Right now, the U.S. appears to be at war. The U.S. and Israel launched a series of attacks on Iran that began on Saturday, and Iran launched a series of counterstrikes at Israel and across the region. The market reaction is about what you'd expect; risk is down, safety is up. On the surface, it may not appear that banks, which don't make guns or tanks or stitch uniforms or package MREs, are directly affected. But banks have always been intertwined with war, in a number of ways. With that in mind, I want to look at two ways this conflict could affect banks, one direct, one indirect.
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The direct one is an increasing risk of cyber threats. Our Carter Pape wrote about this last summer after the U.S. bombed Iran, and it seems like it will be even more germane now. Iranian actors have launched cyber attacks on U.S. financial institutions in the past, and it's a fair bet they will again. And given the rapid pace of how cyber threats are becoming more sophisticated, the threat is some degree greater. This was something Brett Erickson argued just on Friday on these pages, and he re-upped the point over the weekend on LinkedIn. "In a world that has seen more geopolitical shifting than at any point since ... the dissolution of the USSR? World War II arguably? The risk to financial institutions is exceptionally high, and only continues to rise as the situation in Iran unfolds so closely after the ousting of Maduro in Venezuela and the elimination of El Mencho in Tapalpa." So, do everything you can now to bolster your defenses. And then do more.
An indirect way is of course is that wars require money, and eventually those bills come due. This isn't often immediately apparent. Right now for instance, the markets are doing about what you'd expect them to do – tk tkt tk tk. Indeed, the "war risk" effects usually aren't visible in the early days of any military endeavor.
But whatever this action costs, it will be more expensive than anybody thinks, I guarantee that. First off, there are the people, innocents and combatants, who are going to die on both sides. That is the most extreme cost. Beyond that, there is the financing. And financing is what banks do. The Medici and other Medieval bankers made loans to princes, popes, and other political actors, financing wars across the continent. The risk, of course, was that the war would go badly and the loans wouldn't be repaid. That did, sometimes, happen. The financial system is more convoluted today, the connection isn't as direct. But somebody is buying all that government debt, and it's a fair bet that if the Trump administration is prepared to fully commit to whatever it is it's doing in Iran, it's going to cost more than anybody expects. And that can have a number of effects.
Bush estimated it would cost about $60 billion to go to war in Iraq. It ended up costing more than $3 trillion. And all of that was financed. Nobody's taxes went up and the government didn't sell merch to raise the cash. The war was waged on completely borrowed money. And whatever it is that's happening now will also be conducted with borrowed money.
Now first off there are all the "normal" effects of the deepening federal government debt that people have been Cassandra'ing about for decades. But then there are the butterfly effects of war debts. For instance, the $3 trillion Iraq War tab contributed to the Panic of 2008, Tulane professor Thomas Oatley has argued. How so? The debts boosted GDP and the strength of the dollar. That made domestic manufacturing less attractive compared to overseas peers. But the resulting economic growth had to go to some domestic industry, so it went into housing, which got blown into a bubble. Which eventually unwound, as bubbles always do. When Lehman Brothers collapsed because of its exposure to that, it took Wall Street with it and spark an economic meltdown.
None of that was visible in real time, and indeed most people probably don't see those connections even today. But the connections are there all the same. And that is how average citizens will, eventually, feel the effects of this action. And those are your customers.
