Follow the Money Part 1
2001-06-24
SECRETS AND LIES
AS THE international financial system has expanded, so too have financial abuses -- money laundering, tax evasion, and rogue banking. Globalization is now changing the nature of these age-old problems, threatening to undermine U.S. diplomatic, economic, and even strategic interests. Multilateral efforts have begun to combat these abuses and have already achieved some impressive results. But time is running short for the Bush administration to act, and its decisions now will determine whether these multilateral efforts will continue.
Financial abuses have been around for as long as there have been finances to abuse. Money laundering and tax evasion are often viewed as complicated, boring matters hinging on the minutiae of tax codes and regulatory laws. But that image masks a destructive, often bloody reality. Drug cartels, arms traffickers, terrorist groups, and common criminal organizations use banks to launder their dirty money, making it appear as the product of legitimate business. Tax evaders structure transactions to hide their wealth from legitimate authorities, weakening national tax bases. Corrupt government officials exploit banks to facilitate their own misdeeds, breeding a lawless business culture and undermining public confidence in national financial systems. And the underregulated banking systems that facilitate these abuses have sparked financial meltdowns around the world.
The United States and many of its economic allies have long understood these threats and know that "following the money" can unearth big vulnerabilities in criminal syndicates. Over the years, their governments -- remembering that Al Capone was put behind bars for tax evasion rather than murder -- developed legal and regulatory regimes to help detect and deter financial abuses. Banks and other financial-service providers were regulated and supervised. Money laundering and tax evasion were criminalized, banks were required to identify and report suspicious transactions, company-incorporation and trust-formation laws were passed to encourage transparency, and law enforcement agencies developed specialized investigative skills.
As criminal organizations began to operate across international borders, national regulators and law enforcement agencies began to share information. In recent decades, international standards for financial transparency were established through such multilateral organizations as the Financial Action Task Force (FATF) and the Basel Committee on Banking Supervision. But these efforts were not truly global. For the most part, only wealthy countries with well-developed financial systems participated; smaller and less-developed countries were mainly absent from these discussions. This did not seem a problem, however, because most of the world's funds routinely passed through a small number of highly developed economies. In comparison, the banking systems in the developing and then-communist nations were exceedingly small and not globally integrated.
Even among nations with well-developed financial systems, however, a few countries took different approaches. Switzerland and the Cayman Islands, for example, were notoriously reluctant to disclose information on their secret bank accounts. Moreover, they shared certain features that made their banks attractive to money launderers and tax evaders: both possessed stable political and economic environments, professional work forces, and -- most important -- physical proximity to more tightly regulated financial centers. A banker in London or Frankfurt needed only to take a brief plane ride with a suitcase full of cash to a colleague in Zurich. Similar trips were regularly made from New York City or Miami to Grand Cayman Island.
These services were enormously profitable. The Cayman Islands, with 35,000 inhabitants, saw its banking assets eventually exceed $ 670 billion. It became home to 570 banks and trust companies, 2,240 mutual funds, 500 captive insurance firms, and 45,000 offshore businesses. Switzerland, meanwhile, became preeminent in global asset management, controlling up to $ 2.3 trillion under management, more than half from foreign customers.
Under international pressure in recent years, however, Switzerland and the Cayman Islands have begun restricting their bank secrecy regimes. The Caymans also have begun (albeit slowly) to cooperate with foreign law enforcement, particularly with the United States. Switzerland still refuses to cooperate on international tax matters but is steadily improving its efforts against money laundering. Indeed, Swiss measures to combat money laundering are now superior to U.S. approaches in some areas.
But this is not the end of the story. Just as the international consensus among the leading financial centers began making real progress in the 1990s, another force emerged that undermined those efforts and raised a whole new set of problems: globalization.
MONEY FOR NOTHING
THANKS TO globalization and advances in banking technologies, distant countries are now just a mouse-click away. The bank next door may be doing business halfway around the world. This development has opened up great opportunities for nations that were once too small, too bereft of natural resources, or too physically remote from the rest of the world to benefit significantly from the global economy. A remote, poor country can now make easy money by following the example of Tuvalu, a South Pacific nation that sold its Internet suffix ".tv" to an American company for $ 50 million (as well as a 20 percent stake in future revenues) and leases its telephone prefix, 688, to a telephone-sex operator for $ 1.5 million per year.
The lure of quick wealth has generated other ideas as well. For money launderers and tax evaders, the proximity of Switzerland and the Caymans to major financial centers is not as important as it once was. Other countries soon figured out that they too could attract dirty money just by passing a few laws. These laws included provisions to establish strict bank secrecy, criminalize the release of customer information, and bar international law-enforcement cooperation. Other laws involved licensing "brass plate" banks (which have neither physical presence nor personnel) and allowing the creation of anonymous companies and asset-protection trusts, some of which can give ownership to whomever happens to be holding the relevant documents at that moment. Some countries also created offshore regimes with special rules, including tax advantages, that are available only to foreign customers. Others established "economic citizenship" programs, which sell passports to anyone who can afford them, and Internet gambling licenses, which provide convenient cover to those who wish to move large amounts of money. These nations then worked to help their banks set up relationships with established banks elsewhere -- an easy matter given modern banking and communications technologies. All that was left was to set up Internet sites touting the advantages of offshore banking, sit back, and watch the registration and licensing fees accumulate. Not surprisingly, almost none of these countries bothered to establish the financial supervisory institutions or examination mechanisms that even approached international standards.
The result was a vast proliferation of rogue banking. In the 1990s, remote South Pacific island nations including Nauru, Niue, and Vanuatu took this path to quick wealth. Small Caribbean nations such as Dominica, Antigua and Barbuda, and Grenada also joined in. From the Seychelles in the Indian Ocean to Bahrain in the Persian Gulf, a new breed of underregulated financial centers moved from the fringes of the international banking system to full integration into the global economy. Even wealthier countries such as Panama, Israel, Cyprus, and the Philippines -- nations that had long-standing aspirations for international banking but inadequate measures to prevent money laundering -- found themselves awash in questionable funds.
At the same time, many emerging markets were receiving previously unimaginable influxes of legitimate foreign investment, much of which was channeled through underregulated banking systems. Local financial markets were expanding wildly and attracting international bankers, for whom the prospective returns far outweighed the risks of doing business with such shaky institutions. The growth of international criminal organizations, drug cartels, and terrorist groups also strongly contributed to the proliferation of rogue banking. In turn, these underregulated financial institutions became prime conduits for funds flowing out of developing countries struggling with economic transition, crime, and corruption. Nowhere was this more evident than in the post-Soviet states. Funds from organized crime, government kickbacks, widespread tax evasion, the rape of natural resources, and old-fashioned legal capital flight all went to banks promising secrecy. Technological advances allowed rogue banking to flourish in a globalized world, but demand for no-questions-asked financial services drove the supply.
HIDE AND SEEK
OVER TIME, U.S. officials realized that these developments presented a growing threat to American interests. Weak banking systems and poor supervision have long been recognized as an underlying cause of financial crises and economic downturns around the world. But not until the 1997 Asian financial crisis did policymakers begin to ask difficult questions about underregulated financial centers. These questions touched not only on the structural weaknesses revealed by the crisis -- such as lack of transparency, distortions in resource allocations, and endemic corruption -- but on the scale and direction of capital outflows once the crisis had emerged. Policymakers also wondered whether financial abuses might undermine the credibility and efficiency of the international financial system. This subject was put high on the agenda of the Financial Stability Forum (FSF), which the G-7 group of rich industrialized nations established after the 1997 crisis to help promote international financial stability, improve the functioning of markets, and reduce systemic risk.
The International Monetary Fund (IMF) and the Organization for Economic Cooperation and Development (OECD) have also begun to assess the extent and damage of financial abuses. For example, IMF Managing Director Michel Camdessus estimated in 1998 that money laundering represented two to five percent of global GDP -- that is, between $ 800 billion and $ 2 trillion per year -- an amount large enough to merit the attention of policymakers. Among the deleterious effects of such abuses, he noted, are inexplicable changes in money demand, greater risks to bank soundness, contamination of legal financial transactions, and greater volatility of international capital flows and exchange rates. The OECD came to similar conclusions that year, pointing out that harmful tax practices can distort trade and investment, erode national tax bases, and undermine the fairness of tax structures. Oxfam, an international antipoverty organization, has estimated that developing nations alone lose $ 50 billion each year in taxes due to these practices.
Because of globalization, even the strong U.S. economy can be affected by global financial abuses. Experts estimate that the U.S. Treasury loses $ 70 billion annually through offshore tax evasions by individuals. The result is a disproportionate tax burden on law-abiding citizens and fewer resources available for public spending or tax cuts. The 1999 scandal involving $ 7.5 billion of Russian funds moving illegally through the Bank of New York -- with the complicity of senior bank officials -- demonstrated that financial abuses from abroad can corrupt important U.S. institutions. And even without insider wrongdoing, U.S. banks are more vulnerable to abuse if wire transfers of dirty money have been bounced through underregulated jurisdictions before entering the United States -- something increasingly easy to do.
As important as these economic effects are, however, they pale in comparison with the problems that global financial abuses present to U.S. law enforcement and national security. The Colombian black market peso exchange, for instance, is estimated to transmit $ 5 billion in drug money each year from the United States to Colombian drug traffickers through a complex series of trade and financial transactions. Domestic investigations of criminal finances are normally difficult enough, often requiring forensic accountants to sift through reams of bank transactions. But when a criminal's financial trail leads back to a foreign country that categorically refuses to share information, the investigation can end right there. With the globalization of the international banking system and the proliferation of underregulated foreign jurisdictions, U.S. law enforcement increasingly runs into this brick wall. Given their limited resources and previous bad experiences, U.S. investigators sometimes may not even attempt to seek information from some foreign countries.
Multinational crime networks rely increasingly on international financial mechanisms. In December 2000, U.S. intelligence and law enforcement agencies published the first International Crime Threat Assessment, which stressed the growing importance of "safe havens" for international criminal networks. Along with their utility in money laundering, these safe havens are especially useful as staging or transit areas for drugs, arms, and illegal immigrants. In Europe, German intelligence has identified Liechtenstein as a safe haven that some judges, politicians, bank managers, and investment advisers use for illegal financial transactions. Although Liechtenstein has vociferously denied these charges (published in 1999 in Der Spiegel) and successfully refuted some of the specific points made by the Germans, many experts believe that the report's general conclusions remain sound.
The value of safe havens has not been lost on terrorists such as Osama bin Ladin, who rose to prominence due not to his military exploits but to his ability to raise, manage, and move money for Afghan rebels in the 1980s. He still derives much of his authority and influence from the money under his control. He is said to have inherited about $ 300 million, and his Al-Qa'ida organization maintains legal and illegal enterprises, collects donations from supporters, and illicitly siphons funds from donations to Muslim charitable organizations. The funds are moved through a variety of mechanisms, including underregulated banks in the Middle East and elsewhere, then often transferred into better regulated institutions after the funds' origins have been suitably obscured. In the trial of those accused of bombing the U.S. embassies in Kenya and Tanzania, witnesses described Al-Qa'ida bank accounts in such disparate places as Dubai, Malaysia, Hong Kong, and London.
Financial abuses are also affecting regime changes around the world. Corruption has always been unpopular among voters. But recently, revelations of secret accounts held in underregulated banks have helped topple governments. In the Philippines, for instance, President Joseph Estrada was impeached and driven from office this past January after it was revealed that he had opened a $ 10 million trust account under the assumed name of "Jose Velarde." In Peru, President Alberto Fujimori tried to remain in office even as his intelligence chief and adviser, Vladimiro Montesinos, was caught bribing political officials before becoming a fugitive from justice. Fujimori even led a search team through the Peruvian jungle for the benefit of television cameras. It was only after Swiss authorities announced last November that they had found and frozen $ 70 million linked to Montesinos that Fujimori had to flee. In Europe, too, financial abuses are undermining politicians. Revelations of secret political slush funds in Liechtenstein ruined former German Chancellor Helmut Kohl's reputation; it seems almost everyone associated with the late French President Francois Mitterrand is now reeling from investigations into slush funds involving the formerly state-owned oil company Elf Aquitaine.
Rogue banking can even affect key U.S. strategic interests, such as Russian economic and political development. According to the Russian Central Bank, $ 74 billion was transferred from Russian banks to offshore accounts in 1998, the year of the ruble devaluation and the Russian financial meltdown; $ 70 billion of that went to accounts at banks chartered in Nauru. The following year, newspapers reported that Nauru's banks were involved in the $ 7.5 billion that illegally moved from Russia through the Bank of New York. A single bank registered in Nauru was identified as the ordering party for more than $ 3 billion of those funds. Only a few years earlier, Nauru had been less than a footnote in the global banking system -- and suddenly it became a factor in U.S.-Russian relations.
Or take sanctions, one of Washington's most important tools for dealing with states such as Iraq and Yugoslavia. The proliferation of rogue banking has made it harder to enforce these measures. Iraqi leader Saddam Hussein has found enough ways around U.N. sanctions to keep his regime intact more than a decade after the Persian GulfWar, often using foreign banks that choose to look the other way. Former Yugoslav President Slobodan Milosevic, himself a former banker, used a complex web of financial safe havens (especially in Cyprus) to create offshore companies and accounts that helped him evade the bite of sanctions. One of Milosevic's schemes involved moving more than $ 1 billion through a single account in a Cypriot bank between 1991 and 1995 -- money that helped fund his war machine and cause untold misery.
To be certain, New York, London, and other highly developed, well-regulated financial centers are no strangers to money laundering. It is unavoidable that much of the world's dirty money flows through these financial centers, given their size, the architecture of the international banking system, and the desirability of placing criminal funds where they can be of most use. But the United States and its partners have long recognized this problem and have been taking increasingly aggressive actions to curb money laundering and other financial abuses. The new problem lies in clamping down on underregulated jurisdictions and the new threats they pose to U.S. interests -- and that requires a new strategy.
Follow the Money Part 2
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