA), as a hub of illicit North Korean finances. On September 15, 2005, it issued an initial finding that designated BDA an institution of "primary money laundering concern" and launched a formal proceeding. The Treasury announcement was timed to increase pressure on North Korea in the six-party talks, which were then deadlocked as usual. Afew days later, the North Koreans agreed to fully denuclearize the Korean peninsula in exchange for economic aid and normalization of relations.

Meanwhile, in Macau, an unexpected drama was unfolding. The very day after the Treasury announcement, there was a run on the bank: Depositors withdrew some $40 million, wiping out the bank's reserves. Fearing a collapse that might spread to other banks in the former Portuguese colony, the Macanese authorities took over BDA and froze some $25 million held in several dozen accounts related to North Korea.

The effects of the Treasury action spread with a life of their own, and Kim Jong Il's problems had only just begun. Without any apparent prompting from the Macanese authorities, the Bank of China froze several of its North Korea-related accounts in Macau. Banks around the world realized that they could suffer a fate similar to BDA's with a single press release from the Treasury. They reacted by increasing "know your customer" due diligence on their North Korea-related accounts, or closing them altogether, and by refusing to take on any new North Korean business. The Treasury's modest preliminary action turned into a disaster for Kim's regime.

Angered, North Korea backed out of the six-party deal and, for more than a year, refused to return to the talks unless the BDA issue was resolved. In the interim, it test-fired several new ballistic missiles, and detonated a nuclear warhead. Throughout this period, the Americans adopted a negotiating position that must have been maddening to the North Koreans. State Department undersecretary Christopher Hill, who leads the U.S. delegation at the six-party talks, proclaimed over and over that he could not speak for Treasury.