On August 19^th, a car bomb in central Beirut killed eight people and wounded 80; among the dead was Brig. Gen. Wissan al-Hassan.  Hassan was the head of Lebanese intelligence.  A Sunni, Hassan opposed Syrian interference in Lebanese society.   Lebanon’s power structure tends to divide along pro- and anti-Syrian lines.  Hassan was clearly an opponent of the Syrian regime.  For anti-Syrian political figures, Hassan was the primary security official, protecting these leaders from Syrian threats. 

Although the Assad regime has denied involvement, most analysts believe Syria was behind this attack.  The proximate cause of the assassination was Hassan’s arrest of Michel Samaha in August.  Hassan led an investigation into Samaha’s activities and determined he was working with elements of Syrian intelligence to implement a terrorist bombing campaign against anti-Syrian factions in Lebanon.  Samaha, a former information minister and intelligence officer in Lebanon, had close ties to the Assad regime.  It is believed Syria retaliated against the arrest of Samaha by assassinating Hassan.

However, the larger issue is related to Syria’s civil war and the growing potential for the conflict to regionalize.  In this report, we will offer a short history of Lebanon and Syria, examine the current state of the conflict in Syria and discuss the potential for the Syrian civil war to become a regional conflict.  As always, we will conclude with potential market ramifications. 

 

Brief History

Lebanon was part of the Ottoman Empire for 400 years; this membership ended in 1918 in the aftermath of WWI.  France controlled the region until the end of WWII, when Lebanon became independent.  The region was cosmopolitan with a mix of ethnic and religious groups.  From 1946 until 1975, various ethnic or religious groups were allocated seats of power.  The Maronite Christian majority, based on the 1932 census, controlled the presidency, the military and Parliament.  The president of the parliament was allocated to the Shiites and the prime minister was given to the Sunnis.  In 1989, in the aftermath of civil war, the Ta’if agreement established new power allocations.

Over time, population ratios have changed.  The Christian population declined due to falling birth rates and emigration.  Since the Christians controlled the wealth, they tended to have smaller families.  The Muslims, being less affluent, tended to have larger families.  By the mid-1970s, Christians wielded more power than their numbers would warrant.  This led to calls for increased Muslim representation.  Adding to tensions was a large population of refugees in southern Lebanon belonging to the Palestinian Liberation Organization (PLO).  The PLO was heavily armed and upset the delicate political balance. 

In 1975, civil war broke out which lasted 15 years and left Lebanon’s economy devastated.  The central part of Beirut, the capital of Lebanon, was destroyed.  As central authority deteriorated, Syrian troops moved into Lebanon to maintain order. 

Syria has viewed Lebanon as a natural extension of its territory.  During the Ottoman period, the Syrian province controlled what is now Lebanon.  Lebanon is crucial to the Syrian economy.  For most of its history, the dead hand of authoritarian rule dampened economic growth in Syria; the Assad governments have used control of Lebanon and its vibrant trading economy to support Syria’s economy. 

The Assad family, which rules Syria, is part of an Islamic sect known as the Alawites.  Although the Alawites hold some religious tenets specific to their sect, in general, most religious scholars consider the Alawites as being related to Shiite Islam.  Most Sunni theologians believe the Alawites are apostates. 

As the Lebanese civil war came to a close in the late 1980s, Syria had two major goals.  First, it wanted to maintain control of Lebanon and second, it wanted to secure its standing in the region. Hafez Assad, the ruler of Syria during this period, was a Baathist, which was a secular-socialist, pan-Arabist party.  This same party also controlled Iraq.  Although Saddam Hussein and Hafez Assad were members of the same political party, by the late 1990s they had become bitter rivals.  Thus, Assad felt threatened on his eastern border.  At the same time, his relations with Israel were tense due to Syria’s drubbing in the 1967 Six-Day War. 

To compensate for this relative isolation, Syria developed relations with Iran.  Iran became isolated after the Iranian revolution in 1979.  In that event, the Shah of Iran was ousted in favor of Ayatollah Khomeini, who created a Shiite Islamic republic.  Needless to say, the Sunni Arab governments in the region strongly opposed that development.  These two isolated nations had enough in common to develop relations. 

Both Iran and Syria had interests in Lebanon.  As previously mentioned, Syria wanted to control Lebanon to support its moribund economy.  Iran wanted to expand its influence and develop an ally that would give it a base to attack Israel.  Iran’s opportunity presented itself in 1982 after Israel invaded southern Lebanon.  The Sharon government occupied southern Lebanon to prevent the PLO from using this region to launch attacks against Israel.  A resistance movement, called Hezbollah, developed to oppose Israel. 

Iran has bankrolled and trained Hezbollah into a significant asymmetric military force to harass Israel.  Syria has supported Hezbollah by providing logistics for arms and trainers.  However, Iran and Syria’s interests don’t completely align with regards to Hezbollah.  Iran wants Hezbollah to be a military threat.  Syria, on the other hand, wants to dominate Lebanon.  Thus, there are times when Syria is less than helpful to Hezbollah’s development.

Interestingly enough, Hezbollah is not completely a puppet of Iran.  The terrorist group wants to dominate the Lebanese political system which may mean that doing the bidding of Iran will conflict with that goal.  At times, there are disagreements among the three parties.

On February 14, 2005, a massive car bomb in Beirut killed former Lebanese Prime Minister Rafik Hariri.  Hariri had represented the opposition to President Emile Lahoud, who was pro-Syrian.  Lahoud, with support from Syria, was trying to amend Lebanon’s constitution to allow him to stay in office indefinitely.  In the previous year, Hariri was instrumental in UNSC Resolution 1559, which called for the removal of all foreign troops from Lebanon, the disarmament of Hezbollah and the end of foreign interference into Lebanon’s political system.  Needless to say, this resolution was unpopular with the Assad government.

The assassination sparked a revolt, which was called the Cedar Revolution by the West.  The U.S. and France used this revolution to oust the Syrian military from Lebanon.  A tribunal was created to investigate the murder, and both U.S. and French officials made it clear that Syria was the primary suspect.  For the Bush administration, weakening the Assad regime would assist in undermining its support of Sunni terrorism in Iraq.  In addition, the U.S. wanted to disarm Hezbollah and reduce its (and Iran’s) influence in the region.  

Syria was forced to remove its troops from Lebanon due to international pressure.  However, the Assad regime continues to have significant influence in Lebanon through Hezbollah and affiliated Shiite supporters. 

The Uprising

Nearly two years ago, a small protest movement began in southern Syria.  Due to the government’s ham-fisted reaction to the protestors, the protest movement has evolved into a civil war. 

The rebel forces aligned against the government are not strong enough or organized enough to overthrow the regime.  At the same time, the military forces of Syria are not strong enough to end the insurgency.  The Alawites are simply not a large enough part of the military to control the entire country.  Thus, loyal units of the military are engaged in a “whack-a-mole” strategy of hitting insurgents where they reveal themselves and moving to other areas of activity.  However, they cannot prevent insurgents from returning after the military clears an area.

Because much of the insurgency is Sunni, and thus a majority in Syria, the Assad regime is in a difficult spot.  Thus far, the rebels haven’t been given heavy weapons as outside supporters worry about giving such goods to jihadist groups that could stir up problems elsewhere.  At the same time, the insurgency relies on financial support from the U.S., France and surrounding Sunni-dominated countries.  For now, Syria is in a stalemate. 

To try to weaken outside support for the Syrian insurgents, the Assad regime has tried to foment problems in the surrounding region.  There have been artillery exchanges between Syria and Turkey, and the Assad government has granted Syrian Kurds autonomy in northeastern Syria.  Giving the Kurds autonomy raises fears in Turkey that a Kurdish homeland could develop which would be problematic for Turkey. 

The bombing in Lebanon is part of Assad’s goal of raising the costs of supporting the insurgents.  Lebanese Sunnis have been supporting the Syrian rebels, and so Assad views attacking Sunni leaders in Lebanon as a reasonable strategy.  In effect, Syria is trying to disrupt the flow of supplies and other support to the rebels.  It also sends a signal to Western supporters of the insurgency that the potential cost of maintaining that support is a regional conflict. 

There are three other reasons for taking the conflict to Lebanon.  First, if the rebels do eventually turn the tide, the Assad regime will need a secure place to retreat.  Most of the Alawite regions are on the eastern border with Lebanon and so, the regime needs a pacified Lebanon on its flank so it could retreat to their redoubt in the Alawite regions.

Second, Assad needs to keep the Alawites unified in support of the regime.  There have been stirrings of divisions within the group that might offer up Assad for a place in a new government.  Assad has to show he has a plan for holding power and an escape if control is lost.  Ensuring a compliant Lebanon is important to showing Assad’s religious compatriots that he has a program in place if he is pushed out. 

Third, showing that Syria can still attack its opponents in Lebanon will tend to keep Hezbollah in the fold.  Hezbollah has been a tepid supporter of the Assad government since the insurgency began as the former sees itself as a defender of the powerless in the region.  Hezbollah must align itself with Assad due to his relations with Iran, Hezbollah’s patron.  But, Hezbollah isn’t happy about Assad’s conduct against civilians in Syria.  By assassinating a high level official in Lebanon, the Assad regime has made it clear it is still a force to be reckoned with; the regime hopes this show of force will keep Hezbollah in its camp.

Ramifications

To some extent, Syria’s attempts to regionalize its civil war reflect the growing desperation of Assad and his allies.  If Syria is successful in creating a regional conflict, it is not likely that borders will remain intact and even if the Assad regime survives, it may be ruling a smaller nation.  In fact, the more the conflict spreads, the greater the odds that the U.S. and other western powers will intervene to protect surrounding governments. 

Over time, the governments allied with the rebels will likely offer them heavy weapons.   The attraction of overthrowing the regime will probably be greater than the worries about giving jihadists weapons that could cause blowback.  Once this occurs, the Assad regime will be in deep trouble.  However, if Assad falls, it will be very hard to maintain the territorial integrity of the country.  That is why the U.S. and Russia have toyed with the idea of giving Assad safe passage to Russia if he will agree to give up power.  The hope would be that the apparatus of government could be maintained and allow a new regime to develop.  Such an outcome might have been possible a year ago.  However, at this juncture, it is unlikely that the Syrian rebels would agree to such a deal, as the Sunnis would want control and the other groups in Syria would be fearful of reprisals. 

The regionalization of the conflict in Syria is creating a dangerous situation, which, so far, neither the West nor the surrounding powers are prepared to handle.  This bombing in Lebanon is an ominous signal that the civil war in Syria is spreading beyond its borders and will, at some point, require a stronger reaction from the supporters of the insurgency.  Without more direct Western involvement, the likelihood of a regional war will grow.

A regional Mideast conflict will be bullish for oil prices but likely negative for equities, especially emerging economies in the region, e.g., Turkey, Egypt, and Israel.  Given the proximity of Europe to the region, it will also be a bearish event for European financial assets, as the odds of refugee problems would increase.  Overall, this issue isn’t front and center for investors, but if conditions deteriorate further, we would expect this situation to start affecting commodity and financial markets. 

 

Bill O’Grady                  

October 29, 2012

This report was prepared by Bill O’Grady of Confluence Investment Management LLC and reflects the current opinions of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

Confluence Investment Management LLC is an independent, SEC Registered Investment Advisor located in St. Louis, Missouri.  The firm provides professional portfolio management and advisory services to institutional and individual clients.  Confluence’s investment philosophy is based upon independent, fundamental research that integrates the firm’s evaluation of market cycles, macroeconomics and geopolitical analysis with a value-driven, fundamental company-specific approach.  The firm’s portfolio management philosophy begins by assessing risk, and follows through by positioning client portfolios to achieve stated income and growth objectives.  The Confluence team is comprised of experienced investment professionals who are dedicated to an exceptional level of client service and communication. 

 

 

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