That year American banks were treated to a display of the Bank of England’s political muscle when the Bank’s governor Lord Cromer forced Britain’s new prime minister Harold Wilson to throw away half his election promises and slash government spending, prompting Wilson to shout in one debate, “Who is Prime Minister of this country, Mr. Governor, you or me?”46
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. The Bank’s purpose was never defined very clearly, but when the Bank’s directors decided in 1991 to work out more explicitly what the Bank is for, they came up with three main goals. Two were the usual central bankers’ goals: to protect the currency and to keep the financial system stable. The third was, as the Bank’s then governor Eddie George put it, to “ensure the effectiveness of the United Kingdom’s financial services” and to have a financial system “which enhances the international competitive position of the City of London and other UK financial centres.”47 He was effectively admitting to a Bank goal to do what it takes to protect and promote the City at the center of an overseas, or offshore, empire.
A quick numerical exercise shows how unregulated offshore finance can be so profitable, far beyond the potential merely for eliminating taxes.
Governments require banks to hold reserves against the deposits they take. Let’s imagine a bank officially has to hold 10 percent of the value of its deposits in cash, and the going interest rate is 5 percent annually for loans and 4 percent for deposits. For every $100 deposit, the bank may only lend $90 at 5 percent, earning it $4.50. The bank must pay the depositor 4 percent, leaving it 50 cents. Subtract the bank’s operating costs of, let’s say, 40 cents, and it has made 10 cents’ profit on its $100 in deposits.
Now imagine, instead, a bank in the Euromarkets in London, which has no reserve requirements. The bank can now lend all of its $100 at 5 percent, earning $5. Subtract $4 to pay interest to the depositor, then subtract 40 cent operating costs, and the profit now is 60 cents—six times the “onshore” profits. This is grossly simplified, but it exemplifies a basic principle behind offshore’s appeal. On the face of it, this looks like a cost-free benefit for everyone: In a competitive market, the bankers will pass some of those profits on to borrowers and depositors. But this is a false view. First, much of the profit will pass to the bank’s wealthy owners, and to the extent that the banks do pass on these savings, offshore customers will almost always be the world’s wealthier citizens and corporations. Second, the increased profits come at a cost: increased risk. The latest financial crisis has showed what happens when such risks materialize: ordinary people pay. Free money for bankers and for the world’s wealthy—at the expense of everyone else—is a basic leitmotif of the offshore system.
There is another offshore secret at play here too. It hinges around why banks have to hold reserves against deposits in the first place.
Imagine you deposit $100 with an “onshore” bank. Under a 10 percent reserve requirement, the bank may lend out only $90 of that to someone else. That person now has $90 to spend, and that $90 will end up in another bank account. That next bank may then lend 90 percent of that $90 out—so $81 more will end up being lent. And the process goes on. This is a well-known principle of so-called “fractional reserve banking,” and if you follow the calculations through you will find that with a 10 percent reserve requirement your $100 theoretically balloons out into $1,000, spread across the economy. Money really is conjured out of thin air like this: This is what banks do. Money is created by the act of lending it. “The process by which money is created is so simple that the mind is repelled,” said the economist J. K. Galbraith. Money creation is not a bad thing in itself. The question is: how much borrowing, and how much money creation, is healthy? Regulators try to control liquidity—making sure that the amount of money sloshing around the system does not grow out of control—by enforcing reserve requirements.
But in the unregulated London-based Euromarkets, with no reserve requirements, the first $100 deposit theoretically lets the bank lend out the full $100, which turns into another $100 deposit, leading to another $100 loan, and so on endlessly. Of course it never happened like that: If it had, we might have drowned in money long ago. No, there is only so much demand for credit at any time, and if credit grows in the offshore market it will, up to a point, be reined in elsewhere to compensate. Offshore Eurodollars also leak back “onshore,” where reserve requirements will slow down the money-creation machine again. And prudent bankers hold back reserves anyway, even when they do not have to. Controversy has, in fact, raged for decades about how much the Euromarkets contribute to puffing up the amount of money circulating in the world, boosting risk and building unsustainable wobbly pyramids of debt.
Yet some things seem clear. 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. Credit quality is likely to deteriorate, out of sight of regulators. Just as the world was waking up to the ideas of Milton Friedman, who argued that governments should focus on money supply as the lever to use to manage their economies, the new London market was starting to make these levers ineffective.
If the 1960s were thrilling for American bankers in London, U.S. regulators weren’t so happy. The archives from that era show that people were fretting about exactly the kinds of trouble that brought the world economy to its knees in the recent economic crisis from 2007—uncontrollable financial flows across borders, and the financing of long-term lending with very short-term borrowing, risking trouble when short-term markets dry up. “Is the growth of this market a welcome tonic, or a slow poison to the international financial system in general?” The Banker magazine had asked in the earlier years of the Euromarkets’ growth.
In 1960 the Federal Reserve Bank of New York, believing that the Eurodollar markets were already making “the pursuit of an independent monetary policy in any one country far more difficult,”48 sent a team to London to investigate. Bank of England staff charmed the American regulators and doubtless offered them a great number of cups of tea. But they did little to address their concerns, even after the Americans said the Euromarkets posed a danger to stability—and even though some British officials were nervous themselves. “I did get the impression,” one Bank of England official noted in a memo in 1960, “some of them were rather keeping their fingers crossed.”49
James Roberston, vice chair of the Federal Reserve, started to point to another worry: the emerging Euromarket centers in the City’s offshore satellites like Cayman and the Bahamas. “My primary objection is that they aren’t branches in any sense of the word,” he wrote. “They are simply desk drawers in somebody else’s desk. Why make banks go through a sham proceeding to obtain certain privileges?” One enterprising trader at a major U.S. bank, recognizing how artificial this game was, planted a cardboard sign saying “Nassau” on a desk in his trading room in New York and recorded trades at that desk, booking them “offshore” and out of sight of regulators. After someone discovered the ploy the traders continued as before but ensured that a clerk simply copied them into a second set of books in the Bahamas.50 Soon, a shift to computerized trading removed the need for cardboard signs anyway. As the author Jeffrey Robinson noted, “The horse hadn’t merely bolted, it was living in a beach-front condo in the Caribbean.”
The Euromarkets rippled outward, driven from the center in London, first to Britain’s semi-independent Crown Dependencies of Jersey, Guernsey, and the Isle of Man near the UK mainland, then out to the British-held Caribbean jurisdictions, then to Asia, and finally to British-held Pacific ato
lls. These satellites of the City were simply booking offices: semifictional way stations on secretive pathways through the accountants’ workbooks. The banks might park a person or two on each palm-fringed island while the heavy lifting work—the real business of hammering together big banking syndicates, making the accounting cogs mesh properly, and ensuring that the paperwork was legally watertight—happened in London and New York. But these fast-growing, freewheeling hidey-holes helped the world’s wealthiest individuals and corporations, especially the banks, to grow faster than their more heavily regulated on-shore counterparts.
By 1963 the U.S. Treasury already was warning that the market had aggravated a “world payments disequilibrium,”51 and one official suggested publicly that American bankers should “ask themselves whether they are serving the national interest by participating in this sort of activity.”52 That was the year that President Kennedy introduced his Interest Equalization Tax, which drove U.S. banks to London in droves. “It is hardly an exaggeration to say that leading American banks thought little about Europe before 1963,” wrote the U.S. economist Richard Sylla, “and thought about little else in the decade thereafter.53
Once again the U.S. authorities conveyed their fears to the Bank of England and sent the U.S. comptroller of the currency to London to inspect American banks. The Bank of England’s response was, effectively, that the United States could go and screw itself. “It doesn’t matter to me whether Citibank is evading American regulations in London,” one top Bank official said, epitomizing the City of London approach. “I wouldn’t particularly want to know.”54
As the 1960s wore on, U.S. deficits ballooned. America was overspending overseas, in relation to its earnings, and its foreign payments sent an army of dollars outward from the United States, feeding the Euromarkets and further loosening the shackles on finance—just as Swinging London, as it became known, was breaking the constraints of fashion. Ideas about rebellion against authority percolated far into the fabric of society: James Bond’s forays offshore, to Switzerland in Goldfinger in 1964 and to Nassau in Thunderball in 1965, injected an appealingly subversive frisson into the image of tax havens and uncontrolled offshore finance, the new global hothouse for international crime.
By 1967 Robert Roosa, the energetic U.S. undersecretary for the Treasury, warned that the Euromarkets had hugely amplified destabilizing capital flows, “in magnitudes much larger than anything experienced in the past, massive movements.” The response from London always came in two forms: either “This is nothing to worry about” or “Mind your own business.”
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!55
And the Euromarkets just kept blooming. More and more U.S. banks flooded to open offices in London. The publication Euromoney, in its inaugural issue in 1969, described the market as being like a child: “It stuffs itself for some time with whatever goodies take its fancy, refuses to listen to warnings that it will get indigestion, gets it, lies low for a few months, then gets hungry again.”
That year the biggest bank in the market was Citicorp (or Citibank), whose CEO Walter Wriston was a single-minded champion of the idea of freedom for financial capital, who delighted in the way that governments were once more being cowed by financial markets. “The Euromarkets are now the greatest mobile pool of capital in the world,” Wriston said in one interview. “If the British put on reserve requirements or other controls, Bahrain is waiting. In just a couple of keystrokes, the whole market could be gone.” And his love for the Euromarkets was, it seems, matched by his confidence in their resilience. When asked in an interview in 1996 about the Euromarkets whether the world risked financial meltdown on account of increasingly risky financial activities, he said simply, “It can’t happen.”56
By 1970 the London-centered market was measured at $65 billion in all currencies and still growing fast. Daniel Davison, the head of Morgan Guaranty’s London office, gushed about London’s minimal regulation and generous tax treatment. It was, he said, “a banking bazaar unrivalled in history. The Moscow Narodny Bank, whether it is appropriate Bolshevik doctrine or not, sits almost cheek by jowl with the Bank of China, and rubs elbows with the capitalist banking institutions of the West. There are about three times the number of American commercial banks in the City as there are in New York. The City of London beats Baghdad as a bazaar by a country mile.”
The whole character of the City began to change. City gentleman reeled at the sight of Goldman Sachs’s star trader, Larry Becerra, turning up for work on a Harley-Davidson in jeans and cowboy boots, and at the sounds of “holy fucking shit” that began to fill the dealing rooms. Within a few years of Goldman Sachs’s opening its first international office in the City in 1970, its London operation was accounting for a quarter of the firm’s entire business and its offshore satellites a slice more. “The days of friendly co-operation and friendship changed dramatically in the mid-seventies when it became an ugly business,” remarked one British banker, John Craven. “That’s when unpleasant practices came in—in terms of paying investors under the table in order to take bonds and even a little bit of improper entertainment of guests in flats in London—and it undermined the whole spirit of the thing.”57
All the time, the Bank of England quietly kept regulation at bay. In 1973 some German bankers went to see James Keogh, a Bank of England official, to ask what permissions they needed to become an authorized bank in London. “Keogh looked at us,” one banker remembered, “and he said ‘a bank is a bank if I consider it to be one.’” And that, pretty much, was it—apart from what the historian David Kynaston calls the “occasional, indispensable afternoon ceremony”: that cup of tea at the Bank of England from time to time to explain what you are doing.58 By that year, over half of U.S banks’ foreign business was taking place in London—though a lot of that soon began shifting toward London’s satellite tax havens, especially the Bahamas and the Caymans.59
By 1975 the invading Wall Street ruffians had fully overtaken the plodding British banks and were beating them in market after market. “There was never any sense that old English bankers were competing with us in any way,” said Michael Lewis of Salomon Brothers. “It was much more, ‘how much did we have to pay them to clear out of town and do something else with their lives.’”60
By then, the Euromarkets had grown to exceed the size of the entire world’s foreign exchange reserves.61 At the same time, a new source of dollars had begun to feed the markets, as the OPEC oil shocks hit in the 1970s, and oil-rich countries’ surpluses were re-lent through the Euromarkets to finance deficit-plagued oil consumer countries. This gigantic financial recycling via London and its satellites, to be lent out to Latin America and elsewhere, often amid great secrecy and corruption, laid the foundations for the subsequent debt crises of the 1980s.
As the Euromarket bonfire raged ever more strongly, financial capital began a new assault on the citadels of power and the democratic nation-state. Countries were no longer insulated by exchange controls and capital controls against events elsewhere. The Euromarkets seemed to have connected up the world’s financial sectors and economies as if by an electric current: A shock rise in interest rates in one place would switch its effects instantly to anywhere plugged into the system. Tides of hot money once again began to surge back and forth across the globe, with the Euro-markets as a kind of anti-Keynesian global transmission belt making financial markets more sensitive to tweaks and changes elsewhere and allowing enough money to pool together in one place to allow large speculative attacks against currencies.62 Democratic governments began to retreat in the face of financial capital. �
��What annoys governments about stateless money is that it functions as a plebiscite on your policy,” Wriston said. “Money goes where it is wanted and stays where it is well treated. This annoys governments no end.”63
The Euromarkets just kept snowballing: $500 billion in 1980, then a net $2.6 trillion eight years later64; and by 1997, nearly 90 percent of all international loans were made through this market. It is now so all-enveloping that people hardly notice it anymore.
It is fairly easy to explain why Britain welcomed the new markets, even at the cost of squeezing out British banks. There was the crude question of money, for one thing. “We, at the Bank, have never seen any reason to place any obstacles in the way of London taking its full and increasing share,” one official said. “If we were to stop the business here, it would move to other countries with a consequent loss of earnings for London.”65 Not only that, but Britain was rolling out a new political and economic strategy to make up for its loss of status as the world superpower: It would keep as close as possible to a leadership role in world affairs by hitching itself to the new American superpower through a “special relationship” with Washington, which endures, at least in British minds, until the present day. 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.
Treasure Islands: Dirty Money, Tax Havens and the Men Who Stole Your Cash Page 11