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Dear XYZ, money laundering

Posted on 9 mins read

Dear XYZ,

you asked me on comments and thoughts on the problem of money laundering.

1.) In the article in the Journal of Financial Crime he writes:

“But extra-territorial enforcement of bad tax law is not a very appealing cause, particularly when it often involves wealthy, white nations persecuting developing countries governed by people of color”.

In Germany the implications of white vs. color do not play a role in public perception. Quite the contrary, tax havens (developing nations or not) are accused of “growing rich through inviting money that has been stolen from the state”. Most of France and Germany are happy sending tax money as foreign relief to developing nations, but are less happy if non-taxed money is invested there.

The current arguments used in the fight against money-laundering, at least in Germany, center around taxes, “destabilizing investments”, shadow economy and organized crime. Anti-terror investigations via financial flow analysis do not play a big role in the media right now. Since untaxed money hidden via means of restructuring, spreading etc. is defined as money laundered the fight against money laundering is indeed also a fight against tax-evasion, tax-optimization and financial freedom. At least that is my impression.

2.) The first jurisdiction to look at when money is laundered is the country where the black money is earned, as well as the form the money is in. On the one hand there is cash and on the other electronic money (money in bank accounts). When it comes to cash the money needs to be introduced into the banking system for further launder it. Here esp. the bigger nations are vulnerable. The reason for that is simply the amount of business conducted with cash. As soon as cash business exists it can be used to introduce black money in cash. The factors that play a major role here are market size, market diversity, cash portion of transactions, import/export market size, sales tax/VAT, cash registry bookkeeping rules and the size of immigrant populations from underdeveloped nations.

All these factors play a major role in determining the costs (incl. risk overhead) involved and methods available to introduce cash into the banking system. Here several countries are very vulnerable, esp. the USA and most of Europe. The sheer size of their cash business, the amount of foreign trade and immigrant population make those places prime targets to introduce black money in cash. Uptopping/Upscaling of invoices and cash sales figures play the major role here. It is extremely easy to introduce money here if you work with big numbers.

Another major factor for the introduction phase is the access to international banking transactions, foreign exchange- and stock markets. Since the second step of the process is to disconnect the introduction point from the final deposit or investment it becomes most important to use either market scheming (transfer of value through coordinated stock bets, esp on the grey markets), splitting/restructuring or over-the-counter-transactions. otc-transactions are still very common in various  industries and trades, as there would be used car trades, gemstone trading, and at least  a dozen others.

A common way for cigarette smugglers for example is to use the profit from the operation that is generated in Germany to buy used cars, export them to Russia and sell them there. Since all steps of the transaction are cash only they are extremely hard to prove, and the profit made from the final sale of the car is actually already “clean”. The same path has been used a lot in the past to transfer vast amounts of black money to Russia to then buy commodities there and ship them back, resulting in a very hard to unravel transaction that gives lots of room to hide unaccounted money in. There are hundreds of those schemes to use, and little to no chance of an outsider being able to analyze them.

However, it remains that for these schemes non-tax-havens are more vulnerable. Most of the EU, Canada and the US make perfect environments for these schemes. For further removing introduction point and final deposit from each other the main factor is probably the saturation with personal and corporate bank accounts, professional banks and the availability of linked and/or correspondence accounts. Here again Germany, NL, UK and US are prime suppliers of those conditions.

Another thing to mention in this context is that the amount of non-cash (electronic money) laundering has increased tremendously in the last years. Sources for this are often trade schemes, bribes and internet criminality. While bribes are often not laundered (just parked, in jurisdictions with high banking secrecy), trade schemes and internet criminality both rely mostly on swift international banking transactions. Here the European Union and especially the newer member states are prime suppliers of favorable conditions.

The US is also an interesting target for e-money laundering but for different  reasons. Here the ease of ID Theft, account take-overs and wide availability of personal data support the process through creating a rich supply of easy to  procure banking services under false identities. While in the US those operations can be done without even putting a boot on the ground, Eastern Europe has become prominent for so called “bum-banking”. Mostly homeless people are paid to open bank accounts under their own names and turn over internet-banking credentials to the money launderer. The lag between transaction, review as unusual and action by law-enforcement leaves a window big enough for the launderer to channel up to 50k USD through those accounts without risking to loose any.

Since most of the transactions are managed by computing systems the actual cost for these transfers is well below 3%.

Furthermore there is a clear fault on the sides of European Union and the USA. Both of their currencies are so widely traded that they are accepted almost everywhere in almost any volume. One laundering tactic that has been used for decades is to fly cash into developing nations to buy into commodities/raw materials. International air transport is very much uncontrolled, landing strips are widely available, customs and border control easy to bribe or threaten. It is not unheard of that private planes transporting millions in small, used bills.

Banking havens with tight banking secrecy actually seem to play a very small role in money laundering. They might be used as locations to run pooling, parking and long term deposit accounts. However, it is much more favorable for the laundered money to be reinvested in a major market like Europe or the US. This is often done by holdings that have majority shares in local businesses or property. Done right this means that money laundering never has to cross borders more then once (China is popular for that) to become clean and investable in prime markets.

3.) The total amount of laundered money is unclear to anyone. There are educated guesses (often based on the perceived volume of sources like drug trade etc.) but none of them can point to real data. The reason is simple: Effective money-laundering is almost undetectable and even harder to follow. Furthermore a lot of black money comes from crimes that are uncommon to be reported and even a bigger portion of black money is never laundered (see below). My personal guess (after rolling a few dices) is that a total amount of 5-8t USD is laundered each year worldwide. And yes, it seems very much like a few banks in the last 12 months have been rescued by black money.

4.) Risks of fighting money laundering.

Money laundering is pure market force at work. Criminals are first and foremost businessmen. Their organizations are international businesses. As for most market participants laws, limits and regulations are just obstacles to sail around or even use for additional profit. Organized crime is highly adaptable and even entrepreneural in spirit. This leads to unintended consequences of any regulation set up for them. One is that the task of laundering money gets more professionalized.

The other is that investing in bribing, pressuring and tainting of key persons becomes more profitable then direct laundering of money. This has the potential to corrupt whole chains of command. More money is available for bribes, bribes are more profitable, ergo more bribes will be paid. When a system is tainted sufficiently by black money it begins to work for the criminal. Costs drop, limits and laws become meaningless. The policy question here is: Do we force black money into our own societies to remove the effective rule of law, or do we live with the (smaller) consequences

of not being to tough on black money.

5.) Data-mining

Data mining is an extremely bad tool to fight money laundering. It starts with the inability to identify patterns characteristic for money laundering. Furthermore due to the wide range of laundering practices and the constant change of methods any pattern that could be observed becomes meaningless soon after. With known limits and regulations (like notifying investigators about cash transactions above a certain limit) data mining also looses its ability to detect patterns of interest – while unregulated (natural) events have characteristic properties (often bell-curves),  limits actually destroy those properties and make it less possible to identify black swan events, manipulated behavior and transactions which promise higher success when

investigated. Data-mining for money laundering comes thus with a high false-positive and a high false-negative rate, making investigations harder and burning resources.

6.) How to fight money laundering

There are a few tools that look promising to me. One is to use many more feet on the ground, infiltrating criminal networks and identifying key persons of interest. This can lead to “watch-lists” for accounts that are likely to be tainted. Watching only these accounts optimizes resource use in investigations.

Another strategy would be to introduce limits on the type of banking services being available to consumers. Few people actually need access to international transactions except for their credit card. Simply making these services more costly to subscribe to, and then watching the initial uses of these services would help a lot to reduce banking mules, money managers and victims of IP-Theft.

However, fighting real money laundering is not necessarily on the wish-list of politicians. Black money is often cheap money, money that is invested in risky business and especially property. Busting a multi-million crime syndicate can have very real negative consequences to the budget of a city.

7.) Why to fight money laundering?

There are various well-meaning arguments to fight money laundering. Criminals shall simply not be in the position to enjoy their ill-gained profits. However, there are real costs and risks to society in doing it. And with increased pressure it is not unlikely that it will force organized crimes into establishing alternative means of financial services. This has already happened in parts of Eastern Europe (esp the Balkans) as well as in Russia. Should such a split become more global the consequences would be devastating even to more stable governments and nations.