Sanctioning Iran’s Central Bank: An Important Step Too Long in Coming

Washington is abuzz with speculation about a possible interim deal that might help defuse the brewing crisis over Iran's nuclear program. Color me skeptical.

That said, one thing seems clear. Iran's increased interest in negotiations has been driven almost entirely by its search for relief from harsh Western sanctions imposed in the last six months.  

A top official from the Obama administration recently told me that “from what we are seeing, the threat of an Israeli strike hardly figures right now in Iranian calculations. On the contrary, everything indicates that what really worries Iran's leaders is the impact of sanctions and the danger that they could spark domestic unrest.” Senior Israeli intelligence analysts have reached a similar conclusion, noting in conversations that, “at the moment, Iran doesn't think Israel will attack [without endorsement from the U.S.] . . . . The need for sanctions relief is the reason they're back at the table.”

Of course, the centerpiece of the sanctions campaign has been the U.S. decision at long last to target the Central Bank of Iran (CBI). Foreign financial institutions that continue dealing with the CBI to make payments for Iranian oil now risk being cut off from the U.S. banking system. Only countries that show significant reductions in purchases by late June will qualify for exemptions.  

In response, the European Union has agreed to end all imports of Iranian oil as of July 1. Japan — Iran's second largest customer — has already secured a U.S. waiver for its efforts to slash imports. Other major purchasers of Iranian crude, including South Korea, India, South Africa, and Turkey, are scrambling to follow suit. There are even signs that China, Iran's biggest buyer, may be reluctantly cutting back, or at least taking advantage of the shrinking demand for Iranian product to negotiate significant price reductions.

At the moment, the impact on Iranian revenues is shaping up to be truly major. Oil sales account for more than half of Iran's national budget. Some estimates now suggest that Iranian exports could drop by as much as 30-40 percent in the next several months. To find buyers for the rest, Iran may well be forced to offer steep discounts, further cutting into its revenue stream. 

As a result, Iran now stands at the precipice of its most severe economic crisis since the devastation of the Iran-Iraq war in the 1980s. With memories of 2009's popular uprising still fresh in their minds, Iran's ruling mullahs are no doubt concerned over the risks they run by continuing down a path of unbridled confrontation, one that promises to double down on the substantial misery they've already inflicted on the Iranian people. Thus — surprise, surprise — we get the regime's recent negotiations gambit and the prospect, however slim, of meaningful compromise.

Given the obvious success that CBI sanctions have had in escalating pressure on Iran, an interesting question is why it took so dreadfully long for Washington to pull the trigger. After all, the basic idea of attacking Iran's oil sales by targeting the CBI has been around for years.  I can recall discussions on the topic within the U.S. government as far back as 2006. Indeed, I vividly recall President Bush at numerous meetings beseeching his advisors to provide him new sources of leverage for pressuring Iran, and explicitly raising the idea of going after the CBI. Equally vividly, I recall Treasury Secretary Hank Paulson shooting the idea down, labeling it the “nuclear option” and direly predicting that it would wreak havoc on global markets and the U.S. economy. And that was largely that. The supposed Master of the Wall Street Universe had spoken and further discussion, for all intents and purposes, was closed off.  

Distressingly, what I don't remember is anyone stepping forward to back up Paulson's reflexive conclusion about the unworkability of CBI sanctions with any hard analysis or data. Despite President Bush's obvious interest in the issue, and its potential import on a matter of vital national interest, I don't think any of the relevant agencies — Treasury, State, the CIA — ever took it upon themselves to produce a serious study of what the actual impact of CBI sanctions would be on international markets, much less what steps the U.S. might take to mitigate any adverse consequences. Regrettably, I also don't recall any of the president's advisors — myself included — ever taking action to challenge Paulson's thesis by tasking the intelligence community to model it systematically. In retrospect, I think it's an instance where the “process,” the bureaucracy, clearly failed to serve the president well.

As far as I can tell, a similar failure also beset the Obama administration — at least until Congress presented it with the fait accompli of CBI legislation late last year. It's widely understood that Treasury Secretary Tim Geithner, like Paulson before him, opposed CBI sanctions, fearing that they would panic the oil markets, send already-high gasoline prices skyrocketing, and tip the U.S. economy back into recession. Once again, the Treasury Secretary's edict was more or less taken on faith, unsupported by serious study and unchallenged by the bureaucracy.

Thankfully, not everyone was quite so complacent. Here, I'm thinking in particular of my colleague at the Foundation for Defense of Democracies (FDD), Mark Dubowitz. Refusing to accept the conventional wisdom that CBI sanctions had to be off the table, Dubowitz led an expert team in systematically analyzing the potential oil market impact. The result was a detailed assessment — the first, at least as far as I'm aware — that modeled what would happen to petroleum prices and Iranian revenues under different supply restriction scenarios. FDD's confidential report demonstrated that it would indeed be possible to fashion a sanctions regime against the CBI that could dramatically affect Iranian revenues without triggering a devastating disruption in global energy markets.  

Dubowitz's study provided members of Congress with the analytical tools they needed to push back effectively against the doomsday scenarios, and heavily informed the CBI legislation crafted in late 2011 by Senators Kirk and Menendez that was overwhelmingly adopted. And when the Obama administration finally relented in the face of this Congressional tidal wave, FDD's assessment assisted administration experts in developing a nuanced implementation strategy to maximize pressure on Iranian revenues without triggering a massive oil shock.  

So far, the measure looks remarkably successful. Iran's customer base is dwindling. Those that remain are now in position to demand discounts of as much as 20 percent as Iranian oil increasingly takes on the qualities of a distressed asset. Reductions in the amount of Iranian crude on the market have been adequately covered by corresponding increases in production by countries like Saudi Arabia and Iraq. While the sanctions did coincide with a temporary spike in global prices earlier this year, that seems to have had more to do with a crescendo of speculation about an imminent Israeli military strike than with U.S. action against the CBI.  Accordingly, as that speculation has receded, oil prices have gone down. While the market no doubt remains tight, it has clearly stabilized — and all the while Iran faces the likelihood of tens of billions of dollars in lost revenues, driving it back to the negotiating table in search of relief.

That a weapon this effective was not deployed several years ago, at a time when Iran's nuclear program was far less advanced, is indeed a great pity. It's also a potent reminder of the kinds of shortcomings that the U.S. government is perfectly capable of — even when it comes to the most pressing national security issues. And it's as important an example as I can recall of the potentially vital contribution that private think tanks are capable of making to the policy-making process, when they challenge conventional wisdom and bring their intellectual capital and resources to bear decisively on those critical questions that the government, for whatever reason, has neglected, overlooked, or — quite mistakenly — already decided that it has all the answers to.