Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens

Reveals the mechanisms that are systematically shifting economic burdens from the wealthy to the poor and how this cheating destroys accountability between governing elites and the population at large, especially in developing nations.

Treasure Islands: Uncovering the Damage of Offshore Banking and Tax Havens

Shaxson demystifies the murky world of offshore finance and earns my first 5-star rating in my "Year of Crime and Punishment". "Treasure Islands" reveals the mechanisms that are systematically shifting economic burdens from the wealthy to the poor at a mind-boggling scale - "wealthy individuals hold perhaps $11.5 trillion worth of wealth offshore." Like Quinones's "Dreamland", this book infuriated me. While the offshore story is as old as empire, many of the worst American abuses have taken place during my lifetime. You and I have been paying the bill, to the tune of $100 billion a year (roughly $1,000/year per full-time employee) in the US. Shaxson goes further, exploring how this economic cheating destroys accountability between governing elites and the population at large, especially in developing nations. He includes a fair amount of technical detail about transfer pricing, loan-backs, revocable trusts, etc. while noting that:

The drug smugglers, terrorists, and other criminals use exactly the same offshore mechanisms and subterfuges — shell banks, trusts, dummy corporations, and so on — that corporations use.

But what really surprised me in this book was the role that the "City of London Corporation" plays in all these offshore shenanigans. First of all, I had no idea that this "Square Mile" within the greater municipal area that the rest of the world simply knows as "London" is pseudo-sovereign and "effectively outside the normal legislative remit." This means that it can have whatever financial rules (or lack thereof) that it bloody well pleases. Unsurprisingly, this has attracted all the major Wall Street banks and turned the City into a global magnet for "hot money." The unsavoriness and elitism of the City made it a target for abolition by the Labour party for the last 100 years until Tony Blair was bought off and removed the plank from the Labour platform in the 90's. Shaxson makes it sound like the City has enormous economic and political power, and I'll certainly be digging deeper. "Treasure Island" devotes much ink to exploring what Shaxson calls the "British Spiderweb" of former British colonies turned tax havens. These islands remain tightly coupled to their City masters and are conduits for hundreds of billions of dirty money. Why haven't I heard about this until now??

Political theorists have had great difficulty even seeing the Corporation of London, let alone appreciating its significance. With its politics of personal proximity, its bonds of shared identity and principle, and its elaborate ceremonials, the City manages to be at once vastly powerful and barely visible. It fits into no modern analytical framework.

The more I read the angrier I got, especially as Shaxson explained why regulatory efforts have made almost no progress. The economic elites have captured the political ones (he casually notes that Wall Street has "a grip on both main political parties, Democrat and Republican — a grip that is so strong that it amounts to political capture") and it's simply not in the financial sector's interest to pay their fair share. He also explains how "offshore" and the threat of capital flight are used to bully nations into deregulating their financial systems. To reassure us that he's not totally alone in the wilderness, Shaxson shores up his position with a chapter on John Maynard Keynes's reasoned opposition to offshore "investment" and his support for capital controls.

I loved this book because it squarely confronts the line between criminality and white-collar finance. Bernie Cornfeld of Investors Overseas Service appears in this book as a huge cheat while he is lionized in "The Very Very Rich and How They Got That Way". The economic scale of this tax cheating, money laundering, and regulatory avoidance is enormous - far larger than the art heists, counterfeiting, credit card theft, and fraud that I've been reading about so far this year. I suppose it's easy to avoid breaking the law when you're the one writing it (a la Robert Moses). Shaxson also won major points for pointing out the shallowness of the current "corporate social responsibility" fad - "Tax is the missing element in the corporate social responsibility debate." Forget about greenwashing and social justice posturing. Pay your taxes! (Looking at you Bezos)

I was also surprised to find that my own company is actually registered in Delaware with the Wolters Kluwer Corporation Trust mentioned in this book. Offshore is everywhere!

"Treasure Islands" was my April 2018 book club selection.

My highlights below.

PROLOGUE - An Offshore Awakening

This parallel, charmed world, underpinned by the unspoken threat of force against anyone inside or outside the bubble who would disrupt it, is easy to miss in the affluent and easy West. In Africa the jolt was enough to begin to shake me from my sleep. I had stumbled into what later became more widely known through a scandal in Paris as the so-called Elf affair.

they began to discern the outlines of a gigantic system of corruption that connected the French state-owned oil company Elf Aquitaine with the French political, commercial, and intelligence establishments, via Gabon’s deeply corrupt ruler Omar Bongo.

As countries in Africa and elsewhere gained independence, the old beneficiaries of the French empire set up new ways to stay in control behind the scenes. Gabon became independent in 1960, just as it was starting to emerge as a promising new African oil frontier, and France paid it particular attention. France needed to install the right president: an authentic African leader who would be charismatic, strong, cunning, and, when it mattered, utterly pro-French. In Omar Bongo they found the perfect candidate: He was from a tiny minority ethnic group and had no natural domestic support base, so he would have to rely on France to protect him. In 1967, aged just 32, Bongo became the world’s youngest president, and for good measure France placed several hundred paratroopers in a barracks in Libreville, connected to one of his palaces by underground tunnels. This intimidating deterrent against coup plots proved so effective that by the time Bongo died in 2009, he was the world’s longest-serving leader.

Parts of Gabon’s oil industry, Joly discovered as she dug deeper and deeper in Paris, had been serving as a giant slush fund: a pot of secret money outside the reach of French judicial authorities in which hundreds of millions of dollars were made available for the use of French elites. An African oil cargo would be sold, and the proceeds would split up into a range of bewildering accounts in tax havens, where they could be used to supply bribes and baubles for whatever the unaccountable elites who controlled the system deemed fit.

The following year she cast aside the code of silence and published a book, The Whore of the Republic, which became a best seller in France.

When President Nicolas Sarkozy of France came to power in 2007 the first person he called was not the president of Germany or the United States or the European Commission but Omar Bongo.

The Elf system allowed bribes to be paid and other nefarious acts to be committed elsewhere — without the paper trails touching French soil. Offshore. The system did not exactly exist anywhere: It flourished in the gaps between jurisdictions. Elsewhere became nowhere.

The escape routes from the rules and laws of society are provided almost exclusively for the benefit of wealthy and powerful insiders — leaving the rest of us to pick up the bill. The Elf system, a gargantuan octopus of corruption, affected ordinary people in both Africa and France in the most profound, if mostly invisible, ways. Ordinary African citizens saw their nations’ oil money being siphoned off to the rich world through unfair oil contracts and general corruption, while French protection made Gabon’s leaders invulnerable and hence unaccountable to their citizens — at the same time that the Elf system made France’s elites unaccountable to that nation’s citizens too.

“Taxes are for the little people,” the New York millionaire Leona Helmsley once famously said.

In decades and centuries past, colonial systems helped rich countries preserve and boost their elites’ wealth and privileges at home. When the European powers left their colonies after the Second World War, they replaced formal controls over their ex-colonies with different arrangements to retain a measure of control behind the scenes.

“It has taken me a long time to understand,” explains Joly, “that the expansion in the use of these jurisdictions [tax havens] has a link to decolonization. It is a modern form of colonialism.”

The U.S. government and many others have allowed tax havens to proliferate because the elites who use them are the world’s most powerful lobbyists.

Offshore connects the criminal underworld with financial elites and binds them together with multinational corporations and the diplomatic and intelligence establishments.

1 - WELCOME TO NOWHERE - An Introduction to Offshore

Over half of world trade passes, at least on paper, through tax havens.

Nearly every multinational corporation uses tax havens, and their largest users — by far — are on Wall Street.

Secrecy jurisdictions also have very large financial services industries in comparison to the size of the local economy. These places also routinely “ring-fence” their own economies from the facilities they offer to protect themselves from their own offshore tricks. So they might, for example, offer a zero tax rate to nonresidents who park their money there but tax local residents fully. This ring-fencing is a tacit admission that what they do is harmful.

But there is one feature of a secrecy jurisdiction that stands out above all: that local politics is captured by financial interests from elsewhere

And here lies one of the great offshore paradoxes: These zones of ultra-freedom for financial interests are so often repressive places, viciously intolerant of criticism.

Next, each part of this multinational charges the other parts for the services they provide. So Big Banana’s Luxembourg finance subsidiary might lend money to Big Banana Honduras, then charge that Latin American subsidiary $10 million per year in interest payments for that loan. The Honduran subsidiary will deduct this $10 million from its local profits, cutting or wiping out its local profits (and consequently its tax bill) there. The Luxembourg finance subsidiary, however, will record this $10 million as income—but because Luxembourg is a tax haven, it pays no taxes on this. With a wave of an accountant’s wand, a hefty tax bill has disappeared.

The general idea is that by adjusting its internal prices a multinational can shift profits offshore, where they pay little or no tax, and shift the costs onshore, where they are deducted against tax.

In October 2010 a Bloomberg reporter explained how Google Inc. cut its taxes by $3.1 billion in the previous three years through transfer pricing games known by names such as the “Double Irish” and “Dutch Sandwich,” ending up with an overseas tax rate of 2.4 percent.

Transfer pricing alone cost the United States an estimated $60 billion a year — and that is just one form of the offshore tax game.

The U.S. Government Accountability Office reported in 2008 that two-thirds of American and foreign companies doing business in the United States avoided income tax obligations to the federal government in the years 1998–2005, despite corporate sales totaling $2.5 trillion.

The world contains about 60 secrecy jurisdictions, or tax havens, which can be divided roughly into four groups: a set of continental European havens, a British zone of influence centered on the City of London and loosely shaped around parts of Britain’s former empire, a zone of influence focused on the United States, and a fourth category holding unclassified oddities like Somalia and Uruguay.

Well over $2.5 trillion is parked offshore in Luxembourg. In March 2010 South Korean intelligence officials indicated that North Korea’s “Dear Leader” Kim Jong-Il had stashed some $4 billion in Europe — profit from the sale of nuclear technology and drugs, insurance fraud, counterfeiting, and projects using forced labor; Luxembourg, they said, is a favored destination for the money.

the Portuguese Islands of Madeira, which was central to a major Nigerian bribery scandal involving the U.S. oil service company Halliburton that resulted in the second largest fine ever paid in a prosecution under the Foreign Corrupt Practices Act. (NOTE - this involved Brown & Root which was instrumental in LBJ's rise to power)

As I will show, it is no coincidence that the City of London, once the capital of the greatest empire the world has known, is the center of the most important part of the global offshore system. The City’s offshore network has three main layers. Its inner ring consists of Britain’s three Crown Dependencies: the nearby islands of Jersey, Guernsey, and the Isle of Man. The authoritative U.S. publication Tax Analysts estimated conservatively in 2007 that just these three havens hosted about $1 trillion of potentially tax - evading assets.

The Cayman Islands is the world’s fifth largest financial center, hosting eighty thousand registered companies, over three-quarters of the world’s hedge funds, and $1.9 trillion on deposit — four times as much as in all the banks in New York City. And it has, at the time of writing, one cinema.

“We in Jersey regarded Gibraltar as totally subprime,” he said. “This was where you put the real monkey business.

In August 2009 Britain imposed direct rule in the Turks and Caicos Islands after corruption there spun too far out of control.

U.S. officials have periodically tried to crack down on offshore tax abuse, at least since 1961, when President Kennedy asked Congress for legislation to drive these tax havens “out of existence,” but have been thwarted each time by powerful interests on Wall Street.

People have traditionally seen tax havens as marginal players used by mafiosi, drug smugglers, spies, petty criminals, and celebrity tax-dodgers. Plenty of these can be found offshore, it is true. But I need to stress again: The big users of the secrecy jurisdictions are the banks and other financial institutions.

The United States is estimated to be losing $100 billion annually from offshore tax abuses — a gigantic transfer of wealth from ordinary taxpayers to rich people.

“Tax havens are engaged in economic warfare against the United States, and honest, hardworking Americans,” says Senator Carl Levin.

The second offshore tier involves individual U.S. states. A range of different things are happening, in a number of states. Florida, for example, is where Latin American elites do their banking, and the United States generally does not share banking information with those countries, so a lot of this is tax-evading and other criminal money, protected by U.S. secrecy. Florida’s banks also have a long history of harboring Mob and drug money, often in complex partnerships with the nearby British Caribbean havens.

In Africa, Liberia was set up in 1948 as a “flag of convenience” by Edward Stettinius Jr., a former U.S. secretary of state, and its maritime code was “read, amended, and approved by officials of Standard Oil,” according to the historian Rodney Carlisle. Its sovereign shipping registry is now run by another private U.S. corporation out of Vienna, Virginia, about five miles from the Marshall Islands registry. Sovereignty is, literally, available for sale or rent in such places.

The biggest tax haven in the U.S. zone of influence is Panama. It began registering foreign ships from 1919 to help Standard Oil escape U.S. taxes and regulations, and offshore finance followed: Wall Street interests helped Panama introduce lax company incorporation laws in 1927, which let anyone open tax-free, anonymous, unregulated Panama corporations with few questions asked.

Some jurisdictions specialize as conduit havens: way stations offering services that transform the identity or character of assets in specific ways, en route to somewhere else. The Netherlands is a big conduit haven: About €4.5 trillion (US $6.6 trillion) flowed through Dutch Special Financial Institutions in 2008 — equivalent to over nine times the Dutch GDP.

Even if you break through that barrier you may find that the corporation is held by a Turks and Caicos trust with a flee clause: The moment an inquiry is detected, the structure flits to another secrecy jurisdiction.

In 2005 the Tax Justice Network estimated that wealthy individuals hold perhaps $11.5 trillion worth of wealth offshore. That is about a quarter of all global wealth and equivalent to the entire GDP of the United States.

The most comprehensive study of this comes from Raymond Baker’s Global Financial Integrity (GFI) Program at the Center for International Policy in Washington. Developing countries, GFI estimated in January 2011, lost a staggering $1.2 trillion in illicit financial flows in 2008 — losses that had been growing at 18 percent per year since 2000. Compare this to the $100 billion in total annual foreign aid, and it is easy to see why Baker concluded that “for every dollar that we have been generously handing out across the top of the table, we in the West have been taking back some $10 of illicit money under the table.

The drug smugglers, terrorists, and other criminals use exactly the same offshore mechanisms and subterfuges — shell banks, trusts, dummy corporations, and so on — that corporations use.

It is hardly surprising, in this light, that Baker estimates that the U.S. success rate in catching criminal money was 0.1 percent — meaning a 99.9 percent failure rate.

Imagine how different that pledge would be if the G20 had promised to tackle “illicit inflows.”

The offshore system provided Wall Street with a “get out of regulation free” card that enabled it to rebuild its powers overseas and then, as the United States turned itself in stages into a tax haven in its own right, at home. The end result was that the biggest banks were able to grow large enough to attain “too big to fail” status — which helped them in turn to become increasingly influential in the bastions of political power in Washington, eventually getting a grip on both main political parties, Democrat and Republican — a grip that is so strong that it amounts to political capture.

Overall, taxes have not generally declined. What has happened is that the rich have been paying less, and everyone else has been forced to take up the slack. The secrecy jurisdictions, in partnership with changing ideologies, are the biggest culprits.

In January 2008 the accountancy giant KPMG ranked Cyprus at the very top of a league table of European jurisdictions, according to the “attractiveness” of their corporate tax regimes. Yet Cyprus, a “way station for international scoundrels,” as one offshore promoter admits, is among the world’s murkiest tax havens: possibly the biggest conduit for criminal money out of the former Soviet Union and the Middle East into the international financial system. If Cyprus is ranked as the “best” in an international league table on tax, something is clearly wrong with the world. When transparency rankings list Switzerland and Singapore, two great sinks for illicit loot, as among the world’s “cleanest” jurisdictions, then we seem to have lost our way.

Tax is the missing element in the corporate social responsibility debate.

2 - TECHNICALLY ABROAD - The Vestey Brothers, the American Beef Trust, and the Rise of Multinational Corporations

The beef export industry was a major plank in the growth of the political power of the Argentine elites; in his book The Rise and Fall of the House of Vestey, the biographer Philip Knightley argues that the meat packers’ cartel had such a crippling effect on the Argentine labor movement and early economic development that “it led almost directly to the formation of militant labour organisations that pushed Peron into power, the subsequent dictatorship of the generals, the terrorism, the Falklands War and the country’s economic disasters.”

The big historical competitors of the British meat packers, though now inside the Argentine cartel, were the Swift and Armour groups from Chicago that until recently had formed the core of the American Beef Trust, an organization founded by the robber baron Philip D. Armour. The trust had sewn up food distribution inside the United States so effectively that a book about it published in New York in 1905, entitled The Greatest Trust in the World, described it as “a greater power than in the history of men has been exercised by king, emperor or irresponsible oligarchy... here is something compared with which the Standard Oil Company is puerile.”

The brothers lived by two business rules above all: first, never reveal what you are up to; and second, never let other people do something for you if you can do it yourself.

One great historical landmark in this respect emerged in the late nineteenth century when James B. Dill, a New York corporate lawyer, persuaded the governor of New Jersey that the state could get out-of-state corporate managements to incorporate there by passing permissive incorporation laws favorable to managers to the detriment of shareholders. New Jersey passed its first such law in 1889, then relaxed its rules again and again. Corporations, including the Standard Oil Trust, began to relocate out of New York and other large centers and flock to New Jersey.

By 1929 two-fifths of Delaware’s income came from corporate fees and taxes, and it led the United States in incorporations, a lead it has never lost.

This brief digression into corporate law helps remind us what offshore is all about. It is not just about tax: In this case it is about attracting money by offering rewards to insiders, at the expense of other stakeholders, undermining or undercutting the rules and legislation of other jurisdictions.

They had pointed to one of the great problems in international tax. Each country taxes its citizens, residents, and corporations in different ways, and different countries’ tax systems often clash in unpredictable ways. Multinationals based in these different countries face very different tax bills on similar incomes, enabling one to out-compete another on a factor that has nothing to do with efficient management or real productivity.

Many people think that the best way to achieve secrecy in your financial affairs is to shift your money to a country like Switzerland, with strong bank secrecy laws. But trusts are, in a sense, the Anglo-Saxon equivalent. They create forms of secrecy that can be harder to penetrate than the straightforward reticence of the Swiss variety. Trusts are powerful mechanisms, usually with no evidence of their existence on public record anywhere. They are secrets between lawyers and their clients.

Trusts emerged in the Middle Ages when knights leaving on the Crusades would leave their possessions in the hands of trusted stewards, who would look after them to provide benefits to the knights’ wives and children when they were away or if they never returned.

Imagine that the assets in a trust are shares in a company. The company may register the trustee — the legal owner — but it will not register the beneficiaries — the people who will be getting and enjoying the money — anywhere. If you have a million dollars in an offshore trust in the Bahamas and the tax inspectors come after you, it will be hard for them to even start their inquiries: Trust instruments in the Bahamas are in no official register. Even if the tax inspectors or police get lucky and find out the identity of a trustee, that is likely to be simply a Bahamas lawyer who does this for a living, who may be the trustee for thousands of trusts. She may be the only other person in the world who knows you are the beneficiary, and he or she is bound by professional confidentiality to keep your secrets safe. The tax inspector has hit a stone wall.

In June 1922, seven years after leaving the country to escape British wartime taxes, it emerged that William Vestey had bought himself a title, becoming Baron Vestey of Kingswood. Plenty of people who had made fortunes in the Great War had done this, craving the respectability of a peerage to mask the taint of war profiteering. Prime Minister Lloyd George had sold off official honors willy-nilly, causing outrage.

Many jurisdictions, for example, allows things called revocable trusts — trusts that can be revoked so that the money is returned to the original owner. If you can do that, then you have not really separated yourself from the asset. Until it is revoked, though, it looks as though you have passed the asset on, and the tax authorities cannot have it.

When the British Queen finally started paying income tax in 1993 after a public outcry, the latest Lord Vestey smiled and said: “Well, that makes me the last one.”

3 - THE OPPOSITE OF OFFSHORE - John Maynard Keynes and the Struggle against Financial Capital

America’s main war aim after the defeat of the Axis powers, he argued, was to destroy the British empire. “Churchill fought to preserve Britain and its empire against Nazi Germany; Keynes fought to preserve Britain as a Great Power against the United States. The war against Germany was won; but in its effort to win it, Britain spent its resources so heavily that it was destined to lose both its Empire and its Great Power status.” Keynes himself outlined one of his central aims as he negotiated in Washington: “America must not be allowed to pick out the eyes of the British Empire.”

He wrote a book on mathematical probability that the polymath and philosopher Bertrand Russell said was “impossible to praise too highly,” adding that Keynes’s intellect was “the sharpest and clearest that I have ever known.” Russell felt that when he argued with Keynes, he “took his life into his hands.”

He learned of the irrationality of markets first hand, spending half an hour each day in bed speculating with his own money in the famously treacherous terrain of international currencies and commodities, diving into company balance sheets and statistics (and declaring of the latter discipline that "nothing except copulation is so enthralling"

“Experience is accumulating,” he said, “that remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.”

Capital no longer flows simply to where it gets the best return but to where it can secure the best tax subsidies, the deepest secrecy, and to where it can most effectively evade the laws, rules, and regulations it does not like.

As Keynes wrote later, the U.S. administration took every possible precaution to see that the British were as near as possible to bankrupt before giving any help.

Keynes understood the basic tension between democracy and free capital movements. In a world of free capital flows, if you try to lower interest rates, say, to boost struggling local industries, capital is likely to drain out overseas in search of higher returns, thwarting your original intent. Investors hold a kind of veto power over national governments, and the real lives of millions of people will be determined not by their elected representatives but by what the Indian economist Prabhat Patnaik called “a bunch of speculators.” Freedom for financial capital means less freedom for countries to set their own economic policies: from financial freedoms a form of bondage emerges. Keynes’s answer was simple and powerful: control and constrain the flows of capital across borders and limit the trade in currencies through exchange controls. He believed that financing was usually best when it happens inside, rather than between, countries.

Many mainstream economists embrace a simple idea that goes something like this. Poor countries lack capital. Foreign investment can fill the gap. So it makes sense to free up flows of capital to let capital flow into these capital-starved countries, where it can get higher returns. This may seem like a sensible idea, but what mainstream theory has failed seriously to address is that if you free up capital flows, money might not necessarily flow in. It might, instead, flow out. And the ways in which it may flow out might be unusually harmful.

Enter Wall Street bankers and their lobbyists. U.S. banks had profited hugely from handling European flight capital in the 1930s, and, fearing that transparency would hurt New York’s allure, they gutted the proposals.

And a new economic crisis exploded in Europe. America filled the hole with aid: the giant Marshall Plan of 1948. It is widely believed that the plan worked by offsetting European countries’ yawning deficits. But its real importance, Helleiner argues, was simply to compensate for the U.S. failure to institute controls on inflows of hot money from Europe. Even in 1953, the authoritative New York Times correspondent Michael Hoffman noted, American postwar aid was smaller than the money flowing in the other direction.

Friedrich Hayek, Robbins’s former pupil who was just then fathering a new free-market ideology to dethrone Keynesianism, called him “the one really great man I ever knew.”

From 1950 to 1973, annual growth rates amid widespread capital controls (and extremely high tax rates) averaged 4.0 percent in the United States and 4.6 percent in Europe.

Another famous study found that between 1940 and 1971, a period mostly covering the time of the golden age, developing countries suffered no banking crises and only sixteen currency crises, whereas in the quarter century after 1973 there were 17 banking crises and 57 currency crises. A major new study in 2009 by the economists Carmen Reinhardt and Kenneth Rogoff, looking back over eight hundred years of economic history, concluded that, as reviewer Martin Wolf put it, “Financial liberalisation and financial crises go together like a horse and carriage.”

The golden age shows that it is quite possible for countries, and the world economy, to grow quickly and steadily while under the influence of widespread and even bureaucratic curbs on the flow of capital, and high taxes. China carefully and systematically restricts inward and outward investments and other flows of capital, and at the time of writing it is growing fast.

4 - THE GREAT ESCAPE - How Wall Street Regained Its Powers by Going Offshore to London

And here is the crucial part: The Bank of England not only did not stop Midland’s trades, but it actively decided not to regulate the market either. It simply deemed the transactions not to have taken place in the UK for regulatory purposes. Since this trading happened inside British sovereign space, no other regulatory authority elsewhere was allowed to reach in and regulate it, either. Banks in London began keeping two sets of books — one for their onshore operations, where at least one party to the transaction was British, which was regulated, and one for their offshore operations, where neither party was British. A new offshore market had been born, which would become known as the Eurodollar market or the Euromarket.

London’s first claim to be a tax haven is the subject of this chapter: its role as the creator and developer of the Euromarkets, Wall Street’s giant escape route from the checks and balances of U.S. financial regulation. Here the subsidiaries and affiliates of U.S. commercial banks have long been allowed to engage in, among many other things, investment banking — “casino banking,” as some have called it — something the Glass-Steagall Act of 1933 explicitly prohibited. Over the years, as this business became more integral to their global banking models, Wall Street could increasingly pressure the U.S. government to do away with the original restrictions to allow them to do at home what they already did offshore, and this was arguably the main factor that led to the repeal of Glass-Steagall in 1999. It was the classic offshore pattern: banks find an offshore escape route, then say in Washington, “We can already do this offshore — so why not here?” — and domestic regulations get relaxed.

When the United States introduced the Sarbanes-Oxley regulations to protect Americans against the likes of Enron or Worldcom, the City of London did not follow, and more U.S. financial business flowed to London.

Another important role for London has concerned a seemingly arcane practice known as “rehypothecation,” a way of shifting assets off banks’ balance sheets. The U.S. has firm rules to curb the abuses, but London does not — so ahead of the latest crisis, Wall Street investment banks simply went off to London where they could do it without limit. A little-noticed IMF paper in July 2010 estimated that by 2007 the seven largest players in the market — Lehman Brothers, Bear Stearns, Morgan Stanley, Goldman Sachs, Merrill/BoA, Citigroup, and JPMorgan — had shifted $4.5 trillion off their balance sheets in this way.

Almost every Russian firm listing overseas chooses London, not New York, partly because of Britain’s permissive governance standards.

In the second quarter of 2009, the UK received net bank financing of $332.5 billion just from its tax havens of Jersey, Guernsey, and the Isle of Man; in June 2009 the British web as a whole held an estimated $3.2 trillion in offshore bank deposits, half the global total, according to data from the Bank for International Settlements.

Another London attraction is the so-called “domicile” rule, whereby wealthy foreigners can come to live in England and escape tax on all their non-UK income. In pursuit of this tax break, the world’s super-rich—from Greek shipping magnates to Saudi princesses—have descended on London in hordes.

“In America they send hundreds of people to jail: in this country bankers don’t go to jail,” explains the British author and publisher Robin Ramsay. “There are no consequences in London.”

Without understanding the Corporation of London, one cannot properly understand how Wall Street has become so powerful in the United States.

London hosts more foreign banks than any other financial center. In 2008 the city accounted for half of all international trade in equities, nearly 45 percent of over-the-counter derivatives turnover, 70 percent of Eurobond turnover, 35 percent of global currency trading, and 55 percent of all international public offerings. New York is bigger in areas like securitization, insurance, mergers and acquisitions, and asset management, but much of its business is domestic, making London easily the world’s biggest international — and offshore — financial hub.

The head of the Corporation of London is the Lord Mayor of London — not to be confused with the mayor of London, who runs the much larger greater London municipality that contains the City, geographically speaking, but has no jurisdiction over its nonmunicipal affairs. And this separation of powers matters.

When heads of state visit Britain the Lord Mayor throws more lavish banquets than the Queen.

The Corporation has existed since what tour guides and historians call time immemorial, a term taken to mean that its origins extend beyond the reach of memory, record, or tradition. There is no direct evidence, Corporation officials note, of it coming into being: They say, only half in jest, that it dates its “modern period” from the year 1067. This is the world’s oldest continuous municipal democracy, predating the British parliament and rooted in what the Corporation calls “the ancient rights and privileges enjoyed by citizens before the Norman Conquest in 1066.” This, notes the City of London expert Maurice Glasman, means that the City is effectively outside the normal legislative remit.

Earlier that century, the British crown had asked the Corporation to extend its ancient legal protections and privileges to new areas of London, outside the City, that were receiving tens of thousands of refugees from brutal land reforms known as the Enclosures. But the Corporation refused, instead shipping excess populations off to the Ulster Plantation and the Corporation of Londonderry in what is now Northern Ireland, helping build a large Protestant community there and contributing to bitter future conflict. Glasman calls this the “Great Refusal”: the moment where the City turned its back on London and when London’s history properly became a tale of two cities, with a mayor for the vibrant, troubled, and poverty-scarred metropolis, and a Lord Mayor for the City: the world’s most ancient political institution, at the disposal of finance.

For much of the last century the Labour Party, the party of Britain’s working class, had a pledge into its manifesto to abolish the Corporation of London and fold it into a unified London government. The pledge would remain in place, unfulfilled, until Labour Leader Tony Blair undid it in the early 1990s. In exchange for the City’s support in his successful bid for power in 1997, he agreed to remove the pledge to abolish the Corporation and replace it with one to “reform” it instead.

The City of London Corporation also has a pot of money at its disposal named City Cash, which it says is “a private fund built up over the last eight centuries,” earning income from “property, supplemented by investment earnings.” City Cash funds many things, including monuments and ceremonies, stakes in the property developments outside the City boundaries, free-market think tanks, and permanently staffed lobbying offices from Brussels to Bombay to Beijing.

The second boost that year was the birth of Eurobonds: unregulated offshore bearer bonds, which are just what the name suggests: whoever bears the pieces of paper in their hands owns them. They are a bit like ultravaluable dollar bills: No records are kept of who owns them, and they are perfect for tax evasion. Bearer bonds feature in villain-infested Hollywood movies like Beverly Hills Cop and Die Hard, and they are considered so pernicious that many countries have since outlawed them.

Though the Bank of England is accountable to parliament, not to the City of London Corporation, its physical location at the geographical center of the City — just across the road from the Lord Mayor’s Mansion House — reflects where its heart lies: in a shared view, established over centuries, that the path to progress lies in deregulation and freedom for financial capital — with the City at the forefront.

Now imagine, instead, a bank in the Euromarkets in London, which has no reserve requirements.

An unregulated market allowing potentially endless and unusually profitable money creation will expand and displace regulated banking, and lending will expand into places where it wasn’t previously able to and often to where it shouldn’t be.

A bizarre, Alice in Wonderland logic lay behind the Bank’s decision not to regulate these markets — the sort of logic that permeates the offshore system. If there were a run on a regulated bank in London, the Bank of England, by virtue of being its regulator, would feel some obligation to come in and pick up the pieces. In other words, regulation, as a Bank of England memo put it, “would mean admission of responsibility.” Better, then, the logic went, not to regulate them!

The economic anchor of this special relationship has been this partnership between Wall Street and the City of London, under a simple offshore formula: give Wall Street banks what they want, and they will come.

The U.S. dollar is the world’s main reserve currency. Less privileged nations are periodically constrained from spending by shortages of foreign exchange, but the nation with the dominant currency can borrow in its own currency — and it can print money to acquire real resources and live beyond its means for a long time.

Countries choose dollars as the main component in their reserves because dollar markets are large and liquid, and the dollar is trusted to be relatively stable. Everyone trades in dollars.

To claim reserve status, a currency must have huge, deep, liquid, and sophisticated markets — and a currency subject to capital controls and stringent financial regulations is less attractive. U.S. policymakers wanted these deep markets but did not want to give up their taxes and controls. They thought, let’s have our cake and eat it, by preserving the rules and constraints at home while permitting this unregulated dollar market to flourish overseas. What they had not appreciated enough was the extent to which this offshore market would rebound back into the United States, with malign effects.

Not content with all this, the Corporation of London actively promotes international financial deregulation around the globe. With this in mind the Lord Mayor makes 20 or so foreign visits per year.

Political theorists have had great difficulty even seeing the Corporation of London, let alone appreciating its significance. With its politics of personal proximity, its bonds of shared identity and principle, and its elaborate ceremonials, the City manages to be at once vastly powerful and barely visible. It fits into no modern analytical framework.

5 - CONSTRUCTION OF A SPIDERWEB - How Britain Built a New Overseas Empire

As I’ve noted, when Britain’s formal empire collapsed, it did not entirely disappear. Fourteen small island states decided not to become independent and became instead Britain’s Overseas Territories, with Britain’s Queen as their head of state. It is a status that has been preserved until today. Exactly half of them — Anguilla, Bermuda, the British Virgin Islands, the Cayman Islands, Gibraltar, Montserrat, and the Turks and Caicos Islands — are tax havens, actively supported and managed from Britain and intimately linked with the City of London.

A slick Mafia operator — the inspiration for the figure of Hyman Roth in the film The Godfather — Lansky would beat every criminal charge against him until the day he died in 1983. He once boasted that the Mob activities he was associated with were “bigger than U.S. Steel.” Lansky began with Swiss offshore banking in 1932, perfecting the loan-back technique. This involved first moving money out of the United States—in suitcases stuffed with cash, diamonds, airline tickets, cashier’s checks, untraceable bearer shares, or whatever. Next, he would put the money in secret Swiss accounts, perhaps via a Liechtenstein anstalt (an anonymous company with a single secret shareholder). The Swiss bank would loan the money back to a mobster in the United States, who could then deduct the loan interest repayments from his taxable business income there.

The Bahamas, then a British colony, was perfect. Formerly a staging post for British gun-running to the southern U.S. slave states of the Confederacy, and loosely governed for years by laissez-faire members of British high society, the Bahamas were effectively run by an oligarchy of corrupt white merchants. It would quickly become, through Lansky, the top secrecy jurisdiction for North and South American dirty money.

Attracting foreign dirty money, by contrast, was keenly appreciated by the Bank. “There is of course no objection to their providing bolt-holes for non-residents,” the letter continued, “but we need to be sure that in so doing opportunities are not created for the transfer of UK capital to the non-Sterling Area outside UK rules.” In other words: no objections to looting the treasuries of the United States and sucking illicit financial flows out of Latin America — just so long as Britain’s tax base and its postimperial financial network was protected. Any harm being inflicted on other countries was deliberately to be ignored.

Governor Crook also put his finger on a crucial subtlety of the relationship that underpins the entire edifice of offshore finance: the fact that Britain has effective control, while pretending not to be in control.

IOS, however, was no ordinary company. Raw went on to write a book about it, the title of which, Do You Sincerely Want to Be Rich?, was the line that IOS salesmen pitched around Europe, door-to-door, as they vacuumed up retail investments to channel into offshore funds. The company’s founder, Bernie Cornfeld, called it “people’s capitalism,” and for a short time he made IOS into one of the largest foreign institutional investors on the U.S. stock exchange.

Capital is far more valuable to bankers than deposits: The more capital you have, the more you may multiply your balance sheet. And this helps us understand why banks like secret offshore deposits so much. Investigators who probed IOS said it operated under an assumption that 10 to 20 percent of its deposits were, effectively, permanent capital — that is, the owners could not withdraw it, either because it was too risky for them to do so or because they were dead. It is no wonder that Swiss bankers were so reluctant to hand over the deposits of Jews who died in Hitler’s concentration camps: The deposits had essentially, the Swiss believed, become permanent reserves of bank capital. Not only that, but depositors willingly accept below-market interest rates in exchange for secrecy — boosting the profits to offshore banking.

Fearing that Field would spill his clients’ secrets, exposing the Caymans to a major international scandal, an oppressive new secrecy law was drafted, the now infamous Confidential Relationships (Preservation) Law, making it a crime punishable by prison to reveal financial or banking arrangements in the Caymans. You can go to jail not only for revealing information but just for asking for it. It was a giant, fist-pumping “fuck you” aimed squarely at U.S. law enforcement, and it has become a cornerstone of the Caymans’ success until the present day.

By the early 1980s, the Colombian Medellin cartel kingpin Carlos Lehder was smuggling industrial quantities of cocaine into the United States from Norman’s Cay in the Bahamas, having turned it into an ultimate male libertarian fantasy.

“Today Hong Kong is where most of the corruption in China is accomplished.” When the G20 countries sought to approve a tax haven blacklist at a summit meeting in April 2009, Chinese premier Hu Jintao fought intransigently with Barack Obama to get Hong Kong and Macau, another notorious Asian offshore hub, excluded. He got them relegated to a footnote.

Andy Xie, Morgan Stanley’s star Asia economist, described how it had turned out, in an internal email in 2006. “Singapore’s success came mainly from being the money-laundering centre for corrupt Indonesian businessmen and government officials,” he said. “To sustain its economy, Singapore is building casinos to attract corruption money from China.” Xie and two colleagues reportedly had to resign after the email became public.

6 - THE FALL OF AMERICA - How the United States Learned to Stop Worrying and Love the Offshore World

A table in Raymond Baker’s 2005 book Capitalism’s Achilles Heel outlines just how far the United States has fallen. By then, it showed, U.S. banks were free to receive the proceeds from a long list of crimes committed outside the country, including alien smuggling, racketeering, peonage, and slavery. Profiting from these crimes is legal, just so long as the crime itself happens offshore. A few of these loopholes have now been closed, and U.S. law addresses some of the others, though often only in tangential, incomplete ways. But it remains true that a U.S. bank can knowingly receive the proceeds of a wide range of foreign crimes, such as handling stolen property generated offshore. The United States is wide open for dirty money, just as that Hudson memo anticipated.

From 1921 the United States has let foreigners deposit money with American banks and receive interest tax-free as long as it isn’t connected with a U.S. business.

From the 1950s and 1960s, Florida became a pivot for the French Connection heroin route, for Kuomintang drugs flowing into the United States via Hong Kong (which Lansky laundered through Florida real estate), for Latin American flight money, and for Colombian drug money, often routed via the Bahamas, Panama, and the Netherlands Antilles.

In the tax world, this is a concept known as deferral: Companies may legally defer their taxes by holding profits offshore, untaxed, indefinitely. U.S. companies are only taxed on the income they bring back to the United States, usually in order to pay dividends to shareholders. Corporations know this is a bit of a game, partly depending on who is in the White House: Every now and then they are allowed to bring this un-taxed offshore money back home through amnesties. In 2004, for example, George W. Bush’s administration offered his corporate friends a 5 percent tax rate instead of the normal 35 percent for companies repatriating cash. Over $360 billion whooshed back to the country through this Bush loophole, under a claim that this would “provide jobs” as the capital returned home. Instead, however, much of it went into share buy-backs, boosting executive bonuses. The nonprofit research organization Citizens for Tax Justice, which studied the amnesty in detail, concluded, “There is no evidence that the amnesty added a single job to the U.S. economy.”

The writer David Cay Johnston makes an interesting environmental comparison here. “Tax shelters are to democracy what pollution is to the environment.”

In the United States, Lansky had close links to the Mob lawyer Sidney Korshak, a true American Mafia kingmaker who in turn helped build up the career of several Hollywood actors, including Ronald Reagan.

But secrecy makes criminality possible. And in competitive markets, whatever is possible becomes necessary.

So American policymakers had a problem. The United States wasn’t a tax haven, they reasoned, and they didn’t want to help tax cheats unnecessarily. They wanted American companies to borrow overseas, but they wanted to keep the 30 percent tax too, for the revenue. How to square this circle? At first, they settled for a compromise. American corporations could cook up a version of what was known as a “Dutch Sandwich” — set up an offshore finance subsidiary in the Netherlands Antilles, then use it to issue tax-free Eurobonds and send the proceeds up to the American parent. The United States could argue that it did not have to tax this income from the Antilles, under the rules of its tax treaty with this former Dutch colony via its postcolonial relationship with the Netherlands.

The Gordon report, as it was called, was probably the first really serious challenge to the havens in history. It condemned tax havenry as a situation that “attracts criminals and is abusive to other countries” and called on America to lead the world to crack down. Published a week before the Reagan inauguration, it quickly sank out of view.

From 1984, the United States would bypass the Antilles irritant entirely and waive the 30 percent withholding tax under a new loophole. American companies would no longer set up fictional entities in Curaçao but simply issue their bonds at home. Foreign investors would pay no tax on their bond income.

Under cover of the Qualified Intermediary Program, members of the Swiss aristocracy would stalk the America’s Cup and Boston Symphony Orchestra concerts for wealthy Americans, then set them up with tax evasion schemes, even smuggling diamonds in toothpaste tubes to help them evade tax. Then they would check the box to confirm they were respecting American banking laws.

Delaware is the biggest state provider of offshore corporate secrecy, but Nevada and Wyoming are the most opaque: They allow bearer shares, a vehicle of choice for mobsters and drugs smugglers, and they are particularly lax on allowing company directors and other officers to be named, hiding the identities of the real owners.

Being in Delaware gives modest tax advantages over other states, but the killer lure is, as I’ve said, laissez-faire standards of corporate governance that give tremendous power to corporate managers.

A world-famous totem to this artificiality is Ugland House, in the Cayman Islands, which Barack Obama once criticized for housing over twelve thousand corporations: “either the biggest building,” he said, “or the biggest tax scam.” When Obama said that, Antony Travers, chairman of the Cayman Islands Financial Services Authority, fired right back. Obama would be better advised to focus his attention in Delaware, where, he said, “an office at 1209 North Orange Street, Wilmington, houses 217,000 companies.” After Travers said that, I had to see the world’s biggest building. This, as it happens, is the office for the Corporation Trust, a subsidiary of the Dutch firm Wolters Kluwer.

Berlin-based Transparency International (TI), founded in 1993, put corruption on the map, launching its famous Corruption Perceptions Index (CPI) two years later.

TI’s rankings suggest that Britain and Switzerland, not to mention the United States, are among the world’s “cleanest” jurisdictions. In fact, about half the top 20 in the index are major secrecy jurisdictions, while the nations of Africa — the victims of the gargantuan illicit flows — are ranked the “dirtiest.” Clearly, something is wrong here.

7 - THE DRAIN - How Tax Havens Harm Poor Countries

While the old European havens were mostly about secret wealth management and tax evasion, the new British and American zones were increasingly about escaping financial regulation — though with plenty of tax evasion and criminal activity thrown in, of course.

In particular, the London-based Euromarkets, then the wider offshore world, provided the platform for U.S. banks in particular to escape tight domestic constraints and grow larger again, setting the stage for the political capture of Washington by the financial services industry, and the emergence of too-big-to-fail banking giants, fed by the implicit subsidies of taxpayer guarantees, plus the explicit subsidies of offshore tax avoidance, that continue to hold western economies in their stranglehold today.

In reality the system was rarely adding value, but was instead redistributing wealth upward and risks downward, and creating a new global hothouse for crime. The U.S. crime-fighting lawyer John Moscow summarized the problem. “Money is power and we are transferring this power to corporate bank accounts run by people who are in the purest sense of the word unaccountable and therefore irresponsible.”

The narcotics industry alone generates some $500 billion in annual sales worldwide: To put this into perspective, that is twice the value of Saudi Arabia’s oil exports. The profits made by those at the top of the trade find their way into the banking system, the asset markets, and the political process through offshore facilities. You can only fit about $1 million cash into a briefcase. Without offshore, the illegal drugs trade would be more like a cottage industry.

Bank of Credit and Commerce International (BCCI),

It paid off Washington insiders and built up a solid partnership with the CIA. This gave it fearsome political cover and made Blum’s investigations extraordinarily difficult from the outset. “There was an army of people working in Washington on all sides trying to say this bank was a wonderful bank,” Blum said. Friends in law enforcement warned him that his life was in danger, but he pressed on. He took the case to the Manhattan district attorney Robert Morgenthau, who shared Blum’s outrage and put a team together to take BCCI down. Fighting against what must have seemed like half the political insiders in Washington, Morgenthau helped shut it down in 1991 and charged BCCI and its founders with perpetrating “the largest bank fraud in world financial history.” But the most interesting thing about BCCI was its offshore structure.

“There is no way to learn banking from books: it is bullshit,” said Blum, highlighting the make-believe possibilities that emerge in the liberated offshore environment. “Nothing tells you how money-laundering generates products.”

With the help of Senator John Kerry, Morgenthau threatened to raise a public storm if the Bank of England did not act. Only then, finally, the Bank agreed to shut BCCI down.

A wealthy Russian-born Jew named Arkady Gaydamak put together some $800 million in financing to help Angola procure weapons from a Slovak company, repaid in Angolan oil money, via Geneva, and get around the embargo. Later, French magistrates probing these oil-for-arms deals heard from a participant that the arrangements were “a gigantic fraud . . . a vast cash pump,” generating a 65 percent margin on the biggest arms contracts.” The financing trails, of course, involved many tax havens.

In March 2010 Global Financial Integrity (GFI) in Washington authored a study on illicit financial flows out of African countries.** Between 1970 and 2008, it concluded, “Total illicit financial outflows from Africa, conservatively estimated, were approximately $854 billion. Total illicit outflows may be as high as $1.8 trillion.”** Of that overall conservative figure, it estimates Angola lost $4.68 billion between 1993 (when Gaydamak’s main “Angolagate” deals started) and 2002, the year after his Abalone debt dealings ended. My personal belief, based on years of investigating Angola’s economy and its offshore-diving leadership, is that Baker’s estimate — equivalent to just over 9 percent of its $51 billion in oil and diamond exports during that time — simply has to be a gross underestimate of the losses.

Raymond Baker, the director of GFI, was quite right to call the emergence of the offshore system “the ugliest chapter in global economic affairs since slavery.”

Henry’s 2003 book Blood Bankers explores a number of shocking episodes where offshore banking led to crisis after crisis in low-income countries.

Henry’s calculations suggested that at least half of the money borrowed by the largest debtor countries flowed right out again under the table, usually in less than a year, and typically in just weeks.

Today the top 1 percent of households in developing countries owns an estimated 70 to 90 percent of all private financial and real estate wealth.

One U.S. Federal Reserve official noted: “The problem is not that these countries don’t have any assets. The problem is, they’re all in Miami.”

This kind of simple trick is routinely practiced by so-called “vulture funds.” Wealthy foreign investors buy up distressed sovereign debt at pennies on the dollar — typically at a 90 percent discount — then reap vast profits when those debts are repaid in full. The trick is to make sure that influential local government officials are secretly part of the investor group buying the discounted debt—ensuring that these local investors will do battle inside the developing country governments to make sure the debts get paid. Their involvement, of course, is hidden behind a shield of offshore secrecy, so an impoverished nation’s citizens need never find out about the wealth that has been stolen from them or how the investors did it.

The stories in this chapter have been mostly about illicit financial flows drained from developing countries and into tax havens, undermining incentives for local elites to strive for better government by allowing them to remove themselves from the problems of their home countries, building safe offshore stashes that insulate and protect them against the turmoil and poverty that surrounds them.

South Africa’s finance minister Trevor Manuel put the problem neatly. “It is a contradiction to support increased development assistance yet turn a blind eye to actions by multinationals and others that undermine the tax base of a developing country.”

8 - RESISTANCE - In Combat with the Ideological Warriors of Offshore

Currently, most OECD governments take in tax revenues equivalent to 30 to 50 percent of GDP.

Competition between companies in a market is absolutely nothing like competition between jurisdictions on tax. Think about it like this: If a company cannot compete it may fail and be replaced by another that provides better and cheaper goods or services. This “creative destruction” is painful, but it is also a source of capitalism’s dynamism. But what happens when a country cannot “compete?” A failed state? That is a very different prospect. Nobody would, or could, as Mitchell put it, “shut down New Hampshire.”

As I have mentioned, tax, not aid, is the most sustainable source of finance for development. Tax makes governments accountable to their citizens, while aid makes governments accountable to foreign donors. Tax competition is destroying developing countries’ tax revenues and making them more dependent on aid.

Two months after O’Neill’s letter, Senator Carl Levin, fighting a lonely rearguard action, estimated that the United States was losing $70 billion annually from offshore evasion:

The richest 1 percent of Americans paid just over 40 percent of all federal income taxes in 2009. The right-wing Tax Foundation claimed this “clearly debunks the conventional Beltway rhetoric that the ‘rich’ are not paying their fair share of taxes.” Yet in 2009 the richest 1 percent owned almost half of all financial assets in the country — and the proportion was rising.

Offshore structures always serve citizens and institutions elsewhere — so the beneficiaries are always elsewhere. This is why it is called “offshore.” Plausible deniability is the whole game.

“Whenever the cops come calling the banks have a ready response for the particular regulator in each country,” explained Jack Blum. “No one sees the whole picture and it’s really no one’s job to even try. When the big and scary stuff happens, the bankers and their friends trot out the Bank for International Settlements and the Financial Stability Forum as proof of effective coordination and regulation. But these things are glorified fig leaves. They have produced absolutely nothing of real value beyond a few minor process quick fixes.”

9 - THE LIFE OFFSHORE - The Human Side of Secrecy Jurisdictions

Individuals with sums to launder or invest with minimal taxation want to know that they are dealing with people who can be trusted not to have moral qualms. If the bankers don’t know you, you will have to jump through many hoops; if you are a long-standing and trusted client, the rules fall away. These trust-based networks, deferential to the aristocracy of wealth and privilege and resistant to formal laws, are the ultimate source of comfort for the banks’ wealthy clients. The similarities with un-spoken Mafia codes of behavior are no coincidence at all.

His words remind me of an internal memo at the Riggs Bank brought to light in 2004 by the U.S. Permanent Committee on Investigation. “Client is a private investment company domiciled in the Bahamas,” it said, “used as a vehicle to manage the investment needs of beneficial owner, now a retired professional who achieved much success in his career and accumulated wealth during his lifetime for retirement in an orderly way.” The “retired professional” was the Chilean torturer-in-chief and former dictator Augusto Pinochet.

An old offshore saying encapsulates it: “Those who know don’t talk, and those who talk don’t know.”

In his novel Snow Falling on Cedars, the writer David Guterson captures an essence of it. “An enemy on an island is an enemy forever. There is no blending into an anonymous background, no neighboring society to shift toward. Islanders were required, by the very nature of their landscape, to watch their step moment by moment.”

The firm practiced reinvoicing: the practice I described earlier, where trading partners agree on a price for a trade but record it officially at a different price to shift money secretly across borders. Global Financial Integrity, in Washington, D.C., estimates that about $100 billion is drained from developing countries each year just from reinvoicing — about as much as all foreign aid from the rich world to the poor.

In October 2009, having been accused of leaking a police report about the conduct of a nurse, Syvret fled to London and claimed asylum in Britain. He returned in May 2010 to fight an election and was arrested at the airport. Not long afterward, he outlined his views about Jersey plainly. “It is an utterly lawless jurisdiction. Jersey is an environment under the grip of a wholly criminal regime. So absolute — and absolutely corrupted — is all meaningful power in Jersey that the island possesses less scrutiny and fewer checks and balances than a Balkan state.”

One winter night in 1996, toward the end of his time in Jersey, Christensen opened the books for a reporter from the Wall Street Journal who was investigating a fraud ring involving a Swiss bank operating out of Jersey that had been ripping off American investors and who posed some very precise questions. The story, entitled “Offshore Hazard: Isle of Jersey Proves Less Than a Haven to Currency Investors,” ran on the Journal’s front page several months later.

10 - RATCHET - How Secrecy Jurisdictions Helped Cause the Latest Financial Crisis

The Big Four accounting firms — PricewaterhouseCoopers (PWC), Ernst & Young, KPMG, and Deloitte Touche — are giants: PWC employed over 146,000 people and generated $28 billion in revenues in 2008, making it the world’s largest professional services firm.

“Partners who have [joint and several] unlimited liability have a solidarity; the dynamic within the group is totally different,” Hummler said. “On so many boards—and I have quite some experience of this—one doesn’t dare to ask the right questions. This [unlimited liability] is the only way of doing business where you dare to ask the really difficult questions—mostly the simplest questions.

Joint and several unlimited liability for partners in audit firms is clearly, given their special role in policing modern capitalism, a very good idea. What was being proposed in Jersey, however, was different again: a law allowing limited liability partnerships (or LLPs.) An LLP for accountancy firms is an example of having your cake and eating it: An LLP partner not only gets the benefits of being in a partnership — less disclosure, lower taxes, and weaker regulation — but it gets the limited liability protection too.

Big accountancy firms had already gotten LLPs in the United States after first influencing the Texas legislature in 1991; within four years nearly half of U.S. states had it. These limited liability provisions “took away the most powerful incentive for self-policing by the corporate professions of law and accounting,” wrote the tax expert David Cay Johnston, and “help explain the wave of corporate cheating that swept the country.”

A Wall Street Journal article in 1996 noticed, “Jersey is an island that until two decades ago lived off boat building, cod fishing, agriculture and tourism. It is run by a group who, although they form a social and political elite on Jersey, are mostly small-business owners and farmers who now find themselves overseeing an industry of global scope involving billions of dollars.” The article goes on to report the judgment of John Christensen, who was Jersey’s economic adviser at the time: “By and large they are totally out of their depth.”

“They can argue at enormous length about the budget for the local pony club,” said Christensen, “but a new limited liability law or a new trust law will go unchallenged. It’s the captured state.”

Ernst & Young became an LLP in 2001; KPMG went in May 2002; PricewaterhouseCoopers made the move in January 2003; Deloitte & Touche followed that August.

Among the only academic experts to have seriously examined offshore’s role in the financial crisis is Jim Stewart, senior lecturer in finance at Trinity College, Dublin.

A corporation borrows money from offshore, then pays interest on that loan back to the offshore financing company. It then uses the old transfer pricing trick: the profits are offshore, where they avoid tax, and the costs (the interest payments) are onshore, where they are deducted against tax. This simple trick is central to the business model of private equity companies. They will buy a company that someone has sweated for years to create, then load it up with debt, cutting the tax bill and magnifying the returns. Leveraged buyouts — always involving offshore leverage — accelerated fast ahead of the crisis: The amount raised by private equity funds rose more than sixfold from 2003 to over $300 billion in 2007, by which time their share of all U.S. merger and acquisition activity had risen to 30 percent.

More than half of the companies that defaulted on their debt that year were either previously or currently owned by private equity firms.

Banks achieved a staggering 16 percent annual return on equity between 1986 and 2006, according to Bank of England data, and this offshore-enhanced growth means the banks are now big enough to hold us all ransom. Unless taxpayers give them what they want, financial calamity ensues. This is the “too big to fail” problem—courtesy of offshore.

John Maynard Keynes summed up the problem well. “Remoteness between ownership and operation is an evil in the relations among men, likely or certain in the long run to set up strains and enmities which will bring to nought the financial calculation.”

CONCLUSION - Reclaiming Our Culture

About 60 percent of world trade happens inside multinational corporations, which cut taxes by shuffling money between jurisdictions to create artificial paper trails that shift their profits into zero-tax havens and their costs into high-tax countries.

One might think that the main global rule-setter for international accounting standards would be a public international body accountable to democratic governments. It is not. The International Accounting Standards Board (IASB) is a private company financed by the Big Four accountancy firms and global multinationals, headquartered in the City of London, and registered in Delaware.

The City of London Corporation — the offshore island floating partly free from Britain’s people and its democratic system — must be abolished and submerged into a unified and fully democratic London.

Not only that, but a huge share of the profits of the financial sector derive ultimately from real estate business and land value. Tax land’s rental value, and you capture a big slice of this financial business, however much it is reengineered offshore. When Pittsburgh became one of the few places in the world to adopt the tax in 1911, in the teeth of massive resistance from wealthy landowners, it had dramatic and positive effects: While the rest of America went on an orgy of land speculation ahead of the Crash of 1929, prices in Pittsburgh only rose 20 percent. Harrisburg’s adoption of the tax in 1975 led to a dramatic inner-city regeneration. The tax is simple to administer and progressive (that is, the poor pay less) — and can be especially useful for promoting growth in developing countries.

When corporations talk about social responsibility, we can ask if they mean tax.

The economics profession needs to reappraise its approach to understand the effects of things such as secrecy and regulatory arbitrage. It could start to measure illicit, secret things, difficult though that may be.