Testimony before the Senate Committee on Banking, Housing, and Urban Affairs

Watch the full testimony online here.

Submitted Written Testimony

Elizabeth Rosenberg:

Chairman Crapo, Ranking Member Brown, distinguished members of the committee, thank you for inviting me to appear before this committee to discuss new tools to counter Russia.

Today, the security and integrity of the United States is under attack by Russia’s threats to our democratic institutions. Additionally, Russia’s malign activities actively undermine our core policies and values linked to respect for national sovereignty, rule of law, prohibitions against the use of weapons of mass destruction, and protection of human rights. Russia’s malicious and aggressive foreign interference is also a destabilizing affront to U.S. global leadership and to the national interests of our closest allies.

Equally as alarming as the grave and deeply damaging harms wrought by Russia is the inadequate U.S. policy response. The directors of our intelligence agencies, U.S. cabinet-level officials, including the secretaries of State, Treasury, and Defense, and the executives of the most prominent social media companies have spoken clearly about the threat. But so far, the administration’s policy response has appeared uncoordinated or contradictory, and has been insufficiently bold in indicating to Russia that its activities will not be tolerated. How U.S. policy leaders proceed now is of fundamental importance to the character of, and future for, our democracy and core values. Now, U.S. lawmakers must continue their strong leadership role in articulating a strategic vision for addressing this threat and deploying an array of policy tools to push back on Russia and uphold our national security.

The Trump administration has embraced a maximum financial pressure strategy to address many of our leading national security priorities, including responding to threats from Iran and North Korea. With regard to Russia, however, U.S. policy has suffered from uneven execution and limited implementation of the law, and a lack of strategy, uniform messaging, and long-term vision. The administration has offered tough rhetoric and has embraced the use of sanctions. However, the White House has also telegraphed a desire to relieve tensions with Russia at times, sending confused signals to political leaders and to global financial and energy markets, and contributing to a loss of credibility for U.S. policy. The White House is reportedly considering tough new sanctions to respond to foreign meddling in U.S. elections.¹ However, the discretionary nature of such new authorities, coupled with signals from the President that Russian interference into U.S. elections is a “hoax”, undermines their deterrent effect. Members of the U.S. policy community are more keenly aware of these unfortunately mixed signals than most, which is what led Congress to almost unanimous support for tough Russia sanctions legislation last summer, and what motivates the current push for more aggressive Russia measures.

I applaud the seriousness of purpose demonstrated by members of Congress to address the threats from Russia, and I support the notion that much more must be done. It is impossible, and possibly morally reprehensible, to countenance the threats we face and contemplate inaction. However, I urge policy leaders not to embrace policy that appears tough but lacks teeth, that strives to deliver consequences to Russia but instead imposes unintended consequences to our country and its allies, and undermines our foreign policy goals. Sanctions have been a U.S. tool of choice for addressing rogue regimes and thugs, and a favorite tool to address Russia since 2014. But they are not the only option or solution, and their pathological use can diminish U.S. credibility, and the cogency and availability of sanctions more generally. It is possible that the practical utility of U.S. sanctions on Russia is now primarily in the realm of messaging and of exposing malicious activity, rather than as a force to deter Russian malicious activities. Actually achieving such deterrence now will require an adaptation of the sanctions and economic pressure applied to Russia, a holistic foreign policy strategy, and the simultaneous use of an array of complementary policy tools.

The Role of Sanctions in Countering Russia

The present U.S. sanctions regime targets a wide swath of Russia’s malign activity. Currently, authorities are in place to expose and target Russian’s illegal annexation of Crimea and territorial aggression in eastern Ukraine; support for Syrian President Bashar Assad’s war crimes, including his use of chemical weapons on his own people; use of chemical weapons on the soil of a close U.S. ally; malicious cyber activity; violations of human rights; and violations of various sanctions programs, including the North Korea sanctions program.

There has been a robust debate about whether sanctions have effectively delivered policy success since implementation of the major sanctions measures targeting Russia in 2014. The critics have a strong case that becomes more and more convincing with the passage of time, as the list of ills sanctions are meant to address becomes longer, as the United States loses credibility and allies in the campaign to push back on Russia, and as the policy delivery appears episodic and lacking in strategy.² This is a poor framework from which to expect policy success. In fact, it appears likely that for these measures to deliver enough of an economic blow to Russia to compel policy change, they will involve an enormous set of economic consequences for the United States and its allies and trading partners. That may involve costs that the United States is only willing to bear if there is a broadly held view that we are truly at war with Russia, a political belief that is far from mainstream at present.

This does not mean that sanctions should not be part of the policy approach to address Russian threats, but rather that their application must be used to specifically expose and impose consequences for malicious Russian activities. They can also be used successfully to impede the flow of Russian money and curb Russia’s malicious activities. Sanctions must not be overemphasized to the exclusion of other forms of economic statecraft, and sanctions must be paired with other tools of national power and coordinated with allies. Divided from our transatlantic partners on sanctions, we will struggle for clarity and strength in our Russia policy and we will alienate and harm our closest friends in the fight. Ultimately, U.S. sanctions cannot alone be expected to deliver foreign policy success; they must be combined with other tools of national power. Policymakers must proceed from this starting point when deploying this tool in the future.

Looking forward, policymakers must be especially mindful of the size and global interconnectedness of Russia’s economy and the willingness and ability of its leaders to cope with economic hardship and not make political concessions in the face of this stress. While sanctions implemented by the United States and the European Union in 2014 and 2015 did cause economic damage to the Russian Federation, the Russian economy has shown itself to be resilient, and the Russian government has shown itself to be an effective manager of the sanctions-imposed stress. Russia’s recession ended in 2016, and while its growth has been a meager 1.5-2 percent since, this has been enough to avoid broad discontent with Putin’s foreign policy. Rising oil prices and the ability of Russian state and private executives to court foreign exchange, particularly in light of the declining ruble, has been a powerful buoy to the Russian economy. Its leaders have worked diligently to bail out institutions under sanctions stress and raise capital to insulate itself from further sanctions. It has “on-shored” many critical capabilities, especially in its energy sector, is looking to China as an alternative market and financier, and is bracing for a long fight with the United States.³

New Policy Measures on Russia

The Senate is currently considering two major, bipartisan pieces of Russia sanctions legislation—the Defending Elections from Threats By Establishing Redlines Act of 2018 (DETER Act) and the Defending American Security from Kremlin Aggression Act of 2018 (DASKA Act). Both would impose sanctions on new issuance of Russian sovereign debt, place Russian banks on the U.S. Specially Designated Nationals and Blocked Persons (SDN) list, which would freeze any bank assets in the U.S. and block all transactions with the banks that come into U.S. jurisdiction, and would tighten sanctions on Russia’s energy sector, which remains a dominant source of Russian government revenue. There are many ideas in the legislation worth careful evaluation and development, and I strongly support a premise and goal of the legislation: presenting powerful consequences to Russia to deter its threats and interference in our core democratic institutions, its territorial aggression, and Russia’s unacceptable breaches of sovereignty and human rights. The introduction of these pieces of legislation has already achieved a powerful political goal for U.S. foreign policy. It has signaled outrage and critique to Russia, and a clear intent to escalate policy measures in the face of Russian aggression and breaches in international norms that the United States cannot abide.

Lawmakers must proceed in earnest to refine proposed sanctions measures, but they must be mindful of the unintended consequences and the need to target the economic pressure on Russian interests rather than Russian trading partners. Lawmakers should aim squarely at sanctions targets directly involved in threatening and insidious activities. Doing so will expose this conduct in the public domain, garnering credibility for the United States and forming a basis for building multinational support to counter these Russian activities.

Maximalist sanctions designed to deliver a punishing blow to Russia’s biggest economic actors may seem appealing to security hawks eager to constrain or punish Russia, but they are not savvy. If U.S. policymakers attempt to unilaterally and suddenly sever ties between the largest Russian energy companies and their foreign partners they may negatively impact U.S., European, and Asian energy consumers or investors exposed directly or indirectly to the Russian market, and undercut U.S. sanctions strategy on Iran. U.S. policymakers may also inadvertently enrich Russian energy firms that replace foreign firms, thereby consolidating Russian influence in global supply and pricing. A further potential unintended consequence might be increases in the role Chinese firms play in the Russian market, undermining U.S. leverage on Russia. By contrast, a U.S. policy approach attempting to impede future investment and production capacity in the Russian energy sector, perhaps by limiting the provision of technology, specialty equipment, services, and capital, may deliver the economic pressure U.S. lawmakers intend but avoid disruptive market effects and harm to U.S. relationships with partners in Europe and developed Asian economies.

Similarly, U.S. sanctions measures targeting the entire stock of Russian debt trade and transactions can also have wide-ranging and disruptive market impacts. A more targeted sanctions policy approach of tailoring restrictions just on future debt issuance may achieve a strong economic and political signal and limit the consequences to U.S. interests. Although Russian authorities may be able to replace the foreign finance of new debt with either domestic sources (such as state banks, pension funds, or rich individuals) or rely on funds from autocratic states, doing so will impose costs in terms of rising rates, further restricting fiscal policy space and free cash flow of the Russian government. As foreign ownership of Russian local currency debt has already fallen, at 28 percent of total outstanding issuance in late July according to Russian government data, the contagion risk to other emerging markets via direct portfolio effects may have fallen. The symbolic effect of sanctions on primary issuance of sovereign debt might still be meaningful, and the economic effects would be concentrated in Russia and, to the extent that there is contagion, sentiment impacts on emerging markets with weak balance sheets, such as Brazil, South Africa, and Turkey, rather than on the debt of developed markets such as the United States.

Additionally, new defense measures may be most effective by taking a targeted approach to restricting Russia’s ability to procure internationally made component parts for use in weapons and defense systems, possibly through an updated application of Countering America’s Adversaries Through Sanctions Act (CAATSA) section 231. This could be done while maintaining reasonable pressure to reduce Russia’s defense exports and earnings. When it comes to using sanctions to target cronies close to President Putin, it will be important to train these authorities on individuals who are actually part of Putin’s inner circle and to the greatest extent possible expose their involvement in Russia’s malicious and destabilizing activities.

There are certainly an array of other policy options that legislators must study to counter Russia, including through increased force posture and projection in Europe, the Eastern Mediterranean, and the Black Sea, and through offensive cyber operations. There are also proactive measures the United States should pursue, through provision of aid and technical assistance, to advance European energy security, shore up support for backsliding democracies in Eastern and Central Europe, and support an informed and free press into Russia and in countries it seeks to influence and misinform.

Financial Transparency as a National Security Priority

Now, in the realm of economic statecraft to address Russia, I urge U.S. lawmakers, and the members of this committee in particular, to pair any new set of sanctions measures on Russia with critical and much-needed policy to promote financial transparency and the disclosure of beneficial ownership information in the corporate formation process. This may have broadranging and powerful effects in exposing and deterring Russian corruption and illicit financial activity in the United States and Russia’s interference in our democratic processes. Ultimately, it may be the most effective thing that Congress can do to root out and confront Russia’s insidious influence and destabilization campaigns in our homeland. It should be a centerpiece of the array of tools the United States uses in a holistic policy to address the Russian threat, including military, diplomatic, intelligence, economic, technical and development assistance, and legal measures.

The current version of DASKA includes a provision to expand Geographic Targeting Orders for obtaining information from title insurance companies on beneficial owners of entities that purchase high-value residential properties.⁴ While this would represent a useful new measure of financial transparency, it is wholly insufficient on its own to meet the scale of the vulnerability.

I urge you to take up new legislative language to require the collection and disclosure of beneficial ownership information in the corporate formation process and on an ongoing basis. This would offer a powerful solution to the problem of anonymous companies in the United States, which represents an appalling gap in the integrity of our financial system and an enormous loophole that enables malicious actors, including Russian operatives seeking to undermine U.S. democratic institutions and processes, to operate anonymously and with utter impunity in the United States.

The United States boasts the most sophisticated and preeminent financial system globally, with unparalleled financial crimes enforcement capabilities and resources. Yet, even with all of those advantages, our financial system has a wide-open back door for our adversaries to march through, set up shop and wage an enormous and well-funded influence campaign, laundering money, and paying for attacks on our democracy. U.S. law enforcement agencies have been asking for access to beneficial ownership information for some time, the likes of which could help to expose and deter Russian attacks on our democracy. But, despite the severity of the threat, these requests from the law enforcement community have been ignored.⁵ Banking executives also support the requirement for collection of beneficial ownership information, as it would help them to better protect themselves from abuse by criminals and other illicit financiers.⁶

The international community is well aware of the gaps in U.S. oversight of corporate entities. The Financial Action Task Force (FATF), the global standard-setter for financial crimes compliance, found the United States “non-compliant” in its most recent review of our approach to transparency and beneficial ownership. As FATF stated: “Beyond [a SEC requirement for entities which issue securities] there is no requirement for other companies or company registries to obtain and hold up-to-date information on their [beneficial owner] or to take reasonable measures to do so.”⁷ This is an alarm bell about a tremendous gap in our national security, one we know that Russia is exploiting.

At present, anonymous companies are free to operate without providing accurate information to law enforcement. This enables their involvement in illicit activity, such as money laundering, or the funding of major political and social influence campaigns to undermine our democracy and sew discord.⁸ Other jurisdictions also rated by FATF as non-compliant during this evaluation period include: Nicaragua, Sri Lanka, Zimbabwe, and Panama.⁹ It is disgraceful that this level of international public humiliation for inadequate beneficial ownership regulations has done nothing to motivate policy change.

Why have our financial and national security leaders failed to act? Efforts to advance beneficial ownership over the last year have foundered on concerns about privacy and the burden of imposing such regulations on small businesses. But these protestations are often inflated, ideological, and impractical. It is possible to responsibly balance civil liberties concerns and the requirement to disclose basic beneficial ownership information. Our national security and the need to maintain the integrity of our democracy demand it.

Even before the chilling revelations about insidious Russian threats from the U.S. intelligence community and social media executives before Congress, there was a broad coalition of law enforcement, business interests, and national security supporters that supported beneficial ownership legislation. Kenneth Blanco, the Director of the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) testified to the House Committee on Financial Services about the importance of collecting beneficial ownership information for the implementation of the new Customer Due Diligence (CDD) Rule.¹⁰

The Financial Accountability & Corporate Transparency (FACT) Coalition, a non-partisan alliance of civil society and public interest organizations, has highlighted the high cost of allowing illicit money to flow absent greater transparency measures.¹¹ They have focused specifically on the threat of illicit finance originating through the use of anonymous corporate entity formation as a grave national security concern, most recently in an open letter to the House Committee on Financial Services from distinguished experts on the topic with decades of relevant government experience.¹²

State governments, which have specific responsibility for regulating corporate entities within their borders, are also starting to sound the alarm. Earlier this year, 24 state attorneys-general signed a letter to Congress calling for tightening of beneficial ownership transparency.¹³ The need to effectively address Russian threats, including to our democratic institutions and processes, must be the catalyst to motivate policy change on beneficial ownership now. Lawmakers should adopt this policy and make it part of the economic statecraft targeting Russia, embracing it alongside broader economic and financial sanctions in any forthcoming legislation targeting Russia.

Additionally, to further promote financial transparency that can protect us from Russia’s meddling and threats to our homeland, Congress should consider long-delayed cross-border funds transmittal reporting requirements.¹⁴ Current regulations require financial institutions to retain records of electronic funds transfers of greater than $3,000. However, there is no requirement that this information be furnished to FinCEN, merely that it be retained in the event that FinCEN asks for it. This passive approach stands in contrast to other leading economies that require disclosure of international value transfers as a matter of course. The countries, including close U.S. allies, have found this information valuable for understanding and combatting national security threats, including the progress of rogue regimes in the financing of proliferation of weapons of mass destruction and other financial crimes. Congress should revisit the feasibility of the FinCEN proposed rule and consider what implementation of the crossborder rule would do to address and combat the Russian threat to U.S. national security.

Further Congressional Oversight

Beyond these measures there are other policy options that the U.S. Congress should consider to advance its efforts to promote transparency and expose and counter Russia’s threats. First and foremost, lawmakers must keep up the pressure in their oversight efforts, calling the administration to regularly account for its strategy and implementation of policy. The Treasury Department’s repeated extension of a sanctions wind down period to the Russian aluminum firm Rusal should serve as a lesson to Congressional overseers in needing to better understand the potential consequences of sanctions action, and in playing a more active role in making sure that their message and effect are consistent with a coherent policy toward Russia. Rusal was targeted because it is controlled by Russian oligarch Oleg Deripaska, whose holding company was also sanctioned. In designating the entire firm, however, the Treasury Department put the aluminum market into a spiral, with potential long-term consequences for the firm’s operations worldwide, including in the United States, supply chains, and how traders and observers perceive—and unfortunately misperceive—the intent of U.S. sanctions.¹⁵

Congress also has an important role to play in elevating oversight of sanctions authorities already in place. Additionally, CAATSA required the administration to produce an annual report that identifies and maps “illicit financial flows linked to the Russian Federation if such flows affect the United States financial system or those of major allies of the United States.” Congress should use this report as a roadmap for identifying areas in which the Treasury Department could use additional resources, or be encouraged to expand existing efforts to share information with allies, break down barriers to interagency cooperation, identify typologies of Russian illicit finance, and better repair other gaps in our regulatory or legal infrastructure.¹⁶

While Congress considers various measures to advance the transparency of how categories of corporate entities in the U.S. financial sector operate, it should not lose sight of the opportunity to extend transparency to other ways the Russian government and Putin’s inner circle funnels money into the United States. Lawmakers can consider restrictions on investment of Russian money in the U.S. market, especially by individuals identified as oligarchs, many of whom have demonstrable connections to Russian President Vladimir Putin. The U.S. Treasury has wide authority to freeze assets and impose other sanctions on these actors, and initial evidence from the April sanctions of some of these cronies and oligarchs suggests that investment restrictions do put pressure on members of Putin’s inner circle.¹⁷ The current version of the DETER Act includes authorities for mandatory sanctions on “any senior foreign political figure or oligarch in the Russian Federation,” including a visa ban if the Director of National Intelligence determines that the Russian government, or agents acting on its behalf, knowingly interfered in a U.S elections.¹⁸

An additional idea that Congress should begin to study is the development of new anti-money laundering requirements, which currently apply primarily to banks and money services providers, to cover other kinds of professional services providers that Russian oligarchs and cronies rely on to move money into the U.S., such as investment advisors, venture capital and private equity firms, and certain professional services providers. Press reports have highlighted the potential threat from Russian venture capital firms in Silicon Valley, who may be using Russian state resources to acquire sensitive national security-applicable technology.¹⁹

Conclusion

Every American should be concerned about Russia’s efforts to undermine our democracy, to violate sovereignty, and to blatantly support and enable grave abuses of human rights and use of weapons of mass destruction. The scope of these threats is broad, and there is limited indication that Russia is deterred by any of the policy measures that have been undertaken to date. Congress has used coercive economic and financial measures to push back against this malign activity, measures which are justified by the severity of the threat. However, those tools must be used wisely, in conjunction with other financial, diplomatic, and military tools, and in coordination with allies.

In particular, the financial transparency measures I outlined today would constitute a powerful weapon to push back against the flow of Russian money into our financial system, which has been difficult for law enforcement officials to track and account for. These measures would close deficiencies that have made the United States a haven for illicit finance from a variety of sources, including those who work on behalf of Russian’s malign influence campaigns. Many of the solutions I have outlined have been proposed or considered in previous agency regulation or legislation. All that is required is the political will to follow through on their adoption and implementation.

Congress has taken an active role in the application of sanctions to the variety of areas in which the United States and Russia are at odds. Congress has a direct role to play in this aspect of the fight as well, by eliminating the pervasive use of anonymous corporate entities, providing more resources to Treasury/FinCEN, but also exercising oversight of their activities, and pursuing other disclosure measures that will shine a light on dirty money flowing through the U.S. financial system. In doing so, Congress can put tremendous pressure on Russian’s malign activity and offer a strong complement to the other methods the United States is using to defend itself against this unprecedented threat.

Thank you for your time and attention. I look forward to your answering your questions.

Submitted Written Testimony

Daleep Singh:

Mr. Chairman and Ranking Member Brown, thank you for the opportunity to appear before this committee.

As a Treasury official, I worked extensively on the design of Russia sanctions in 2014. Looking back, I draw three main conclusions from the experience: (1) sanctions “do their job” if they are carefully designed and embedded into a coherent foreign policy; (2) the signaling of future sanctions is at least as potent as the actions themselves (like any weapon, the best sanctions are never used); and (3) sanctions aren’t enough to change behavior. Bearing these lessons in mind, I will offer suggestions to counter ongoing Russian aggression and malign behavior – both using sanctions and other economic tools.

For context, allow me to share perspective from the 2014 experience.

How were sanctions designed in 2014?

Before 2014, the United States had never imposed sanctions on a country the size of Russia. It was the tenth largest economy in world, with a GDP roughly the size of Italy. More important than its size was the complexity of Russia’s economy and its connections to the rest of the world. Russia was and is of systemic importance in global energy markets, ranking second and third in the production of natural gas and oil, respectively. Its largest banks were comparable in size and complexity to Lehman Brothers before 2008. Given the high stakes involved, our objective was clear: design a menu of options that could deliver1 economic costs while minimizing spillovers to the U.S. and global economy.

We pursued this objective by first writing down a set of guiding principles that remain instructive. Sanctions against a large, complex, and integrated market economy such as Russia should be: (1) powerful enough to demonstrate U.S. resolve and our capacity to impose overwhelming costs; (2) responsible to limit contagion through the U.S. and global financial system; (3) targeted to avoid the appearance of punishing the Russian civilian population and, in doing so, strengthening Putin’s domestic narrative; (4) calibrated to increase the chance of partnering with European and international allies; and (5) staged to preserve scope for escalation or de-escalation, in addition to learning from previous steps.

Putting these principles into action required an understanding of Russia’s economic pressure points. We focused on asymmetries. Where did U.S. economic leverage intersect with Russia’s vulnerability? Foreign capital was and is an obvious choice. U.S. and European firms are the dominant suppliers of something Russia needed in large quantity and could not easily replace from other sources. Similarly, in energy, Russia's supply chains were dependent upon U.S. and European technology to boost their long-term production capacity and innovative potential. Here again, U.S. and EU companies are major suppliers of goods and services that Russia needs and cannot easily replace.

Financing restrictions proved especially potent

Restricting foreign capital proved even more potent than we anticipated. By removing U.S. and European supply of debt and equity financing to the largest Russian stateowned enterprises in the most critical sectors of the economy, the 2014 sanctions triggered a wave of capital outflows from Russia, followed by economic recession.

The mechanism by which the financial restrictions operated is worth recalling to appreciate their potency. For sanctioned entities, the restricted supply of Western capital spiked their cost of borrowing and reduced their access to foreign capital at any price. The sudden financing shock impaired our targets’ credit profiles, leading to record levels of capital outflows from Russia as a whole. In a futile attempt to defend the ruble, the Russian central bank depleted about a quarter of its foreign currency reserves before allowing the currency to depreciate up to fifty percent from its pre-sanctions level against the U.S. dollar. Importantly, the speed of the negative feedback loop in Russia was determined by market forces and Putin’s own actions, not prescribed in advance by U.S. policy.

Import prices surged in tandem with the weakened currency and pushed overall inflation to the mid-teens, forcing several rounds of emergency interest rate hikes by the central bank to extreme levels. Banks required government injections of capital and regulatory forbearance to avoid insolvency. Adjusted for inflation, wages and spending collapsed. Bank lending and investment dried up.

Spillover risks were managed carefully

By the second half of 2014, we knew these sanctions had the potential to deliver a knockout blow, particularly with lower oil prices causing a dual shock2 , but we took care to limit unwanted spillovers – both to increase the staying power of sanctions and to avoid appearances of targeting Russian civilians. Our sanctions only targeted a handful of state-owned companies in key sectors. We did not target private companies, nor we did not sanction all sectors of the economy. We prohibited new U.S. flows of financing to the targets of our sanctions, but existing stocks of risk were not disrupted. U.S. investors remained free to reduce exposure to Russia at a pace and magnitude of their own choosing. Derivatives and money markets, both of which tend to be the ‘dry tinder’ of financial crisis, were largely untouched by sanctions.

Impact and spillovers were largely as expected

Due in large part to this restraint, the economic impact to and spillovers from Russia were in line with our expectations. The Russian economy contracted 2.8 percent in 2015, the largest decline among large economies, and the recession continued in 2016. Somewhere between one-half and two-thirds of this impact was likely caused by lower oil prices; the rest we can conservatively attribute to sanctions.

Over the medium term, these sanctions dealt a weak strategic hand to Putin's Russia. Its already depleted capital stock was starved of much-needed financing and direct investment. Removal of U.S. and European energy technology, and the de-integration of Russia from the global financial system, deprived Russia of key inputs to productivity growth and made its economy even more brittle. The overall chilling effect reportedly prompted defections from talented portions of Russia’s declining labor force. As of last July, the IMF estimated potential growth in Russia over the medium-term at no more than 1.5 percent.

Meanwhile, unwanted spillovers within Russia and to western economies were largely contained. Sanctions forced the Russian government to deplete a portion of its finite set of resources to contain financial and economic stress, but we avoided causing widespread panic and impoverishment among the general public. This was consistent with our purpose: to create diplomatic leverage and deal space, not to deliver a knockout blow.

Blowback to the U.S. economy was minimal in the aggregate, although certain businesses and sectors were more negatively affected. (By construction, sanctions are an economic distortion; spillovers are unavoidable). Even for Europe, where direct trade and financial linkages to Russia are far more significant, the effects were summarized by the European Commission as “contained.” 3 In fact, without sanctions, it is fair to project that the costs and uncertainties brought about by unchecked Russian aggression in the heart of Europe would have been far less contained that what was experienced.

Signals were at least as important as actions

Throughout this process, both the impact and spillovers from sanctions were managed through signaling. The signals were expressed by the most senior officials of the U.S. government, and they were made credible by a coherent, multi-faceted, and coordinated foreign policy.

In March 2014, after announcing the first round of sanctions against Russia, President Obama signaled the possibility of further escalation with a new executive order that authorized broader sanctions against key sectors of the Russian economy. In the same statement, he pushed forcefully in favor of an IMF bailout program for Ukraine – a recognition that the best defense against Russian aggression was a strong economic offense. Vice President Biden was dispatched to the Baltic states to reinforce our Article 5 commitment to NATO countries, and to step up cooperation with Europe on developing buffers against energy shortfalls in the region.

After announcing sanctions in July 2014 against Russia’s largest banks, energy companies, and defense firms, President Obama warned again that the costs on Russia would ratchet higher if Putin’s aggression in Ukraine continued. He also signaled that European allies were poised to replicate our sanctions after close consultations (which they did, multiplying the direct effect of sanctions and reducing the competitive disadvantage to U.S. firms). The same credible threat of escalation was repeated by President Obama in September after another round of sanctions, this time targeted at Russia’s largest bank, even amid diplomatic efforts in Minsk to broker a ceasefire.

Many of the most punishing days in Russian markets during 2014 were not those in which new sanctions actions were formally announced; some of the biggest impacts were delivered after signals about future policy were revealed. This makes intuitive sense. Markets are forward-looking; asset prices determined by expectations about the future. Escalatory signals were often enough to could deliver impact to Russian markets without taking any new action, and they were perhaps a small counterweight to Putin’s so-called “escalation dominance” in the military realm. Of course these effects become muted when investors doubt the credibility of the threat, but this has only become a relevant concern more recently.

Changing behavior

Did any of these costs ultimately matter to Putin? Answering this question is beyond my expertise, but I would observe that any leader – however rogue – cares about popularity (at least as a method of control), and recessions do not win hearts and minds. Putin’s tolerance for economic pain is demonstrably higher than that of most Western leaders, but I believe there is a threshold above which his calculus is changed. Pointing out Putin’s history as a tactical opportunist, some have argued convincingly that were it not for the mounting costs to the Russian economy in late 2014, Putin’s forces would have marched all the way to Kyiv; or, at a minimum, he would have rejected even halfhearted engagement in the Minsk process. We’ll never know the counterfactual, but by the Russian leadership’s own admissions the impact of sanctions was appreciable during this period. Even less clear is whether we managed to win the narrative. Do the Russian people understand that U.S. sanctions were an attempt to defend the sovereignty and territorial integrity of a free country? Or do most Russians believe in Putin’s story that the recession of 2014-15 is just the latest in a series of historical injustices perpetrated by the West? We simply don’t know the answer, and this is a subject I will address in the recommendations section.

Current context and recommendations

Turning to the current context, we know that Russian aggression and violations of sovereignty have spread across Europe and the UK, into Syria, and certainly here at home. At the same time, economic and financial conditions in Russia have improved markedly. The economy is out of recession. Inflation recently touched an all-time low. Oil prices have tripled from their trough. Foreign reserves have been replenished to pre-sanctions levels. The government’s deficit and debt profiles remain sound. Both the provocations from Russia, and its ability to absorb a hit from sanctions, have increased.

Against this background, I would emphasize that the sanctions toolkit designed in 2014 does not need to be reinvented. What matters, ultimately, is the political willingness to use our sanctions tools in a sustained and coherent fashion, together with high-level signaling that expresses our resolve to change Putin’s behavior. Escalation can take two general forms: increasing the scope of existing sanctions to cover a broader set of targets, or deepening the scale of impact on any particular individual or institution. Sanctions can go broader, deeper, or both.

Below I sketch out an illustrative set of options that apply the principles described earlier.

1. First, costs should be broadened to include the very highest levels of the Russian government. At a minimum, Treasury and other authorities should conduct a study that attempts to identify the location, holdings, and financial intermediaries that manage and benefit from Putin’s wealth. Even in the unlikely scenario that this effort has no effect on Putin’s geopolitical calculus, it will signal to the Russian people that our quarrel is not with them, and it might provide a measure of transparency on his fortunes held abroad.
2. Second, U.S. investors should be prohibited from purchasing new Russian sovereign debt. In 2014, I was more cautious about the unpredictable spillover effects that could result from a sudden disruption to Russia’s risk-free, benchmark asset, particularly during a period of acute stress. To be clear, this is still a serious step -- but circumstances have changed. Russia is far better able to absorb a hit to its sovereign debt market, considering the background conditions described earlier, 4 and investors have had years to reduce exposures in Russia. More to the point, I can think of no credible argument why U.S. public pension funds and savings vehicles should indirectly fund the Russian government while the latter continues to sponsor violations of U.S. sovereignty.
3. Third, while I am not in favor of prohibitions on secondary market trading5 of Russian assets as a general matter, there is merit in constructive ambiguity. Requirements on U.S. persons to disclose any existing holdings of Promsyvazbank (Russia’s designated bank to service the defense sector), and possibly VEB, would be an effective step to generate a broader chilling effect, especially if it includes a grace period. By itself, this measure would not prohibit any activities, but markets are conditioned to read the signals. These financial institutions are appendages of the Russian government, oriented around domestic lending with relatively fewer international linkages than other large Russian banks.
4. Fourth, a comprehensive package to counter Russian aggression requires an offensive economic strategy in its near abroad, not only to Ukraine but also to Georgia, the Baltics, Moldova, and possibly central Asia. Possible steps could include conditions-based financial support to reinforce long-standing IMF priorities in the region to improve the rule of law, battle corruption, and implement market-oriented reforms. The overarching purpose is to create successful alternatives to Russian-style autocracy.
5. Finally, I would strongly encourage a robust campaign to improve transparency within Russia. Distributing verifiable evidence of corruption, and the dependence of the current regime on kleptocracy, would help to counter the government’s disinformation campaigns and its control of the media. Working with the IMF and other multilateral institutions could also shine a light on the basic challenges of doing business in Russia – enforcing contracts, protecting intellectual property, and defending property rights. Fostering genuine private-sector exchanges between the U.S. and Russia could also help in this regard.

Mr. Chairman and Ranking Member Brown, thank you once again for the invitation to testify, and I look forward to your questions.