Cay: I dunno squat about banking, but I'm giving it a shot

Parmalat scandal forces an in-depth look at the offshore finance industry

Cayman Islands Monetary Authority director Richard Rahn wrote an article published in Cayman Net News on February 13th. He is also the author of Why the War on Money Laundering is Counter Productive, in which he dismisses anti-money laundering arguments such as money laundering, terrorism, tax evasion -- but not corporate malfeasance evasion -- and concludes:

if you truly want less crime, more prosperity and opportunity, and more freedom, you will "just say no" to the anti-money laundering laws and regulations.

Mr. Rahn begins by saying that:

Some of you reading this maybe thinking, "Ah Cayman, isn't that the place with all the illegal financial activity?"

It is true Cayman is the world's largest offshore financial center, and the world's fifth-biggest financial center, even though it is in the middle of the Caribbean on a small, pleasant island with only 40,000 people.

But contrary to the mythology from movies and novels, Cayman did not become rich by catering to criminals. The truth is just the opposite. Think about it for a moment. If you were looking for a place to put your money, would you choose a bank run by incompetents or criminals in a jurisdiction run by the mob, or would you put your money in a bank run by honest and competent bankers in a country with the rule of law?

"Cayman did not become rich by catering to criminals." This and the following is troublesome. "If you were looking for a place to put your money, would you choose a bank run by incompetents or criminals in a jurisdiction run by the mob, or would you put your money in a bank run by honest and competent bankers in a country with the rule of law?"

I think that the second statement fudges the issue, which is whether criminals might use Cayman banks because the banking system is honest and the country has the rule of law. In a country with an abundance of banks, why would an honest investor eschew American, European, and Swiss banks for the Caymans. Mr. Rahn's answer no doubt would be that the investor would use off-shore banking because it affords "more prosperity and opportunity, and more freedom." In spite of the rule of law in the Cayman Islands, the question remains whether its banking laws require a criminal and financial background check for prospective foreign account holders.

Moreover, in light of the Parmalat scandal, one must query the use to which a legitimate corporation would truly make of off-shore banking services. With Parmalat in mind, it is possible that services may actually serve as a blind for corporate ill-health and fiscal impropriety.

Rahn continues:

Most of the money in Cayman is institutional rather than individual, and it is more difficult for an individual to open an account in Cayman than in the US.

This remark is pretty much meaningless given that there are such things as dummy corporations. Apart from terrorists and drug dealers, anyone with enough funds and interest can establish a dummy corporation in order to cloak their financial ventures in the garb of legitimacy, or to provide some sort of recover for fiscal mismanagement.

Rahn adds that the:

Cayman also has agreements with the Internal Revenue Service and the US Justice Department for exchange of information on suspected criminals, tax evaders and terrorists. If you are a crook, it is not wise to try to open an account in well-run jurisdictions like Cayman and Switzerland, because neither the banks nor the governments will protect you.

Inasmuch as his article implies that there are no checks and balances in the Cayman system to determine legitimate from dummy corporations or legitimate from illegitimate use of financial services, then agreements can be adhered to with a nod and a wink. Cayman banks can't provide information they don't have, especially if they don't look for it.

He further argues that:

Honest people, however, do benefit from reasonable bank privacy in these jurisdictions. Another fact is that more money is "laundered" in New York and London than in places like Cayman and Switzerland.

See his article, Why the War on Money Laundering is Counter Productive.

Says Rahn:

.... What Cayman and some of its competitors provide is a place for large companies and financial institutions to consolidate funds, in electronic form, without being taxed or subject to unnecessary costly regulation, until these funds are productively reinvested throughout the globe (which can be as little as a matter of seconds).

This absence of regulation might be precisely why the Caymans may be attractive to dummy corporations or to legitimate business which are involved in prosecutable activities.

He further argues that:

Most of the money that flows into Cayman is invested in the United States. Something on the order of $1 trillion now flows through Cayman each year, but this money does not physically reside in this little island, nor do the locals own it. (The locals make their money from providing first-rate legal, accounting, financial and tourist services.)

Rahn's opening statement here seems like a rhetorical blind on the order of post hoc, ergo propter hoc or after this therefore because of this. In other words, corporations invest in the Caymans; the Caymans invest that money in the U.S.; therefore, the corporations and their financial activities are perfectly legitimate.
...
Rahn adds that:

It is not well understood that the world would be poorer and there would be more people in poverty if places, such as Cayman, did not exist.

Rahn seems to be setting up a straw man here, one which appeals to the emotions so that the reader would set aside the thorny issue of the veracity of the corporate identity of Caymans account holders.

Rahn continues:

In the modern world, economic growth is highly dependent on capital investment. Financial capital is necessary to build new plant and equipment, to fund research and development, including medical breakthroughs and to provide the funds to hire workers. Many countries have very heavy taxes on capital, which means lower rates of investment and slower job creation.

Neither individuals nor companies will save if their savings are taxed away. Without savings there is no money for investment.

World economic growth is maximized when capital is invested in those activities and enterprises that provide the highest after tax risk adjusted rate of return. Places like Cayman provide highly efficient and low-cost environments for institutions to acquire and invest capital, protected by the rule of law. This is why most of the world's big banks operate in Cayman, as well as hundreds of insurance companies and thousands of institutional mutual and hedge funds.

Because Cayman and its competitors exist, institutions and individuals are willing to save more because they know they have a safe haven for their funds until they can find another productive and profitable investment. Without these financial centers, there would be less saving and investment and less efficient allocation of capital throughout the globe.

This is all good economic thinking; however, again, it's a straw man. The issue is the improper use to which the legal corporate institutions put off-share banking havens, such as the Caymans.

Case in point is the Parmalat financial scandal in which seven banks are under investigation for dealings with the Italian based Parmalat company. Reports such as this raise questions which Rahn does not address. Thus, they cause one to wonder if off-shore banking really serves a beneficial purpose/

Deutsche Bank was a bookrunner on a $420-million bond Parmalat sold in September and a longtime adviser of Parmalat.

UBS bought a $500 million Parmalat bond in July, $350 million of which was used by Parmalat in a tax scheme to buy bonds issued by a Cayman Islands unit of Banco Totta of Portugal, owned by Spain's biggest bank Santander Central Hispano.

UBS Chief Executive Peter Wuffli said on Tuesday his bank had no knowledge of Parmalat's woes at the time.

The whole mess seems incestuous, and there appears to be no oversight in the banking and financial industries to investigate corporate activities. But, that seems to be the point of off-shore banking. Nothing Richard Rahn has said has addressed the issue of Parmalat's use of Cayman Islands off-shore services. While I hesitate to call Mr. Rahn's remarks a dodge, it does seem that he has failed to deal with the very critical issue of what happens to profit, opportunity, and freedom when legitimate corporations use off-shore banking services for illegal reasons.