Operation Choke Point

American officials have been watching the financial sector around the world in an effort to detect and stop a number of bad activities.  These bad things include hiding and moving the proceeds of crime (so called money laundering), hiding income from tax authorities (tax evasion), moving income to lower tax jurisdictions (tax avoidance), and financing terrorism.  Our Big Brother to the North has been building costly systems for tracking to the extent possible every use of the U.S. dollar anywhere in the world. Thus banks are required to know their customers (KYC) and track every payment and to provide such information to the authorities on demand. Anti-money laundering rules allow governments to block and confiscate money that is suspected of being the proceeds of crime even when no crime has been or can be proven.

Big Brother hates cash because its use leaves no audit trail and thus a hole in the government’s increasingly complete records over every payment made. American law enforcement officials have taken to confiscating significant amounts of cash when they see it (asset forfeiture) and requiring those from whom they took it to prove that it was “honest” money being used for legal purposes.  AML/CFT and asset forfeiture laws turn our traditional legal system (innocent until proven guilty) on its head. In addition, payment systems are being used as part of political sanctions to block payments to or from specific individuals (and their families, and relatives, and friends?) and companies.

In addition to detecting crime with AML and Foreign Corrupt Practices Act (FCPA) type measures, the U.S. is also pursuing payment information in connection with tax evasion with the Foreign Account Tax Compliance Act (FATCA) and other measures being forced on the rest of the world in a futile effort to compensate for bad tax laws in the U.S. These initiatives have nothing to do with prudential regulations, i.e. those designed to limit bank risk taking. Their purpose is to detect and prevent uses of money that Big Brother disapproves of. There is no evidence that they have succeeded in doing so. A study for the International Monetary Fund in 2014 reported that: “Benefits of the FATF AML/CFT system have not been demonstrated….”1

The costs of the system, on the other hand, have been staggering. The compliance costs for banks alone in 2013 were $10 billion.2 While these fall equally on all banks and are easily absorbed by large banks, they impose a significant burden on smaller, community banks. Partially as a result, banks have become more concentrated in the U.S. with the largest banks significantly increasing their share of total bank assets and the number of smaller banks shrinking. Between 1985 and 2010 the number of banks in the U.S. with assets greater than $10 billion increased from 36 to 107 while the number with assets less than $100 million declined from 13,631 to 2,625. Conducting the IMF’s assessments of its member countries’ compliance with AML/CFT requirements (but not of its effectiveness) cost $300,000 each in 2013.3

The most damaging costs of the AML/CFT requirements, however, fall on the poor, who are often excluded from the formal financial sector all together. “This study has learned of no significant effort by any of the standard-setting or assessor bodies to undertake a cost-benefit analysis….  The Fund staff itself has raised questions about whether its substantial investment… has yielded adequate returns.…There needs to be more open acknowledgement of actual and potential financial costs of AML/CFT controls, their potential misuse by authoritarian rulers, and possible adverse effects on populations that rely on remittances and the informal economy, as well as potential negative impacts on NGOs and parts of civil society.”4

“Money laundering and counter-terrorism measures can reduce the volume of overseas remittances to the most vulnerable populations in the poorest countries….  A report by the UN Food and Agricultural Organization reported that: ‘every year, Somali migrants around the world send approximately $1.3 billion to friends and family at home, dwarfing humanitarian aid to Somalia… Banks in the West are closing down the accounts of money transfer operators, thereby threatening to cut the lifeline to hundreds of thousands of Somali families.’”5

Why would banks shut out some of their customers? Foreign banks have been closing the accounts of American customers right and left rather than face the compliance costs and uncertainties (and intimidation) of FATCA. But closing out millions of the world’s poor for fear of AML violations seems a particularly low blow. Apparently not for the American bureaucrats implementing Operation Choke Point.

Todd Zywicki reported that: “The Justice Department’s “Operation Choke Point” initiative has been shrouded in secrecy….  The general outline is the DOJ and bank regulators are putting the screws to banks and other third-party payment processors to refuse banking services to companies and industries that are deemed to pose a “reputation risk” to the bank.6 AML rules require banks to know their customers (KYC), but when their customer is Western Union or its competitors, they need to know the customers of their customer. This can be a tall and stifling order. In many parts of the world the poor who are the usual beneficiaries of remittances, have no birth certificates or other documentary proof of their identities. In Afghanistan, for example, a person’s identity is traditionally verified by the village chief.

Moreover, the collection of such information opens the risk of abuse and it did not take Big Brother long to abuse it. Jonah Bennett reported that: “A Justice Department fraud prevention program came under fire Thursday for allegedly morphing into actively pressuring banks to deny financial services to businesses for political reasons.”7 The IMF sponsored report notes the risk of autocratic regimes misusing such information. Now we must add misuse by the U.S. government.

Cayman has just lived through the consequences of this program (see extensive reports in the Cayman Compass). The Cayman Islands Monetary Authority (CIMA) reported that in 2014 people in Cayman sent $180 million U.S. dollars to family and friends abroad in 682,000 separate payments (averaging $264 per transaction). Over 60 percent of these were sent to Jamaica, largely reflecting the remittance of earnings of Jamaican workers in Cayman.

A Jamaican worker in Cayman, for example, sends money home to his family by taking his Cayman dollar (CI dollar) wages to a money service provider who exchanges them for U.S. dollars at its local bank for onward transfer to Jamaica through the international banking system. The Cayman bank redeems the CI dollar bank notes with CIMA for a U.S. dollar deposit at its correspondent bank in New York, which transfers the funds to Western Union’s bank in the country of the intended recipients. The operation relies on money service providers being able to exchange CI cash for USD deposits abroad so that they can be moved around the world through the international banking network.

On Friday, July 17 of last year Western Union’s local bank, Fidelity, closed Western Union’s accounts thus preventing it from exchanging CI dollars for U.S. dollars and depositing them in New York.  Western Union promptly closed its operations throughout Cayman. Western Union is one of four money transfer services in Cayman. Cayman’s other three money service providers soon received the same treatment from their banks.

Charles Duncan reported in the Cayman Compass that: “hundreds of workers from overseas, mainly from Jamaica, packed into the town hall in George Town on Tuesday night, looking for solutions to the problem of sending cash home.  Standing in the midst of a packed room, one man said, ‘People are waiting.  People are hungry.’  Some in the crowd told of families back home waiting on money for school tuition and other financial support.”8 Without their banks to exchange Cayman dollars for U.S. dollar bank notes, several Cayman money service providers responded by accepting U.S. dollars only and flying them to Jamaica or to a New York bank that would accept them for onward electronic transfer. This required Jamaican workers to exchange their CI dollars for US dollars before visiting the local money service provider. Few of these guest workers have bank accounts and were either charged a higher exchange fee or limited in the amount they could exchange at the banks. The banks in term were quickly drained of the USD cash in their vaults and had to fly in additional bank notes from Miami, as CIMA does not provide USD banknotes. So banks were flying cash in while money remitters were flying it out on a much grander scale than were the alleged money launderers with suitcases.

What brought this situation about? Fidelity explained that profit margins were being squeezed while AML compliance costs and the risk of fines for violations threatened by Operation Choke Point led to their decision to stop these services.  Under Operation Choke Point pressure, Cayman’s retail banks were also being threatened with the loss of their correspondent accounts in New York if they did not give up banking the remittance business. The existing remittance business is relatively expensive.  Western Union charges $12.00 to send $100 dollars to Jamaica from the U.S. Much cheaper services have been and are being developed but are not yet available in Cayman. In the mean time Western Union has sufficient clout to have prevailed on their correspondent banks to back off, at least for the time being, and they and the other money service providers have reopened full services.

All of this is largely the result of Big Brother’s demand that everyone providing payment services know their customers – a requirement that no one has been able to document provides any benefit (i.e. reduction of crime). In fact, Cayman’s money remittance companies comply with KYC requirements established by CIMA, but American pressure has raised the regulatory costs and risks sufficiently that their banks would generally rather not take such business. New payment technologies are likely to by-pass the existing correspondent banking network for transferring funds at much lower costs. But if Big Brother insists on fingerprinting or iris scanning every one using them, they will be largely denied to the poor forcing them suffer unnecessarily for a problematic law that has not made any measurable contribution toward reducing crime.

ENDNOTES

  1. Terence C. Halliday, Michael Levi, and Peter Reuter  “Global Surveillance Of Dirty Money: Assessing Assessments Of Regimes To Control Money-Laundering And Combat The Financing Of Terrorism”  Center on Law and Globalization, 30 January 2014, p. 47
  2. “Global Anti-Money Laundering Survey 2014”, KPMG, January 2014.
  3. Before retiring from the IMF in 2003, I led 5 such assessments.
  4. IMF Report: Op. cit. p. 7.
  5. Op. cit.  p. 51.
  6. Washington Post, May 24, 2014.
  7. Daily Caller July 18, 2014.
  8. October 1, 2015.

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