Emptying Iran’s Pockets

George W. Bush is clearly getting tough with Iran. He took aim at Tehran in his speech to the nation Wednesday night, stressing that he holds the Iranian government responsible for helping to destabilize Iraq. Within hours came reports the U.S. was arresting Iranian diplomats inside Iraq .

But there's probably only one really effective way left, short of war, to put pressure on a government that has threatened a new Holocaust. And that is to adopt a strategy that Americans pursued a decade ago against the perpetrators and collaborators of the last Holocaust—the Germans and the Swiss.

Stuart Levey knows this well. Levey, the undersecretary of the Treasury for terrorism and financial intelligence, has been leading the U.S. campaign to isolate and slowly asphyxiate the Iranian economy. "Asphyxiate" is not a word he would use, but that is effectively the strategy being pursued by Levey and Treasury Secretary Hank Paulson as they exert pressure on international banks and trading partners to stop dealing with Iran. While there are no real "metrics" to assess the success or failure of behind-the-scenes diplomatic pressure of this sort, some recent evidence suggests that many Iranians are no longer comfortable dwelling in the thin air of their country's isolation. And they are beginning to second-guess their militant Islamist president, Mahmoud Ahmadinejad, who has led them there. Even as the populist Ahmadinejad continues to hurl spitballs at Washington and Europe over the U.N. Security Council resolution that sanctioned Iran last year, dissident groups have popped up on state TV and radio, questioning his policies. And the Iranian president saw his political allies take a beating in local elections on Dec. 15.

Can this sort of financial “waterboarding” stop a nuclear bomb? The Israelis seem to think so. The Israeli government this week dismissed a report in London’s Sunday Times that said it was planning a preemptive attack against Iranian nuclear sites using nuclear bunker-buster bombs. While Prime Minister Ehud Olmert may well have a last-resort plan of this kind in his back pocket, Israeli sources say they are still hoping the U.S. approach will succeed. "The Iranian economy is a house of cards," says a Western diplomat who would only discuss the campaign anonymously, owing to its diplomatic sensitivity. "It is being kept afloat only by public subsidies based on energy revenues."

In an interview, Levey said he was consciously modeling his strategy in part on what one of his predecessors, Stuart Eizenstat, did a decade ago in strong-arming Swiss banks and German corporations to first acknowledge that they benefited actively from the destruction of the Jews, and then to compensate the families of the victims. Eizenstat, then undersecretary of State, and others in the American Jewish community like then-New York City Comptroller Alan Hevesi, knew that shaming the Swiss and Germans would go only so far. It wasn't until the Americans made active threats to curb or even bar entry into the lucrative U.S. market that the Europeans caved. "Eizenstat laid the groundwork for what we're doing now," Levey told me. Ultimately after Hevesi threatened to stop lucrative mergers in New York that jeopardized the international reps of big players like United Bank of Switzerland and Credit Suisse, and some 20 U.S. states and 30 cities joined in to threaten to cut off business with the banks, the Swiss agreed to fork over $1.2 billion to settle dozens of lawsuits. A similar strategy, including a threat to prevent Deutsche Bank and New York-based Bankers Trust from merging, led German corporations to agree to a $5 billion reparations fund to settle lawsuits over their use of slave labor during World War II.

In recent weeks Levey has been dramatically raising the pressure on European and Asian banks that do business with Iran, further cutting off Tehran's air supply. On Tuesday he announced that another major Iranian bank, Sepah, the country's fifth largest, would be sanctioned because it has been directly involved in financial transactions for Iran's ballistic missile industry. What that action does is to tell every major bank in the world that if it dares do business with Sepah, its name will be mud on Wall Street, and among U.S. regulatory authorities. This is already having serious impact, says Eizenstat, now an international lawyer who represents some of these same banks, and who says he has consulted with Levey on the strategy. "The sanctions involving banks and financial institutions are the most significant," Eizenstat told me. "The reason: oil transactions are in dollar assets. To the extent that any banks have to convert their assets into dollars, they must use U.S. facilities and can be subject to U.S. sanctions." Recently the Iranians have countered, threatening to do business in Euros, but one by one, European banks are falling under U.S. pressure as well. On Wednesday The Wall Street Journal reported that Commerzbank, Germany's second largest, will stop handling dollar transactions for Iran—making it the last European bank to agree to do so. A much-touted $5 billion oil-and-gas investment in Iran's badly underdeveloped energy industry has also been held up because Japanese banks are frightened of falling on the wrong side of U.S. regulators, according to a source close to that negotiation. "I think it's one of the reasons there's at least the beginning of a debate in Iran about whether it's wise to go forward with the nuclear program," says Eizenstat.

There are many differences between this financial crusade and the one waged against the Germans and the Swiss, of course. The Iranian government is far more recalcitrant than those countries—which were panicked in the late '90s, the high tide of globalization, about their tarnished reputations. The international financial system has become so complex that tracking all the banks' business can become an accountant's game of whack-a-mole. And even if it succeeds, this approach will almost certainly not by itself stop Ahmadinejad and Co. from pursuing a nuclear program that has also become a point of national pride for the Iranians. But it will give Washington what it has lacked for too long—leverage in reopening serious negotiations with Tehran. And that will work much better than war.