Ten years on

A decade after the crisis, how are the world’s banks doing?

Though the effects of the financial crisis in 2007-08 are still reverberating, banks are learning to live with their new environment, writes Patrick Lane. But are they really safer now?
THE ELECTION OF Donald Trump as America’s 45th president dismayed most of New York; Mr Trump’s home city had voted overwhelmingly for another local candidate, Hillary Clinton.

But Wall Street cheered. Between polling day on November 8th and March 1st, the S&P 500 sub-index of American banks’ share prices soared by 34%; finance was the fastest-rising sector in a fast-rising market. At the time of the election just two of the six biggest banks, JPMorgan Chase and Wells Fargo, could boast market capitalisations that exceeded the net book value of their assets. Now all but Bank of America and Citigroup are in that happy position.

Banks’ shares were already on the up, largely because markets expected the Federal Reserve to raise interest rates after a long pause. It obliged in December and March, with three more rises expected this year. That should enable banks to widen the margin between their borrowing and lending rates from 60-year lows. Mr Trump’s victory added an extra boost by promising to lift America’s economic growth rate. He wants to cut taxes on companies, which would fatten banks’ profits directly as well as benefiting their customers. He has also pledged to loosen bank regulation, the industry’s biggest gripe, declaring on the campaign trail that he would “do a big number” on the Dodd-Frank Wall Street Reform and Consumer Protection Act, which overhauled financial regulation after the crisis.
So have the banks at last put the crisis behind them? This special report will argue that many of them are in much better shape than they were a decade ago, but the gains are not evenly spread and have further to go. That is particularly true in Europe, where the banks’ recovery has been distinctly patchy. The STOXX Europe 600 index of bank share prices is still down by two-thirds from the peak it reached ten years ago this month. European lenders’ returns on equity average just 5.8%.

America’s banks are significantly stronger. In investment banking, they are beating European rivals hollow. They are no longer having to fork out billions in legal bills for the sins of the past, and they are at last making a better return for their shareholders. Mike Mayo, an independent bank analyst, expects their return on tangible equity soon to exceed their cost of capital (which he, like most banks, puts at 10%) for the first time since the crisis.

But financial crises cast long shadows, and even in America banks are not back in full sun yet.

Despite the initial Trump rally, the S&P 500 banks index is still about 30% below the peak it reached in February 2007 (see chart). Debates about revising America’s post-crisis regulation are only just beginning. And the biggest question of all has not gone away: are banks—and taxpayers—now safe enough?


Plenty of Americans, including many who voted for Mr Trump, are still suspicious of big banks. The crisis left a good number of them (though few bankers) conspicuously poorer, and resentment easily bubbles up again. Last September Wells Fargo, which had breezed through the crisis, admitted that over the past five years it opened more than 2m ghost deposit and credit-card accounts for customers who had not asked for them. The gain to Wells was tiny, and the fine of $185m was relatively modest. But the scandal cost John Stumpf, the chief executive, and some senior staff their jobs, as well as $180m in forfeited pay and shares. Wells has been fighting a public-relations battle ever since, and mostly losing.

This report will take stock of the banking industry, chiefly in America and Europe, a decade after the precipitous fall from grace of banks on both sides of the Atlantic. The origins of the crisis lay in global macroeconomic imbalances as well as in failures of the financial system’s management and supervision: a surfeit of savings in China and other surplus economies was financing an American borrowing and property binge. American and European banks, economies and taxpayers bore the brunt.

Banks in other parts of the world, by and large, fared far better. In Australia and Canada, returns on equity stayed in double figures throughout. It helped that Australia has just four big banks and Canada five, which all but rules out domestic takeovers and keeps margins high. As commodity prices have sagged recently, so has profitability in both countries, but last year Australia’s lenders returned 13.7% on equity and Canada’s 14.1%, results that banks elsewhere can only envy.

Japan’s biggest banks, which had been reckless adventurers in the heady 1980s and 1990s, did not remain wholly unscathed. Mizuho suffered most, writing down about ¥700bn ($6.8bn). The Japanese were able to pick through Western debris for acquisitions to supplement meagre returns at home. Some chose more wisely than others: MUFG’s stake in Morgan Stanley was a bargain, whereas Nomura’s purchase of Lehman Brothers’ European business proved a burden. Chinese lenders were mostly bystanders at the time, remaining focused on their domestic market.
The seven consequences of apocalypse
Ask bankers what has changed most in their industry in the past decade, and top of their list will be regulation. A light touch has been replaced by close oversight, including “stress tests” of banks’ ability to withstand crises, which some see as the biggest change in the banking landscape. Before the crisis, says the chief financial officer of an international bank, his firm (and others like it) carried out internal stress tests, for which it collected a few thousand data points. When his bank’s main supervisor started conducting tests after the crisis, the number of data points leapt to the hundreds of thousands. It is now in the low millions, and still rising. The number of people working directly on “controls” at JPMorgan Chase, America’s biggest bank, jumped from 24,000 in 2011 (the year after the Dodd-Frank act, the biggest reform to financial regulation since the 1930s) to 43,000 in 2015.

That works out at one employee in six.

The second big change is far more demanding capital requirements, together with new rules for leverage and liquidity. Bankers and supervisors agree that the crisis exposed banks’ equity cushions as dangerously thin. For too many, leverage was the path first to profit and then to ruin. Revised international rules, known as Basel 3 (still a work in progress), have forced banks to bulk up, adding equity and convertible debt to their balance-sheets. The idea is that a big bank should be able to absorb the worst conceivable blow without taking down other institutions or needing to be rescued.

Between 2011 and mid-2016 the world’s 30 “globally systemically important” banks boosted their common equity by around €1trn ($1.3trn), mostly through retained earnings, says the Bank for International Settlements in Basel.

Third, returns on equity have been lower than before the crisis. In part, that is a natural consequence of a bigger equity base. But the fallout from the crisis has also squeezed returns in another way.

Central banks first pushed interest rates to ultra-low levels and then followed up with enormous purchases of government bonds and other assets. This was partly intended to help banks, by making funding cheaper and boosting economies. But low rates and flat yield curves compress interest margins and hence profits.

Balance-sheets have been stuffed with cash, deposited at central banks and earning next to nothing.

According to Oliver Wyman, a consulting firm, the share of cash in American banks’ balance-sheets jumped from 3% before the crisis to a peak of 20% in 2014. As the world economy is at last reviving after several false starts, earnings may pick up in Europe as well as in America.

Sweat your assets
Fourth, sluggish revenues, combined with the competing demands of supervisors and shareholders, have forced banks to screw down their costs and to think much harder about how best to use scarce resources. “If I’m going to get a good return on a high amount of capital, I’d better focus on what I’m good at,” says Jim Cowles, Citigroup’s boss in Europe, the Middle East and Africa. Citi, which under Sandy Weill in the late 1990s had become a sprawling financial supermarket, selling everything from investment-banking services to insurance, has retreated to become chiefly a corporate and investment bank, much as it had been in the 1970s and 1980s. Its bosses emphasise its “network”, a presence in nearly 100 countries that multinationals’ treasurers can count on. It once also had retail banks in 50 countries, many of them second-string. That total is now down to 19.

Such retreat from marginal businesses has also meant fewer jobs and lower bonuses, even if bankers’ pay is still the envy of most. That has brought about a fifth change: banks have become less attractive employers for high-powered graduates. “The brightest people no longer want to go to banks but to Citadel [a hedge-fund firm],” laments a senior banker. Some millennials, he adds, are drawn to technology companies instead. Others “don’t want to deal with business at all”. That is because of a sixth change: the financial sector’s reputation was trashed by the crisis. One scandal followed another as the story of the go-go years unfolded: providing mortgages to people who could not afford them; mis-selling securities built upon such loans; selling expensive and often useless payment-protection insurance; fixing Libor, a key interest rate; rigging the foreign-exchange market; and much more.

Seventh and last, financial technology is becoming ever more important. That may be better news for banks than it sounds, despite the creakiness of some of their computer systems. Plenty of financial startups are trying to muscle in on their business, but in a highly regulated industry heavyweight incumbents are harder to usurp than booksellers or taxi drivers. As a result, there is a good chance of banks and technology companies forming mutually beneficial partnerships to improve services to their customers rather than fighting each other.

Will Economic Illiteracy Trigger a Trade War?

Jeffrey D. Sachs
. Wilbur Ross

NEW YORK – Nearly 100 days after US President Donald Trump took office, he and his commerce secretary, Wilbur Ross, continue to commit an economic fallacy that first-year economics students learn to avoid. They claim that America’s current-account deficit (or trade deficit), which is in fact the result of America’s low and falling saving rate, is an indicator of unfair trade practices by Germany and China, two current-account surplus countries. Their embrace of economic ignorance could lead to disaster.
The current-account balance, measuring the balance of trade in goods, services, net factor income, and transfer payments from abroad, is equal to national saving minus domestic investment. That’s not a theory. It’s an identity, save for any statistical discrepancy between gross national product (GDP) and gross national income (GNI). It’s true whether you are liberal or conservative, populist or mainstream, a Keynesian or a supply-sider. Even Trump and all his deal making can’t change that. Yet he is threatening a trade war because of deficits that reflect America’s own saving-investment imbalance.
A country runs a current-account deficit if investment exceeds national saving, and runs a surplus when investment is less than national saving. For a country with a balanced current account, a deficit can arise if its investment rate rises, its saving rate falls, or some combination of the two occurs.
Suppose that the US is trading with foreign countries that maintain protectionist policies. If these countries liberalize their trade regimes, they will tend to import more US goods that compete with their own industries. The size of the import-competing sectors will then shrink, freeing up workers and capital to increase output in export sectors. As exports rise, so will the foreign-exchange earnings that pay for the higher import bill.
Suppose, conversely, that the US imposes new import barriers in response to its current-account deficit. These import barriers would pull workers and capital into import-competing sectors and away from export sectors, roughly leaving the US trade balance unchanged while lowering national income and average living standards. The trade deficit could fall if the import barriers were in the form of trade taxes that lowered the budget deficit (thereby raising government saving) but that effect would work through the budget, not through trade policy per se.
There is no particular reason why a reduction of foreign trade barriers or an increase in US trade barriers would have any first-order effects on the US saving and investment rates, and therefore on the US current-account balance. To reduce its current-account deficit, the US must either save more or invest less in its economy.
It’s not hard to see why the US runs chronic current-account deficits. The US national saving rate – the sum of private saving plus government saving, measured as a share of GNI – has declined markedly during the past 30 years. Most of the decline in the US saving rate is due to a decline in the government saving rate.
Government in the US (federal, state, and local) is a net dis-saver, meaning that current outlays (for consumption, interest payments on the public debt, and transfers) exceed revenues, currently by around 2% of GNI. This is not surprising. The lion’s share of the problem is at the federal level. Every president since Ronald Reagan has promised “middle-class tax cuts” and other tax breaks, undermining revenues and leaving the federal budget in chronic deficit.

Democratic presidents favor the supposed Keynesian “stimulus” of tax cuts, while Republicans champion their alleged “supply-side” effects.
Both the Democratic and Republican parties are practitioners of populism, American-style: they repeatedly cut taxes, increase the public debt (which doubled from 35% of GDP in 2007 to 74% of GDP at the end of 2015), and generally blame somebody else for the slow US growth that arises from low saving and investment rates. Now it’s the turn of China and Germany to be in US leaders’ crosshairs.
America’s trade and budget imbalances could soon get a lot worse if Trump and congressional Republicans get their way in cutting federal taxes still further. This would be a ruinous fiscal policy, yet perhaps a popular one in the short term – before the economic bills start coming due. With a larger budget deficit, America’s current-account deficit would soar as well, just as it did when Reagan’s tax cuts expanded the federal budget deficit sharply in the early 1980s.
One can imagine that the rising trade deficit would then lead to even more outlandish claims by Trump and his officials about alleged Chinese and German trade perfidy.
Americans should not allow themselves to be fooled. The emperor has no clothes, imported or domestic; and, apparently, he has no competent economic advisers, either.

How Unconscious Biases Block Effective Interactions

Most people would not consider themselves biased. But a new book says that nearly everyone has unconscious biases — and they affect how we interact with others, with real consequences. Filter Shift: How Effective People See the World by Sara Taylor notes that one can learn to manage these biases, or filters, by being mindful that they are there and then working on ways to address them.
Critical to the process is the “Platinum Rule,” which is learning to treat people how they not you — would like to be treated, because what works for you may not work for others. Taylor recently shared insights from her book on the Knowledge@Wharton show, which is part of Wharton Business Radio that airs on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

An edited transcript of the conversation follows.

Knowledge@Wharton: When you talk of ‘filter shift,’ what exactly do you mean?

Sara Taylor: This is about how our unconscious [biases] dictate how we’re seeing our interactions. What we need to [recognize] are the filters operating in our unconscious, and eventually [learn] to shift those filters in order to be more effective.

Knowledge@Wharton: How many people realize they probably have this problem and are able to manage it? You say that to navigate through this problem one could learn along the way.

Taylor: With one of the cultural competence models that we use, we see that between 95% and 99% of us don’t realize that we have a problem. That’s the number of folks that have a significant gap between where they think they are versus where they actually are in their [level of] competence in interacting [with other types of people].

What does that mean? If I think that I’m Wonder Woman when it comes to having interactions with folks that are different from me, in reality, I don’t have that skill. That means I’ve got some huge blind spots, and it might also mean that I’m unintentionally offending others. None of us wants to unintentionally offend others. So, learning how to filter-shift helps us to become more intentional, and match our impact with that good intent.

Knowledge@Wharton: There’s an interesting example in the book involving [a meeting between former Iraqi leader] Saddam Hussein and [former New Mexico governor] Bill Richardson, and how subtle some of these slights could be

Taylor: The key learning in that story is, we’ve got all kinds of great mantras and philosophies that we all live by. But we don’t realize that many times, those mantras perpetuate this ineffectiveness. The one that we talked about with that particular story is the mantra of the Golden Rule: We should treat others as we want to be treated. That is a reflection of one of the ineffective [phases along the] five stages of development.

Why is that ineffective? Because it’s based on just this teeny, tiny assumption that the whole universe wants to be treated the way I want to be treated. That’s not the case. We’ve got to learn how to treat others as they want to be treated, which is the Platinum Rule.

Knowledge@Wharton: Richardson was sitting at the table, getting ready to meet with Saddam Hussein, and he had his knee crossed over his other leg. That allowed the bottom of his shoe to be seen, which is a big insult in Iraqi culture.

Taylor: Bill Richardson is a very competent, very successful and very effective person. He even had three staff people helping him prepare for that meeting for three months. Yet, it was still over in less than a minute, because it was incredibly offensive, the way he was showing the sole of his shoe.

That would be the equivalent of Saddam Hussein sending a diplomatic emissary to President Clinton, and that diplomatic emissary sitting down in the Oval Office would be flipping off President Clinton. (While Saddam Hussein abruptly left the room, he returned a while later to the meeting, as Richardson noted in a 1996 interview in Fortune magazine.)

The learning there is that we can’t know what every gesture [means]. But, Bill Richardson [could have prepared] from the perspective of Saddam’s filters — how does Saddam look at this meeting? [Instead,] what he did to approach it was to say, “What would I want if I were in Saddam’s shoes?” That’s the Golden Rule, and that’s what tripped him up.

[Richardson] thought, “If I were in Saddam’s shoes, I wouldn’t want the big powerhouse of the world, the United States, coming in and being all uppity and formal with me. I’d want them to be informal.” That’s why he went into that meeting, sat down, leaned back, crossed his legs, and up went the sole of his shoe.

Knowledge@Wharton: That could similarly play out in boardrooms or negotiation tables and have a negative effect.

Taylor: That’s right. The reality is, lots of us aren’t in situations like that, with a dictator who can just get up and leave a meeting because they’re upset. For the rest of us, we may be in meetings or in other interactions, and we might get a sense afterward that, “Hmm, I don’t know that that went very well.” We don’t have the [other] person telling us [what was amiss]. We don’t have the person getting up and leaving. So, we don’t have those cues from others everyday that we’re not being our most effective [selves].

Knowledge@Wharton: The word ‘see’ is important to this process. The letters in the word stand for See, Explain, and Evaluate.

Taylor: That’s right. When we observe anything, or when we’re in an interaction, all kinds of thoughts come to our mind: I think he’s this, I think he’s that; I thought this about what he said. What we don’t realize is, the vast majority of those thoughts are coming from our unconscious. That’s the “Explain” and “Evaluate.”

My unconscious takes what I see, what’s objective, and then its job is, “I’ve got to pass up an explanation to that conscious mind. Here’s how I’m going to explain what I think I see.” The unconscious goes even further. It says, “Now I’ve got to place a judgment on it. Here’s the judgment of what I think I see.”

Those filters are operating, doing all this in my unconscious, but those filters are created by my past experiences. In my interaction with you, my brain is giving me all kinds of explanations and judgments about you. But I have no idea if what my filters are telling me matches what your filters are telling you.

You’ve got it coming from the other side [as well]. Your filters are telling you all kinds of things about me. And then we can get into a misunderstanding. What we don’t realize when we’re in those misunderstandings is, many times those are filter fights.

Knowledge@Wharton: How often are some of those situations just misunderstandings?

Taylor: I think it’s the vast majority of the time. I’ve asked this question to probably tens of thousands of people — folks in the audience during my presentations, and I see head-nods in agreement — “Do you think the vast majority of us enter the workplace every day with positive intent?”

If we all are entering the workforce and want to have positive relationships, we want to contribute, and we’ve got that positive intent, then why do we have misunderstandings? The reason we have misunderstandings is because we aren’t able to match that positive intent with an equally positive impact.

When it gets down to it, what is it that really matters? I could have the best of intentions. Let’s say I’m presenting, and I’ve got my stiletto heels on, which I never do when I present. I accidentally step on someone’s foot, in the front row with my stilettos. Their reaction is going to be a scream, probably, right?

I’m going to say, “Oh my gosh! I didn’t mean to hurt you! I’m so sorry.” Now, what’s going to actually determine whether that person was hurt or not? Is it going to be the scream, or my ‘Oh my gosh, I didn’t mean to’? We know it’s the impact that decides.

Going back to our interactions, it’s our impact on others that decides our effectiveness, not our intent. I can have the best of intentions, and then I get into a misunderstanding with someone, and then [conclude that] it must be their fault [or] they were disrespectful. I don’t say, “Wait a second. How is my unconscious really controlling that situation? How did that determine how I interacted? What do I need to do to have a better impact the next go-around?”

Knowledge@Wharton: You mention that a lot of times this happens because people aren’t taught to be able to deal with and understand others. Why do you think that’s the case? And how are you able to handle that?

Taylor: Exactly. Why aren’t we taught? I would say that the reason why most of us aren’t taught this competence is because we believe a number of myths.

One is we believe that just being comfortable with differences means that I’m going to be competent.

Think about it, in what other areas does comfort equal competence? I am completely comfortable holding my high school clarinet that I used to play. But you do not want to hear me try to play it. I am nowhere near competent.

The other myth is, “I’m exposed to all kinds of differences. I’ve got differences all around me. My best friend is gay. My next-door neighbor is black. My mom has lived with a disability all of her life.

I get this stuff.” But in what other area would we say that exposure equals competence? If that were the case, we wouldn’t need schools. We’d just have, say, a math guru, and everybody would send their kids to be exposed to the math guru for an hour, and they’re going to know math. We know that that’s not true in [cases where skills are a competence to be learned].

The reality is that we just don’t see [bias shifting] as a competence [that needs to be developed]. But we need to start seeing it that way.

Knowledge@Wharton: You also talk about how some things seem so obvious to some people. Yet, we have problems believing that it could be that easy.

Taylor: What we sometimes do is [point out] something that is obvious — an obvious difference, in particular. But we [may be] uncomfortable talking about it.

[This is something that happens] all the time, with my husband and me. I’m a white woman. My husband is a black man. There are times when we’re in all-white groups, except for my husband. Somebody will say, “Sara, which one’s your husband?” If I’ve got the one black guy in a sea of white folks, wouldn’t it be obvious to just say — as I’m trying to point him out — “the black guy?”

But, many times, folks just feel very uncomfortable with that, because we [get many social] messages that we shouldn’t talk about those differences. So, lots of times, when I say that, I’ll get very uncomfortable responses. Particularly, what I get most is a nervous laughter. I know what they’re thinking: “Oh my gosh, Sara just said ‘black.’ She called her husband that. She doesn’t even know that she’s not supposed to say that.”

There, it’s our unconscious telling us, “Oh, that’s a topic you should avoid.” But then, what happens if we’re avoiding those topics — when do we get into them? If we’re uncomfortable talking about differences, especially the easy-to-see differences, then how are we ever going to be comfortable in our workplace, interacting with those differences? And also, talking about the differences that are even more difficult to see?

Knowledge@Wharton: Do you feel we can effect change in these areas with more understanding relationships in our personal lives, and hopefully that will carry over into our business life, where some of these issues apply as well?

Taylor: Yes, I hear that all the time. I work with people, mainly in the workplace. What I hear from them is, “Oh my gosh, you just solved an issue that I’ve been struggling with for 20 years with my husband.” Or, “I just want to bring my wife in,” or, “I just want to bring my partner in, my kids in, so they can hear this.” So, yes, it definitely plays out both at home and at work.

The second piece is that this is something that can be developed. There are some people who might naturally be nicer people. There are some people who are naturally more extroverted, versus introverted. That’s not what we’re talking about. We’re talking about a competence that we can develop.

To that point, let me see if you can guess — we plot this out — the five stages of development. They’re progressive; you have to move through them to get to the most developed stage. In the most developed stage, we can see the full complexity of differences that are around us, and we can respond to them effectively. So, what’s your guess? How many of us, do you think, operate in that stage?

Knowledge@Wharton: I’m not sure what the percentage is, but I would say it’s got to be way up there.

Taylor: That’s what most of us think. But guess what? I don’t mean to be a Debbie Downer here, but it’s only 2.5%. Only 2.5% are operating in the highest stage of effectiveness, where we can see the full complexity [of someone else], and respond to it. The good news is we can develop this competence.

Knowledge@Wharton: What do you think is the best way to try to do that? That seems like it would be a large task to undertake.

Taylor: The good news is, it isn’t. It used to be, though. To get folks to that last stage, it takes about 40 hours of intentional development work. During that work, we show people all kinds of differences, from all kinds of different groups. Eventually, what will happen is, you’ll develop [that competence].

We did that for years, and what I started to see is that the process did work, and people developed to that last stage. But, as we did it, I started to hear and see patterns of people making these shift points. And so, I said, what if we just taught those shift points? At the time, I called them ‘key developmental shifts,’ or things that you needed in order to develop [these skills.]

There are six of those. I started to teach just those key developmental shifts. With that, we were able to bring the 40-hour process down to nine hours. That’s the process we talk about in Filter Shift. It starts with myself, understanding my own filters, then understanding the filters of others, and finally, understanding how I shift my filters to approach a situation more effectively.

What a War with North Korea Looks Like

None of the options, apart from de-escalation, are attractive.

By George Friedman

In the last week, the possibility of war between the Democratic People’s Republic of Korea and the United States has increased. It is necessary therefore to consider what such a war might look like. I am using the term war rather than merely American attacks on North Korean nuclear and missile program facilities because we have to consider the possibility of North Korea’s response and a more extended conflicto.

Such a war would be based on North Korea’s decision to move its nuclear program to a stage where the U.S. and other countries conclude it is possible that North Korea is close to having a deliverable nuclear weapon. Given that the North Koreans could not survive a nuclear exchange, it is hard to understand why they would have moved their program to this point. The obvious reason for having a nuclear program is to use it as a bargaining tool. The reason for having a nuclear weapon would be as a deterrent to a foreign power seeking regime change in North Korea. The most dangerous period for North Korea is when it is close to having a weapon but does not yet have it. That is the period when an attack by an external force is more likely. It is the period before North Korea could counterattack. Pyongyang’s decision to deliberately send signals that it has a nuclear weapon increases the urgency of an attack. Its decision is odd, even if it already has one or two nuclear weapons.

A photo from North Korea’s official Korean Central News Agency shows ballistic missiles on display at Kim Il Sung Square during a military parade in Pyongyang, on April 15, 2017. STR/AFP/Getty Images

A U.S. decision to attack will be based on the severity of the consequences should the North Koreans use their weapons, if they have them. If not, the decision is based on the possibility that North Korea is close to having them. The problem with a U.S. strike is five-fold. First, does U.S. intelligence have clarity on the locations of critical North Korean facilities? Second, are the president and his staff confident in their intelligence? Third, can the facilities be destroyed with non-nuclear weapons? Fourth, is battle damage assessment possible (in other words, can we know with confidence whether the facilities were destroyed)? Finally, if only a nuclear weapon – or multiple nuclear weapons – can destroy the facilities, does stripping North Korea of nuclear weapons justify the significant political fallout the U.S. would face in launching such an attack a second time? And does it justify the risk that it might legitimize the use of nuclear weapons by others?

I don’t know the answers to these questions. I don’t think the U.S. will stage a pre-emptive nuclear attack absent clear intelligence that North Korea intends to strike first. I also will at least assume that a conventional attack is possible, and that battle damage assessment is possible. Under those circumstances, absent Chinese pressure compelling North Korea to step back from its current capabilities and demonstrate that it has stepped back (which is hard to prove), the United States might well attack.

Assuming an attack is successful, North Korea would face the question of how it would respond. It has two options. The lesser of the two, which North Korea appears to have threatened, is to attack American citizens in South Korea, including kidnapping and extracting them to North Korea. A far more significant counter would be to use its heavy concentration of artillery along the western section of the border with South Korea to initiate extremely intense shelling of Seoul. The casualties and damage from such a move could become extreme, even in a short period of time. Trading Seoul for North Korea’s nuclear program is not an option.

Were this to happen, the American response would likely be missile strikes and airstrikes designed to destroy North Korea’s artillery. The problem is that if the U.S. waits to see if North Korea initiates a barrage, that delay of a few hours would create unacceptable casualties. For the United States, such an attack on a close ally would be unacceptable, and it therefore would have to assume that this is what North Korea will do. North Korea deployed substantial resources for this possibility and has conducted exercises to test readiness (although it hasn’t fired).

Therefore, the United States must consider air attacks on an area running along the border to a slant distance from Seoul of about 25 miles, and a depth also of about 25 miles. In other words, the U.S. must devastate an extremely large area very quickly. The immediate problem is North Korea’s air defenses in this area. North Korea has a range of surface-to-air missiles (SAMs), including some indication that it has developed the equivalent of the Russian S-300, which is similar to the American Patriot system. If so, they are able to engage aircraft several hundred miles from the target.

The sequence for destroying the artillery is by dispersing vast numbers of area munitions from strategic bombers. The workhorse aircraft for this mission would be the B-52, which is able to carry a large tonnage of munitions and release it quite accurately from high altitude. But given that North Korea has high-altitude SAMs and the B-52s are not stealth, the losses of B-52s could be high. The U.S. has B-1s and B-2s, and the latter is said to be invisible to radar, but no one has tried to use them against a SAM concentration like North Korea has. At any rate, the U.S. has fewer of those, and for an area attack the number of sorties required and the time penalty for Seoul would be unacceptable.

Therefore, the U.S. would have to fall back on a conventional opening of an air campaign with a Suppression of Enemy Air Defenses (SEAD) attack. In English, they must destroy the SAMs.

This would be carried out by a number of aircraft, particularly a class of plane called the “Wild Weasel.” These are attack aircraft armed with missiles that home in on radar beams. They carry electronic warfare systems for detecting and jamming radar. These missiles are extremely fast and follow the beam down to destroy the search radar and render SAMs useless.

An SEAD attack could last for days or weeks, during which time North Korean artillery would be raining down on Seoul. The U.S. either accepts the possibility of extreme aircraft losses or the destruction of large parts of Seoul.

That leaves open the possibility of a ground assault. A ground assault directly against a concentration of artillery requires large losses as the force moves into contact. A flanking move to the east is possible, but it will be visible and the artillery can pivot – at least some can. Plus, the North Koreans have mine belts deployed throughout the border region. Similarly, the artillery is defended at depth, so an airmobile operation to take them from the rear would likely require deployment over 60 miles to the rear.

The North Koreans, therefore, appear to have an effective counter. Their artillery is dangerous and targets South Korea’s capital and largest city. Destroying the nuclear facilities while Seoul is devastated would raise questions about American military capability that would resonate. The United States needs a win for political reasons.

It is possible that North Korean artillery is less formidable than most think. It also is possible that U.S. military planners have defined a solution that is less dangerous than I have. But the fact is that on the surface, North Korea could give up its nuclear capability, still win a decisive victory against the Americans by destroying Seoul, and inflict severe losses on the American Air Force. It would emerge with the regime intact and even more credibility than before.

The artillery deployment north of the Demilitarized Zone facing Seoul has been in place for many years. Married to competent SAM systems and radar-guided guns, it seems to represent a formidable capability. This means that if the U.S. attacks the nukes, North Korea has the initiative to start a battle in the DMZ, posing unacceptable choices for the United States and catastrophic choices for South Korea.

If you detect a lack of enthusiasm by the South Koreans to the idea of a U.S. airstrike on North Korean nukes, this is why. It’s not about the cost of integrating North Korea into South, although that matters. Rather, it is their fear of losing their capital. Japan, also at risk from nuclear weapons but not artillery, is much more enthusiastic about these strikes.

North Korea might not initiate a response. But the United States doesn’t know what North Korea intends, and its intentions might change. Therefore, it must take this into account in any battle plan. I began by asking if the North Koreans are crazy. Perhaps so, but in this case they have handed the Americans a far weightier problem than simply wondering whether they have good intelligence and whether that intelligence can be trusted. With the best intelligence in the world, attacking and destroying a SAM concentration takes time, and Seoul doesn’t have time.

The North Koreans know that and calculate that they have the upper hand.

What Turkey’s Referendum Means for the Country’s Future


Turkish President Recep Tayyip Erdogan has claimed victory following this week’s referendum that would would replace the country’s parliamentary system with a powerful presidential system — a move that could let him stay in office until 2029. Following a close vote — 51.4% for “yes” vs. 48.6% for “no” — international election monitors noted election irregularities and indicated that the vote was not a true measure of popular will. Chief among the problems they cited was media domination by the “yes” campaign. Opposition parties have demanded recounts.

The referendum will do away with Turkey’s parliamentary system, instead turning to an executive presidency with few curbs on the power of that office. The vote followed a failed coup in July 2016, and members of the opposition contend there has been a campaign of intimidation by Erdogan supporters to sway the vote that included the jailing of some journalists and opposition leaders.

The country has also been under a state of emergency since the coup attempt.

There has not been this much election “unfairness” in Turkey since 1946, according to Wharton finance professor Bulent Gultekin, a top advisor to two former Turkish prime ministers and also formerly governor of the Central Bank of the Republic of Turkey. “The legitimacy of the referendum is really in question,” he said. “He’ll have a very difficult time governing the country – there is a question of legitimacy…. There is also a sense of dissatisfaction … and people are feeling quite cheated.” 

Gultekin made these and additional comments on the Knowledge@Wharton show, on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.) Joining Gultekin on the show was Steven A. Cook, a senior fellow at the Council on Foreign Relations. Cook is the author of the upcoming bookFalse Dawn: Protest, Democracy, and Violence in the New Middle East. Their discussion includes what is likely to happen to Turkey’s economy going forward, and the effect of the referendum’s results on Turkey’s efforts to join the European Union. Cook noted that Turkey is the only experiment in the Muslim world as a secular society, and there is a chance that effort could now be lost. “People are more worried about that sort of change and are more mobilized than in any other election.”

Knowledge@Wharton: You’re seeing this unfold firsthand. How much concern is there over the vote?

Bulent Gultekin: There is quite a bit of concern in the country, and not [only] with the vote — even before that. There was a concern that the country was moving into some sort of a totalitarian regime, a one-man rule. Even though he’s supposed to be an impartial president, Erdogan has been acting almost like a man above the law. He has been pretty much violating the constitution ever since he was elected by popular vote in Turkey.

The reason for this election — I don’t think there was any real economic or political reason — is mostly for self-preservation. Erdogan doesn’t seem to trust the army, police and even probably his own party, especially after the coup attempt last July. Then there is another complication in Turkish politics that you don’t see elsewhere. We had this unusual affair [involving exiled cleric Fethullah] Gülen, who managed to infiltrate just about all institutions, particularly the judiciary, government, police and army. And I think that created some political infighting, or at least a fight within political Islam.

So, Erdogan wants to control, and he wants to be unaccountable. I think this referendum was about one man. And, of course, there is another reason underneath. Erdogan has been [fighting] with the Republican regime of modern Turkey [which has ruled] since 1923 [when Mustafa Kemal Atatürk became president]. He represents political Islam. He is the product of a secular society, but he always has these instincts to go back, or at least to use Islam for his political objectives. He’s been an exceedingly successful campaigner, and he has extremely well-oiled election machinery in the party.

I served as chief adviser to two prime ministers in Turkey. I served as the governor of the Central Bank…. In 1991, I even managed election campaigns for the ruling party. Then I set up my own party in 2002 to run against Erdogan and the ruling parties at the time. I’ve never seen such an election in the history of Turkey. That is, Turkey since 1946. The campaign was extremely unfair.

They used the entire state support, which is illegal. And though successful from a political stance, [Erdogan] turned it not into a referendum on the constitution, or even regime change.

He realized that he might have difficulty and turned it into more of a personality issue — whether they would choose him against the opposition — and he used Islamic themes [to win].

But despite all that, there have been significant allegations of fraud. My guess is that these allegations are serious. And it was pretty close – 51% to 49%. There is this very serious legitimacy shift. So Erdogan is going to have a very difficult time ruling.

Knowledge@Wharton: You mention the concerns over the voting in this referendum and the fact that there were many votes that were accepted that weren’t certified. They weren’t stamped as being official votes. So the concern is with the closeness of the referendum vote to begin with. If there were a number of votes that fell into that category, then it could potentially flip the result?

Gultekin: It could. I don’t have the data to say what would have been the case. The legitimacy of this referendum is really in question. But there are other issues that are silver linings in the whole thing. This time, the NGOs and the civil society were mobilized to a degree I have never seen in Turkey. The results are also quite indicative. The most important result of this referendum is that Erdogan lost Istanbul. That has been his power base since 1994, since he won the election as mayor. That’s very significant. He was expecting to win about 60% to 70%.

But this did not occur.

The loss in major cities is quite a significant change. This is where people are mobilized. The rural areas are very strong in party apparatus. This probably had a significant impact on the vote. This equation is not really very different from the U.S., if you look at the red states vs. the blue states. Turkey along the coastal lines voted predominantly no; the rural areas voted yes, and the southeast, Kurdish areas also voted no. So Erdogan managed to split the country into three.

But I would call this probably the beginning of his end. He’s going to have a very difficult time governing the country. There is a question of legitimacy. This has never happened in any election in Turkey. No one ever questioned the legitimacy. So I don’t know how long this is going to last, but there is certainly a very strong sense of dissatisfaction. People are almost feeling cheated.

Knowledge@Wharton: Erdogan’s expectation was that he would win about two-thirds of the votes. When the election cycle came around again in 2019, he wouldn’t have that much of an issue. Now that it’s 51-49, and you mentioned Istanbul as well, is he potentially a leading candidate, or do you not see him as even a potential leading candidate going into 2019?

Gultekin: He’s going to be the leading candidate. Erdogan has no choice. He’s like a man on a bicycle. He has no choice but to pedal. The moment he’s out, he’ll be in deep trouble. There are very serious allegations of corruption about him and his family. Many people argue that this is all to save himself and his family, which is a very sad thing to say about Turkey these days. But no, he will be in the running. It’s very difficult to make predictions in politics, but I won’t be surprised if they call an early election soon.

Knowledge@Wharton: What’s the reaction so far from Europe? Turkey has been trying to push, especially recently, to join the European Union (E.U.). I would think something like this would not sit well with the E.U.?

Gultekin: Well, there are two views. One is sort of a naive view that [Europe] might look at Turkey with concern. But I’m sure that a lot of countries — France, Austria and others — are experiencing relief that this is the Turkey they want to see. And this will be the end of Turkey’s adventure with the E.U. But they may worry about what might happen and how to deal with Erdogan eventually.

Turkey’s accession to Europe has never been guaranteed. Europeans have been pretty stingy about that. If they had really helped Turkey like the E.U. helped the Eastern European countries after the fall of the Berlin Wall, Turkey would have been in a very different situation.

And I would call that Turkey paying a very high price for the Cold War, being pretty much left out afterwards.

Knowedge@Wharton: If Erdogan does win the elections in 2019, that sets him up to be President of Turkey for how long?

Gultekin: I’d say it’s going to be another two terms. So it will add 10 more years — almost 2029.

Knowledge@Wharton: Do you think we will see more potential uprisings like [the one that] was attempted this summer in Turkey?

Gultekin: That was a coup. But we also saw civil protests a few years ago in Taksim. It all started with the protest to protect a green area in the center of the city. A sort of civil society in the country has been growing, which is very promising. I doubt whether Turkey will have another coup. The coup came from a group, the supporters of Gülen. There are a lot of unanswered questions about that affair.

Knowledge@Wharton: What do you expect, then, to see from the people of Turkey over the next several months?

Gultekin: There has been a pretty repressive environment in Turkey, in academia and elsewhere, and the media is pretty much nonexistent, pretty much owned by the government. It remains to be seen whether young people are willing to leave the country, or decide to stand up and resist — in the sense of fight or just work for the future of the country. There is some anecdotal evidence that a lot of youngsters want to leave the country. They always worry is it going to be tricky like Iran after Khomeini.

My guess is: I don’t think it’s going to happen. I don’t know if Europe is a better place nowadays for Muslims. Turkey is a predominantly Muslim country. My guess is people are going to resist. People are not going to take freedom, secularism and democracy for granted.

They just have to fight for it. It’s not going to be easy, because Erdogan and these people, political Islam, have demonstrated that they have no ethics whatsoever. So anything can be expected. People are expecting the worst, but I think they will brace for it. Nothing will surprise them from now on.

Knowledge@Wharton: There was a call by the opposition for this referendum vote to be canceled. It doesn’t seem the chances of that happening are very high, correct?

Gultekin: There might be some technical issues that I don’t know, but my guess is this government is not going to pay any attention to legalities.

Knowledge@Wharton: What is the status of the Turkish economy right now under President Erdogan?

Gultekin: Right now the economy is doing reasonably well, but we see some signs of fatigue, because the growth rate is going to come down. Erdogan spent most of his time politicking, as opposed to building the country for the next jump — to get out of the middle-income trap. And, of course, the success has been pretty much maintaining a decent fiscal discipline. There was a massive stimulus in the economy, which is not going to be sustainable. So I expect because of the lack of investment over the last 10 to 15 years in the country, growth is going to come down.

The population is young and is going to have a very difficult time with unemployment. So I don’t see the same high growth rate that we observed in the previous 10 years. As a result, I don’t expect bright days in the near future.

Knowledge@Wharton: Good morning, Steven Cook. What was your reaction to how the referendum played out?

Steven Cook: Well, it was not pretty by any stretch of the imagination, and there are obviously allegations of electoral fraud. All that being said, however, President Erdogan has already made it clear that there is going to be no way that the outcome will be reversed. And Turkey’s authoritarianism will deepen as he takes up more and more power, scheduled to begin with the general elections of 2019.

Knowledge@Wharton: So what are the expectations that he will continue as president in 2019 at this point?

Cook: I think it’s abundantly clear that he is going to be the AKP’s (Adalet ve Kalkınma Partisi) candidate. Just as they have dominated the media landscape and other areas of the country in order to get the outcomes that they wanted in both this referendum as well as the general elections of 2015, one will expect that the party and President Erdogan will pull out all the stops to ensure that he is once again reelected, and that he will stay in power until 2029 and perhaps even beyond.

Knowledge@Wharton: The accepting of the ballots that weren’t certified is obviously the big point of contention in this whole process. Here in the U.S., almost every time we have some sort of election, there is concern of some level of election tampering. So I guess we shouldn’t be surprised that this is occurring in this referendum vote.

Cook: Well, we shouldn’t be. Although, in 2010, the AKP-dominated Parliament passed a law that would have made it more difficult for this kind of electoral tampering, ensuring that unsealed, unauthenticated ballots were not counted. This time, they used their influence with the supreme election board to ensure that those ballots were counted. So they ran counter to their own law in order to secure this electoral outcome for President Erdogan.

Knowledge@Wharton: I want to get your opinion on how this plays out in Europe, and the impact that this has in that region, since Turkey has been trying to see if they can get into the E.U. for quite some time now?

Cook: Turkey has had a long-term goal of joining the E.U. But that has been on life support at best for the last 10 years or so. Europeans haven’t wanted to walk away, because they didn’t want to be accused of double standards and being Islamophobes. And the Turks haven’t walked away, because they didn’t want to let the Europeans off the hook. I can’t imagine that the result of this referendum, which gives President Erdogan sweeping powers and undermines checks and balances in the system, will enhance Turkey’s candidacy for E.U. membership. And, of course, President Erdogan has already announced that there may be a referendum on the continuation of Turkey’s candidacy. So Turkey is isolated from its European partners, in part because of crises that the Justice and Development Party manufactured in the run-up to this election, stirring up trouble among Turkish populations in Holland and Germany. Then there is this question of E.U. membership and whether Turkey will walk away.

Knowledge@Wharton: What is your greatest concern now for Turkey going forward, assuming that President Erdogan wins reelection in 2019?

Gultekin: Erdogan was greeted very warmly in the U.S. and Europe when he won the election. I haven’t changed my mind since 2002. Erdogan is more of a counterrevolutionary. I think he has been known for that, and he never actually hid that. So what I worry about is the change in the regime.

And this country has been the only experiment in the Muslim world as a secular society. And that may be lost if they continue in this fashion. I don’t want to say it’s going to be lost. But that’s the highest and worst risk. That’s the most dangerous thing that might happen.

Will it happen? We shall see. I think people are more worried about that sort of change and are more mobilized this time than in any other election, because they see the dangers of complete reversal of the regime. That’s what I see as the most problematic or the most profound change.

In the West, with the economy and [other factors], we’ve had crises back and forth, and will eventually come back to some sort of equilibrium. But a fundamental shift in the orientation of this country is quite crucial, not only for Turkey, but for the Muslim world and the Middle East. And Europe, for that matter.

Knowledge@Wharton: Do you make anything of President Trump calling President Erdogan to congratulate him in the wake of this referendum vote?

Cook: Well, it was certainly odd, given the fact that the OSCE (Organization for Security and Co-operation in Europe) observers called the referendum unfair. It puts the U.S. in some strange company, with, for example, the Palestinian terrorist organization Hamas, or the Palestinian authority, the government of Djibouti in Turkmenistan. Those are the people who have called President Erdogan to congratulate him.

But my sense is that President Trump’s call was an effort to mitigate the tension between the U.S. and Turkey as the U.S. accelerates its operations against the Islamic State in Syria, in cooperation with Syrian Kurdish groups that the Turks regard as terrorists. It’s a fact of life that Turkey is strategically important to the U.S. and that Ankara sits literally at the geographic center of some of America’s most pressing foreign policy problems. [In the past] American presidents overlooked some of the excesses of the Turkish government, in order to secure their cooperation for a variety of other priorities.