Why Tax Havens Will be at the Heart of the Next Financial Crisis

[Winehole23]

Why Tax Havens Will be at the Heart of the Next Financial Crisis (http://www.nakedcapitalism.com/2015/09/why-tax-havens-will-be-at-the-heart-of-the-next-financial-crisis.html) Posted on September 4, 2015 (http://www.nakedcapitalism.com/2015/09/why-tax-havens-will-be-at-the-heart-of-the-next-financial-crisis.html) by Yves Smith

(http://www.nakedcapitalism.com/author/yves-smith)

By Nicholas Shaxson, the author of Treasure Islands (http://www.amazon.com/Treasure-Islands-Uncovering-Offshore-Banking/dp/0230105017), an award-winning book about tax havens. Originally published at Tax Justice Network

(http://www.taxjustice.net/2015/09/03/why-tax-havens-will-be-at-the-heart-of-the-next-financial-crisis/)

This post examines another excellent in-depth investigation by Reuters into global financial stability issues, and the role of tax havens in this giant game of pain and plunder. The investigation uncovers, among other things, a whole lot of offshore shenanigans, complementing what we (and relatively few others) have been saying for some years now, and it goes right to the heart of what capitalism is — or at least what it has become.


Before reading this, though, see the box “What is a tax haven?” There’s a lot of misunderstanding out there.


What is a tax haven?
http://www.taxjustice.net/wp-content/uploads/2014/10/London-panorama-300x55.jpg (http://www.taxjustice.net/wp-content/uploads/2014/10/London-panorama.jpg)
The term ‘tax haven’ is a bit of a misnomer: they aren’t just about tax. We will mostly use the term ‘offshore’ here instead of ‘tax haven’ – what we are talking about is the same basic phenomenon: jurisdictions offering escape routes to financial players elsewhere, helping them avoid taxes or disclosure or financial regulation or whatever other ‘burdens’ of society they don’t like.

In financial stability terms the world of offshore — a world that includes places like Ireland, Luxembourg, Cayman and the City of London (see box) – has been where financial services players have been able to escape regulatory barriers at home, taking the cream from risky activities while shifting the risks onto taxpayers via bailouts and other nasties. Offshore was very significantly at the root of the global financial crisis that erupted in 2008 — and on all evidence it will be at or near the epicentre of the next one too. We have written about this many times, (http://www.taxjustice.net/topics/race-to-the-bottom/financial-regulation/) and we have fingered London as being especially dangerous (http://taxjustice.blogspot.ch/2012/06/us-watchdog-hits-at-risky-london.html) for global financial stability. And this comes in the context of the UK just having announced (http://www.taxjustice.net/2015/09/02/as-the-murk-grows-the-uk-rows-back-on-money-laundering-checks/) that they will be rowing back on money laundering checks and so on, in the name of ‘cutting red tape.’ (Read (http://www.taxjustice.net/2015/09/02/as-the-murk-grows-the-uk-rows-back-on-money-laundering-checks/)it and weep.) As was reported in the Financial Times not so long ago:



“Carolyn Maloney, a Democratic representative from New York, said there was a “disturbing pattern in the last few years of London literally becoming the centre of financial trading disasters””


Whatever one might think of Congresswoman Maloney (https://maloney.house.gov/issues/financial-services), that statement is spot on.


This article looks at two Reuters stories in particular:




How Wall Street captured Washington’s effort to rein in banks (http://www.reuters.com/investigates/special-report/usa-bankrules-weakening/); and
U.S. banks moved billions of dollars in trades beyond Washington’s reach (http://www.reuters.com/investigates/special-report/usa-swaps/).


The first story notes:


“[The] FASB, the private group that sets accounting standards for public companies, came under political pressure to tighten rules blamed for exacerbating the financial crisis. Critics said FASB had made it too easy for banks to stash mountains of securitized loans in off-balance-sheet vehicles based in the Cayman Islands, hiding their exposure to risks that eventually swamped them and the global economy.
http://www.nakedcapitalism.com/wp-content/uploads/2015/09/VIEs-247x300.pngHere, too, banks pushed back hard. And here, too, their protests reached sympathetic ears. Ultimately, FASB’s rules barely dented the size of banks’ off-book holdings”
. . . as the Reuters graphic here suggests. The banks, Reuters reports, hold nearly $3.3 trillion of securitized loans in off-balance-sheet entities. And that’s just Cayman and six U.S. banks.

“It isn’t just the banks. As hedge funds and private equity funds have ramped up high-risk lending in recent years, their use of off-balance-sheet vehicles has ballooned.”
There are two guilty parties here, geographically speaking: first, the United States, which shouldn’t allow this to happen; and second, “offshore” (which some think (http://www.taxjustice.net/cms/upload/pdf/Doggart_2010_by_Brittain_Catlin.pdf) of as a single seamlessly interconnected place) where, as a general rule, the big players are allowed to do whatever they damn well like. As a former top Cayman official once put it (http://www.compasscayman.com/cfr/story.aspx?id=1564):

“The responsibility of the Cayman government was managed by avoiding the concept of prudential regulation.”

http://www.nakedcapitalism.com/2015/09/why-tax-havens-will-be-at-the-heart-of-the-next-financial-crisis.html

[Winehole23]

And now, as an aside, here’s a little snippet that Reuters unearthed, which we hadn’t seen before, about a big pre-GFC crisis:



“Gensler often told people how, at the Treasury, he was stuck with the task of briefing then-Treasury Secretary Robert Rubin about Long-Term Capital Management in 1998. The Connecticut hedge fund collapsed under $1.2 trillion in swaps booked to a post office box in the Cayman Islands.”



Cayman again. LTCM was a biggy – causing global market carnage at the time. However, the only book today’s blogger has read about it – Roger Lowenstein’s otherwise excellent When Genius Failed — does not mention Cayman once in the footnotes. You will hardly find it mentioned here or in other detailed analyses. This wasn’t on anyone’s radar screens at all. And far too few people are paying attention to the financial stability threats that lie offshore, hidden and unknown until crisis hits.

Now this isn’t to say that the next crisis won’t be triggered and significantly caused by an economic collapse in China, or an asteroid strike, or something. But the last big crisis showed — if you look carefully — how tightly connected all this stuff is, and how offshore is so often at the heart of it. This IMF graph from 2010 (http://www.imf.org/external/np/pp/eng/2010/100410.pdf) is one of the only bits of research that really points the finger offshore. (Even then, though, they pussyfoot around using such emotive words such as ‘tax haven’ or ‘offshore.’) But just look at that rogues gallery in the cross hairs: BVI, UK, Luxembourg (http://www.financialsecrecyindex.com/PDF/Luxembourg.pdf), Ireland (http://www.financialsecrecyindex.com/PDF/Ireland.pdf), Bermuda, Cayman, (http://www.financialsecrecyindex.com/PDF/CaymanIslands.pdf) Jersey (http://www.financialsecrecyindex.com/PDF/Jersey.pdf), Isle of Man, Switzerland (http://www.financialsecrecyindex.com/PDF/Switzerland.pdf), Liechtenstein. And of course the United States (http://www.financialsecrecyindex.com/PDF/USA.pdf).


http://www.nakedcapitalism.com/wp-content/uploads/2015/09/Greece.jpg


As mentioned, this stuff goes to the heart of what capitalism has become. All this regulatory arbitrage, like tax cheating and so much other stuff that is going on, is a form of what academics call rent-seeking, and we prefer to call ‘wealth extraction.’ In this case, it’s ultimately about extracting wealth by gambling with other people’s money: taking risks and getting others to pay when the balloon goes up.

[Winehole23]

"Systemic risk is the risk that a significant part of the financial system stops working--that it cannot perform its function," says IIASA Advanced Systems Analysis program researcher Sebastian Poledna, who led the study. For example if a major bank fails, it could trigger the failure of other financial institutions that are linked to it through loans, derivatives, securities, and foreign exchange exposure. The fear of such contagion is what drives governments to bail out banks.


"Previous studies of systemic risk had just examined one layer of this system, the interbank loans," says Poledna. The new study expands this to include three other layers of connectivity: derivatives, securities, and foreign exchange. By including the other layers, Poledna and colleagues found that the actual risk was 90% higher than the risk just from interbank loans.


Currently, financial regulators tend to use market-based measures to estimate systemic risk. The researchers find that these measures also underestimate the actual risk. In Mexico, which the researchers used as a case study, they found that systemic risk levels are about four times higher today than before the financial crisis--yet these risks are not reflected in market-based measures.


"Banks today are far more connected than they were before the financial crisis," explains Poledna. "This means that in a new crisis, the public costs for Mexico could be four times higher than those experienced in the last crisis,"

http://www.eurekalert.org/pub_releases/2015-09/iifa-rof090215.php

[RandomGuy]

http://www.nakedcapitalism.com/2015/09/why-tax-havens-will-be-at-the-heart-of-the-next-financial-crisis.html

Came across something in my work called a "Guernsey protected cell" entity.

Essentially it was a tax dodge. The company got together with an outside reinsurer... transferred part of their risk (and revenues) to the reinsurer, then the reinsurer transferred the risk (and revenues) right back to the cell, which was nominally owned by the company group that originally transferred the risk/revenue in the first place.

Essentially the cell is a partnership, run by yet another company. the insurer got to account for all the revenue/profits it transferred to this cell as "investment income", taxed at 15%, rather than keeping it on their books, and presumably paying 40% corporate income tax on it.

Nice trick.

Guernsey is a tiny island off the coast of britain. Baliwick of Guernsey. The entity pays very little tax to the Baliwick (all of 65,000 people).

[RandomGuy]

http://www.eurekalert.org/pub_releases/2015-09/iifa-rof090215.php

US banks have been forced to have a lot more capital on hand though. That cushion means a lot.

Still will take a look at the study.

[RandomGuy]

http://www.eurekalert.org/pub_releases/2015-09/iifa-rof090215.php


Poledna points out that the new method may still underestimate systemic risk, as it leaves out two additional potential sources of risk - overlapping investment portfolios, and funding liquidity. The researchers are now working in collaboration with the IIASA Risk, Policy and Vulnerability program on a new study that brings in these additional layers.

The study relied on data from the Mexican banking system but the researchers say that the method could be used for any country, as long as the data were available.

Might actually pony up the money for that, since it is professionally relevant.