Prometheus 6

Hope you're not tired of further explanations for our economic collapse last year, but an interview in The American Interest with Jack A. Blum, chairman of Tax Justice Network USA and an expert on tax evasion, money laundering, banking and real estate scams, and corporate fraud, should add a little grist to your mill (hat tip to submariner for bringing it to my attention). There's only a small excerpt available online, but even that lets you know the 14,700 tax evaders that were scared into confessing by the knowledge that UBS had to turn over their most egregious tax evaders to the Feds, is just the tip of the iceberg.

I want to say all the tax cut fanatics should understand that money was moved out there to avoid sane regulations and paying taxes, to avoid supporting the infrastructure that made it possible to gather all that wealth in the first place.But we all know that...what we may not be aware of is the size of this multi-billion dollar black market.

In our September/October 2008 issue, Robert Morgenthau, the District Attorney of New York City, wrote:

Liechtenstein reports having 161 billion in Swiss francs (equal to about $158 billion at current rates) on deposit in 2006. The Bahamas reportedly has about $200 billion in deposits. By contrast, the Cayman Islands boasted that it had over $1.9 trillion on deposit as of September 2007. . . . Total deposits in the Caymans now amount to four times the total deposits in all the banks in New York City.

Now, most Americans, I think, would be amazed at numbers like these, despite having become a bit jaded by the large bailout sums disbursed over the past year or two. How did these numbers get so large? Is this an old problem that has lately gotten much worse, and if so why?

Jack Blum: There’s no way to make sense of the offshore problem without getting your head around the numbers you mentioned. And those numbers leave out financial assets held by corporations and trusts. Trying to understand the role of offshore secrecy and regulatory havens in the financial crisis is like the problem a doctor has treating a metabolic disease with multiple symptoms. Diabetes, for instance, causes high cholesterol, high blood pressure and all sorts of other problems. You can treat several symptoms and still not cure the disease. Similarly, there are plenty of discrete aspects of the meltdown to talk about and many possible treatments for symptoms, but offshore is at the heart of this metabolic disorder. Its roots reach back decades, in bankers’ attempts to escape regulation and taxation and make banking a highly profitable growth business that mimics the industrial economy.

Once you understand the scale of the problem, you need a coherent explanation of how it developed. I think you'll find Mr. Blum's explanation actually sheds additional light on your current understanding.

Jack Blum: ...the point is that the bank was trying to escape the basics of banking, and so were many others in the late 1970s and early 1980s, all in an effort to have profits keep pace with rising corporate profits in general— as increasingly expressed in share prices more than dividend yields or productivity increases. To make their institutions ultrahot stocks on the market, bankers called in consulting firms like Booz Allen Hamilton to figure out why investment bankers were making so much more money than they were. The answer was that their way of doing business was still too expensive. This led to a trend in which bankers sought to escape the cost grind by farming real banking out to unregulated entities and mostly dealing with the products of their unregulated activity. They also successfully lobbied Congress to relax a range of regulations starting in 1980. Then they focused increasingly on moving financial products from those who created them to those who wanted to buy them. As middlemen, the new breed of bankers could take on less risk and employ very little of their own capital. It worked: They made a lot of money.

But things did not stop there. To make even more money, bankers invented financial instruments that no one understood, and so couldn’t be properly priced by the market. They could get a hell of a mark-up on that and lay it on the customer. So it was the inability or unwillingness of bankers to stick to their business that led them to try to get out from under regulatory supervision.

AI: So now we’re in a position to bring in the offshore piece. What’s the connection between the sort of dynamics you’ve just described and places like the Caymans?

Jack Blum: The connection is fundamental: Banks and other financial institutions that go offshore get out from under regulation and from their reserve requirements. Offshore banks and affiliates have no reserve requirements. The appalling aspect of the offshore world has been that the banks and other financial companies that fit into the world of shadow banking (hedge funds, insurance giants and others) have an unlimited ability to create money. Normally money creation by ordinary banks is limited by reserve requirements— loan loss and liquidity reserves. Without those limitations, their ability to lend goes through the roof. The more crazy financial instruments they produce and sell on money they lend the more money they make. The beauty of this is that the more they lend, the more the junk derivatives they sell increase in value. It works beautifully until the bottom falls out.

AI: And crazy instruments have a way of generating scandals. The Caymans was the nominal home of Long Term Capital, the giant hedge fund that collapsed in 1998. Enron Corporation used 441 Caymans affiliates to hide $2.9 billion in losses. Bear Stearns and especially AIG are interesting cases in this regard, too, are they not?

Jack Blum: AIG’s entire credit-default-swapcum- insurance policy business was offshore, because AIG would have been required to have reserves against possible losses onshore. The credit-default swap is a perfect scheme: You write insurance, in many cases for deals in which no assets or equity is involved, and then all you have to do is nakedly pass out contracts saying, “We’ll repay you if this thing goes bad.” You don’t have to keep money on hand; you just keep writing those policies and collecting the premiums.

AI: The assumption being that not many will go bad, and that if they do—

Jack Blum: —you’ll cover it either out of cash flow, or you’ll retire and leave the U.S. Treasury to pick up the pieces. The whole thing represented a threat to the stability of the financial system, and it couldn’t possibly have reached the scale it did without the offshore secrecy jurisdictions which gave AIG the ability to hide the risk as a contingent liability.

AI: That’s just one side of the picture, right? A lot of these offshore shenanigans were technically legal despite being so pernicious, like systematic efforts at tax avoidance.

Jack Blum: Right, and tax is the aspect people usually overlook. These financial games were played in a tax-free environment. So not only will banking businesses onshore be more expensive because they have to keep reserves, making their cost of money higher; they will be taxed while transactions offshore won’t be. The perfect world offshore consists of three parts: No one is watching your activities, it’s at low cost, and you’re not paying taxes.

An enormous amount of super-charged money is what took us over the precipice. Until that super-charged money-creation machine is brought under control and taxed, we haven’t fixed anything. Some people are now yelling “Hallelujah, the recovery cometh!”, but the underlying problem, the bankers’ attempt to get out from under their basic function, remains.

Eight pages in print. All eight of them recommended.