State of Failure

by Jonathan Schanzer

  Meanwhile, the PLO continued to suffer from a crisis in confidence. An August 2002 poll by the Palestinian Center for Policy and Survey Research found that 85 percent of Palestinians believed that corruption existed within PA institutions.26 This poll came on the heels of reports by Agence France-Presse about former PLO financier Joweid al-Ghossein.27 Al-Ghossein, who served as secretary-general of the Palestinian National Fund until 1996, charged that Arafat had transferred some $8 million of international donations to one of his personal accounts.28

  Arafat, for his part, finally appeared to understand the pressures he faced. Or perhaps others within the Palestinian leadership forced his hand. As Brown noted, the Palestinian Legislative Council in September 2002 “accomplished what other parliaments in the Arab world have been shut down for even discussing; it brought down the cabinet and forced a decree for new elections.”29

  6

  Fayyadism

  In June 2002, Salam Fayyad was named finance minister of the Palestinian Authority (PA).1 A quiet and unassuming bureaucrat, Fayyad was serious about reform. He stood in stark contrast to the Palestinian figures who had dominated the political scene during the Arafat era. And it was his approach to governance that provided hope to advocates of the Palestinian national project after Arafat was gone.

  In 1996, shortly after the PA was created, Arafat assigned Salam Fayyad, a Palestinian who holds a doctorate in economics from the University of Texas at Austin, to be his representative to the International Monetary Fund (IMF). Just three years into the creation of the PA, Fayyad was convinced that a focus on building strong institutions and fighting corruption was the key to success. As James Prince, a former adviser to Fayyad, recalls, “Fayyad believed that although the newly minted Palestinian economy was absorbing billions of dollars in assistance, the average person was not feeling better. In fact, all the financial indicators and quality of life factors began a steady decline upon the establishment of the Palestinian Authority. Only [through] effective institutions . . . would the PA ever move into a legitimate, popular, and durable public administration able to gain support from its constituency.”2

  However, at the time, Fayyad was largely overshadowed by the brash leadership style of Yasser Arafat. As Prince noted, “He had a point of view that couldn’t compete with Arafat’s role as a Nelson Mandela figure.”3

  Of course, nobody could compete with Arafat’s larger-than-life personality in the early years of the PA. But Fayyad was not trying to compete with him. He was focused on the economic viability of the Palestinian national project. To this end, in 1997, just after joining the IMF as the Palestinian representative, Fayyad reportedly penned a rather bold letter to IMF official Stanley Fisher (who went on to become Israel’s Federal Reserve chief), asserting that even if the Israelis and Palestinians were to find a way to sign a peace agreement, the final status of Palestinian statehood was doomed because of Palestinian public administration challenges. To say the least, this was a minority position at a time when optimism over the peace process was in full bloom. The memo was suppressed,4 but the thinking behind it was the basis of what became known as “Fayyadism”: Palestinian nationalism would only succeed in the creation of a state if the proper effort went into institution building.

  By 1999, it was getting harder to ignore Fayyad. With the mishandling of international donor funds, financial indicators were deteriorating. But one particularly jarring incident in 1999 involving the Palestine International Bank (PIB) shook the international community’s faith in the Palestinian system. As the former chairman of the bank, Issam Abu Issa, relayed in the pages of Middle East Quarterly:

  Arafat issued a decree dissolving the Palestine International Bank’s board of directors. The state-controlled Palestine Monetary Authority [PMA] took over the bank, and with Arafat’s blessing and written approval, formed a new supervisory board of directors, including at least one convicted and Interpol-wanted felon. The unlawful takeover was a confiscation of my own, my shareholders’, and my clients’ private assets for Arafat’s personal use. At the date of seizure, PIB total assets amounted to $105 million.5

  At the time, Prince, who worked for the multinational accounting firm PricewaterhouseCoopers (PwC), “had been repeatedly trying to convince Arafat and his adviser Nabil Shaath of the need to reform the financial systems of the PA in order to keep donors from cutting off funds and to win back the hearts and minds of the increasingly frustrated Palestinian population who had not yet felt the benefit of any peace dividend. When the PIB threatened to become a significant international incident, Arafat, with advice from Mohammed Rachid and Shaath, compromised.” The PA retained PwC to conduct a fraud investigation based on international standards. According to Prince, the subsequent “PwC report concluded by recommending prosecution of Abu Issa in a court of law and the public dissemination of the investigative work product.” However, Prince notes that Arafat “missed the opportunity to do what was right and he cut a deal by which Abu Issa could safely leave the country, [with] his assets firmly controlled by Arafat and the Palestinian Monetary Authority.”6

  Abu Issa’s version was significantly different. He alleged that

  The PMA altered, hid, or destroyed bank records in their campaign to demonstrate malfeasance on my part retroactively. They supplied false information to the PricewaterhouseCoopers (PwC) group leading to a faulty audit . . . As they seized the bank, Arafat’s security services harassed me. I fled to the Qatari mission in Gaza. Arafat’s staff confiscated my private belongings, including my car, which Arafat took for himself. My brother Issa accompanied a Qatari Foreign Ministry delegation to Gaza in order to resolve the stalemate. But, upon his arrival, Palestinian police acting on orders from Arafat arrested him. The PA said they would trade his freedom for mine. Only after the State of Qatar threatened Arafat with financial sanctions and severing of diplomatic ties did the PA give us free passage to leave Gaza for Qatar.7

  It became clear to the international donor community that the Palestinian financial system was insufficiently regulated. The Palestinian leadership had little choice but to shift its focus away from the glamor of international diplomacy and toward the significantly less sexy realm of institutional development. In a mid-1999 meeting in Gaza, according to Prince, Arafat told a delegation from PwC that he was “determined to implement reform.” He asked PwC to help design a “methodology and concept for the reform effort.” Arafat pledged that he would go to the forthcoming Tokyo donor summit in October 1999 to read the statement committing to reform.8 To be sure, none of this was called “Fayyadism” at the time. But there is no denying that Fayyad’s ideas had won the day.

  There was also no denying that the international donor community wanted economic reform and did not trust Arafat to implement it. This is why the PA turned to outside auditors and accountants. With their assistance, Fayyad would soon push the PA toward political reform and institution building and away from neopatriarchy.

  The basis for the Palestinian reform plan was somewhat simple. The Palestinians, in the interest of creating a viable state, needed to get a handle on a few key sectors. For one, the PA needed to consolidate its security forces. After the outbreak of the second intifada in 2000, too many factions were undermining domestic security (not to mention regional security).

  Another challenge was to wean the Palestinians off a cash system and to bring workers onto a formal payroll system. This would help the Palestinian leadership get a better handle on the economic health of the territories while also cutting down on opportunities for corruption or financial mismanagement. Along these lines, the PA also needed to consolidate its revenue generators that were controlled by Arafat or elements of the Palestinian Authority but were not included in the Palestinian budget. Indeed, the government truly lacked any solid sense of what its debits and credits looked like at any given time. Finally, the PA needed to establish a better-functioning bureaucratic system, which a
lso meant the decentralization of presidential power. To put it another way, the office of the president was too strong, whereas the other offices that were essential to the daily governance of the PA were simply too weak. All of this needed to change.

  While the challenges were great, there appeared to be genuine interest among the Palestinians to effect this change. But the timing could not have been worse. The move toward better governance came right as President Clinton’s time in office was ending. And Clinton’s goal was to finish what he started. The president sought to push the Palestinian leaders to make painful compromises at the negotiating table with the Israelis while they were still scrambling to make sense of the economic challenges that faced them. As a result of the economic challenges (admittedly much of their own making), the Palestinian leaders were weak and less sure-footed going into final-status talks in 2000.

  For this reason, along with other domestic and broader strategic considerations, Arafat spurned Clinton’s offer of a Palestinian state on some 95 percent of the West Bank and 100 percent of Gaza. Inexplicably, soon after that, Arafat launched a new round of violence against the Israelis rather than returning to the negotiating table.

  Not surprisingly, the figures in Arafat’s inner circle most closely associated with corruption reportedly supported the peace plan. They likely understood that they had the most to lose if peace was not achieved. Arafat apparently did not understand this. His decision to embrace violence at this time was, in retrospect, a strategic mistake. To be sure, the violence launched out of the West Bank and Gaza had a deleterious impact on Israel, which was the primary goal. But it was also clear that some of the Palestinian violence and frustration stemmed not only from hatred for Israel but also from the fact that the quality of life in the territories had never really improved for a great many Palestinians despite massive donor aid year over year. This fact was not lost on the average Palestinian.

  The intifada began in late September 2000, and the violence raged for about four months before the inauguration of a new US administration under President George W. Bush, who immediately made it clear that Arafat was part of the problem and would not likely be part of the solution. Bush did not see the utility of investing his presidential credibility in a process where Arafat, a former terrorist who had returned to terrorism, was a key player.

  Arafat reportedly was aware of his reputation in the West. He was also aware of the PA’s significant cash shortfall, brought on by a steep drop in donor assistance. He began to undertake efforts to rein in the violence. He also continued to promise reform. However, he lacked the credibility to do so. That’s when he turned to Salam Fayyad.

  As Bush noted at the time, the appointment of Fayyad was a “positive development, because one of the things that worries us is spending any international aid on an authority that might not keep good books; that the money might not actually get to help the Palestinian people, but might end up in somebody’s pocket.”9

  When Fayyad, then a regional manager for Arab Bank, was named finance minister in June 2002, the intifada was still raging. Palestinian terror groups continued to attack Israel with frequency, and the Israeli military responded with harsh retribution. Under these difficult external circumstances, Fayyad went to work.

  Fayyad’s approach was simple. He was less worried about the violence and more concerned with the troubling political culture that had overtaken the PA. It did not bother him that he was appointed by Arafat. He undoubtedly knew that he represented the upstanding image that Arafat sought to project to the international donor community as he struggled to salvage what was left of the PA. But it is unclear whether he understood that he would serve as a convenient straw man for any shortcomings in the reform program. He also may not have realized that, despite the fact that Arafat needed him to instill confidence among the donor community, Arafat could still oppose the economist domestically, which would play well on the Palestinian street.

  Fayyad wrangled with Arafat over security reform and payroll reform, which was effectively a direct challenge to Arafat’s control over the PA’s estimated 120,000 employees. In retrospect, Fayyad’s greatest point of leverage was the Karine A Affair. In January 2002, Arafat had been caught red-handed trying to smuggle in weaponry from Iran by sea, and the Israelis intercepted the shipment.10 This discovery only served to reinforce the perceived need for a single treasury account as a means to ensure that Palestinian finances were spent on governance, not on illicit ordinances. It also reinforced the need for reform in the security sector. Bush administration official Elliott Abrams recalls that “13 security agencies had to become three agencies and report to the prime minister, not the president. I think we made progress.”11 Dennis Ross also lauded Fayyad’s reforms in this area, which enabled the PA to “stop paying the security guys from paper bags in cash, and letting them skim off the top.”12

  The Israelis, however, had written off Arafat. In many ways, they had written off the entire PA. In May 2002, the Israeli Foreign Ministry weighed in, charging that “corruption is rampant in the PA,” marked by “monopolies which enable the financial rewarding of senior PA officials and their families,” not to mention the “expropriation of lands, and altering verdicts by bribery and threatening the lives of judges.”14

  But the Israelis were also part of the problem. In December 2002, former Israeli intelligence official Uzrad Lew exposed in the pages of Maariv that PA tax and customs revenues had been transferred in 1997 to a Swiss bank account in the name of an offshore holding company called “Ledbury Global Inc.”15 Lew went on to publish a full book titled Be-tokh ha-kis shel ha-Ra’is (Inside Arafat’s Pocket) in 2005 alleging how Palestinians and Israelis alike benefited from corruption during the Arafat era. Yossi Ginnosar, a former Israeli security official and back-channel envoy to the Palestinians who died in 2003, took the brunt of the criticism.16

  “Ginnosar was the key player. Not one Israeli had access to Arafat the way that Ginnosar did,” Lew recalls. “Ginnosar began to take cuts of deals the Palestinians made with Israel. . . . We’re talking about millions of dollars here. This goes on for many years, even through the intifada, while the Palestinians were at war with Israel.”17

  In August 2002, with Arafat’s blessing, Fayyad announced the formation of “a fund to oversee all money handled by the Palestinian Authority, in response to pressure on the leadership to clean up its finances.”18 The Palestine Investment Fund (PIF) was officially founded in 2003, and its primary aim was “to safeguard and consolidate the Palestinian people’s investments and property, both in Palestine and abroad.”19 The idea for PIF, according to Prince, was born in 2001, when PwC “was engaged by Arafat to animate Fayyad’s vision in developing an appropriate investment holding vehicle by which to manage public investments and stimulus programs.”20

  As Fayyad stated in 2002, “There is something liberating about full transparency, it helps you sleep better at night.”21 The fund helped the international donor community sleep at night as well. As Abbas later ceded, the fund was created “in response to calls from the United States government (USG) and the European Union (EU) for increased transparency and accountability within the Palestinian Authority institutions and affiliates.”22

  The creation of the fund was no easy task, however. The PLO had amassed a huge investment portfolio over the course of four decades. In some cases, little was known about the investments. As such, bringing them into the newly revamped Palestinian Treasury brought a certain amount of risk. Fayyad’s goal was to lower the risk profile and include only transparent and clean investments.

  Fayyad spearheaded the investigation of money and assets controlled by Arafat or anyone else connected to the PA. Dozens of consultants and accountants, including Jim Prince, were assigned to the task of investigating some 80 enterprises around the world.23 Once they determined where the assets of PA or PLO were hidden, their job was to “clean” and take control of them.


  In January 2003, initial media reports began to reveal where Arafat had squirreled away millions of dollars in PLO money over the years. The reports indicated that the PLO had lucrative deals with Israeli figures, among others, with assets held in Switzerland, Africa, and America, to name a few. The reports created a splash in the international media. Locally, they sent shockwaves through the Palestinian economy as monopolies were exposed and sometimes shattered. The timing was less than fortuitous. The intifada continued to wreak havoc on the Palestinian economy. The exposure of these secret businesses often exacerbated the instability.

  As Prince notes, the companies brought into the fund were only part of the story. The holdings that Fayyad elected not to include in the PIF were deemed not “clean enough.” Many of those assets were never revealed. It is unclear whether they are still held by Palestinian interests today.24

  In the end, Fayyad settled on a model based on a German public investment fund. By all accounts, it was a successful endeavor. In 2003, the PIF had a net income of $40.1 million on revenue of $85.1 million.25 Moreover, by forcing the sale of assets not related to economic development or in competition with the private sector, hundreds of millions of dollars were put back into the Palestinian Treasury—up to $700 million.26

  The New York Times summed up the venture nicely. In short, Fayyad had tracked down “assets in 79 commercial ventures, from Canadian biopharmaceuticals to Algerian cellphones, and hired Standard & Poor’s to examine them for their value and ownership structure. He published the results as they came in, identifying the officials involved, centralizing the investments under a new supervising agency and laying plans to sell them off.”27 The result was that Fayyad had earned his first big success.