Treasure Islands: Dirty Money, Tax Havens and the Men Who Stole Your Cash

by Nicholas Shaxson

  As this offshore expansion accelerated, the erosion of America from the inside gathered pace.

  The oil crises of the 1970s led to high inflation: This, plus the legacy of Vietnam-era deficits, sent the dollar spiraling downward. In August 1979, U.S. president Carter appointed Paul Volcker, a renowned hard-money man, to head the Federal Reserve Board and reassure the markets. Carter cut spending, and Volcker tightened monetary policy savagely.

  But Volcker had a problem. “Monetarist” theories of tackling economic problems by focusing on the money supply were coming into vogue, just at the time that unregulated Euromarkets, lacking regulation and official checks on banks’ abilities to create money out of thin air, were starting to disrupt the Fed’s efforts to control that very money supply.15 Volcker called for a new cooperative international framework through the Bank for International Settlements, in Switzerland, to get other countries to stamp down on uncontrolled money creation in the offshore system. But New York bankers, in an alliance with the Bank of England and the Swiss National Bank, killed the initiative.16

  The bankers of Manhattan began to wield the offshore system as a weapon to attack the New Deal regulations that had so effectively clipped their wings at home. In the words of Professor Ronen Palan, a leading academic authority on the offshore system, “The New York banking fraternity, led by Chase Manhattan, used the real or imagined threat posed by the Euromarket and the Caribbean tax havens—which the same banks had of course helped establish as large financial centres in the first place—to achieve their aim of more liberal financial laws.”17 If you can’t beat the offshore markets, the lobbyists argued, then join them.

  In June 1981, less than six months after Reagan’s inauguration, the United States approved a new offshore possibility, the international banking facility. The United States was another step closer to becoming the tax haven imagined in the memo to Michael Hudson.

  IBFs, as they are known, are kind of offshore Euromarkets-lite: They let U.S. bankers do at home what they could previously do only in places like London, Zurich, or Nassau: lend to foreigners, free from reserve requirements and from city and state taxes. The bankers would sit in the same Manhattan offices as before and simply open up a new set of books and operate as if they were a branch in Nassau. Once the IBFs were in place, the banks could dispense with the subterfuge entirely and book them openly in New York. The United States had moved closer to the British offshore model.

  Bankers in New York signed on to the new possibility with gusto, followed by those in Florida, California, Illinois, and Texas. In three years almost five hundred offshore IBFs had popped up inside the United States, draining money out of other offshore markets in the Caribbean and elsewhere.18 It was a new get-out-of-regulation-free card for Wall Street and another hole in the American fortress. Not only that, but as author Tom Naylor puts it, “The US hoped to use the IBFs as a bludgeon to force other countries to relax restrictions on the entry of US banks into their domestic financial markets.”

  Japan followed the lead in 1986 by creating its own offshore market, modeled on the U.S. IBFs. This happened just at the start of a massive credit boom, followed by what was at the time the biggest asset market crash in history. That roller coaster had many causes, but the wildfire was stoked by the $400 billion that whooshed into Tokyo within 24 months19 and showed local bankers what liberalized finance was all about. That year was also, as noted in chapter 4, the year of the fateful Big Bang of deregulation in the City of London, which provided Wall Street with major new escape hatches from financial regulation.

  As offshore finance moved onshore, it became ever harder to tell the two worlds apart. And this, crucially, fed the giant blind spot, which persists to this day. Nearly every tax analyst took this blurring between onshore and offshore as a signal to stop trying to measure or analyze the secrecy jurisdictions, or just to focus on a few smaller, more colorful island havens. Palan, in his book The Offshore World, explains what was really happening. “Far from signalling the decline of offshore,” he wrote, “the process “must be interpreted as the embedding of offshore in the global political economy.”20

  John Christensen remembers noticing this blind spot in 1986. He was working as a development economist in Malaysia and came across some odd local structures known as deposit-taking cooperatives. These were unregulated quasi-banks that took large volumes of deposits from Malaysian widows and orphans and channeled the money offshore. In July 1985, one of these cooperatives offered him a king prawn luncheon at a sumptuous office penthouse in Kuala Lumpur, washed down with Guinness and Courvoisier. As the lunch wore on, it became apparent that the chief financial officer, a leading light in the Malaysian Chinese Association, wanted to steer the conversation toward Christensen’s childhood roots over six and a half thousand miles away in the crown dependency of Jersey, and he was especially interested in its status as a tax haven. He wanted to know if it was safe to invest.

  Christensen resolved to look into the cooperatives. “The whole thing was a massive scam,” he said. “The Central Bank wouldn’t regulate it and nobody else would touch it. Everyone said ‘keep away.’” Their international offshore dimension made it impossible for anyone locally—whether curious depositors or government regulators—to find out what was really happening: how profits were being shifted to insiders and risks heaped onto the shoulders of ordinary Malaysian depositors or taxpayers. After doing detailed research, Christensen was able to get an article published in the Business Times of Singapore in December 1985 before leaving the country as the ensuing scandal broke. Within months the central bank had suspended twenty-four cooperatives amid a massive run by depositors.

  Back in Britain Christensen spent a couple of months combing libraries and seeing all the economists and capital markets experts he could find to try to understand where the money was flowing and how the offshore system worked. Nobody knew anything. “I don’t think anyone understood how malevolent this thing had become,” he said. “There was no useful information anywhere.”

  As the Vietnam War heated up, Michael Hudson worked out that the whole of the U.S. balance-of-payments deficit could be attributed to the costs of Vietnam. And the deficits, later worsened by the great Reagan tax cuts of 1981, posed a quandary. American companies needed to borrow money by issuing bonds, but if they borrowed it all at home, they would compete for funds with the U.S. government, pushing up interest rates and crimping economic growth. So it would be best if they could borrow from overseas.

  But there was a hitch. A French investor, say, who wanted to buy some bonds faced a simple choice: either invest in American bonds, and pay a 30 percent withholding tax on the bond income, or hop on the “coupon bus” to Luxembourg and earn income tax-free, and in secret, from Eurobonds. Many investors saw this as no choice at all. They shunned American bonds.

  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 U.S. Internal Revenue Service could easily have decided that the Dutch Sandwich was a sham and taxed the income. But it looked the other way. “These were Eurobonds, bearer bonds, which were virtually impossible to tax,” explained Michael J. McIntyre, a top U.S. expert on international tax, who was one of very few people in the United States to have opposed this at the time. “You British people were quite happy about (the tax-free, secretive Eurob
ond markets). And we wanted in. We wanted to attract the hot money too.”

  David Rosenbloom, who was in charge of these matters at the U.S. Treasury during the years 1978–80, also remembers how questionable these officially tolerated offshore antics were. “People were very nervous. Those companies wanted access to the Eurodollar market, and they really wanted security,” he said. “The Antilles structures were kind of phoney—these were paper entities; they weren’t doing anything real. They existed in some notaire’s desk drawer down in Curaçao.”21

  In response to the Antilles structures, the Carter administration commissioned a major survey of secrecy jurisdictions that was published in January 1981, the month Reagan came to power.

  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. Yet the report was an acknowledgment that there was a big problem, and in this, it was new. “I can’t remember any overarching ‘Let’s go after the havens’ thing prior to the Gordon report,” said Rosenbloom.

  While the Bahamas and Switzerland were certainly on the radar screen, he said, the Netherlands Antilles was the big one.

  Eventually, the United States told the Netherlands Antilles it wanted to renegotiate the treaty.

  “A whole bunch of rulings came down that scared the bejesus out of everybody,” said Rosenbloom. “These were the days when people were actually afraid of our tax authorities.”

  But there was another hitch: Having tacitly encouraged the Antilles loophole, the United States was not in a great position to object. “From the point of view of U.S. tax policy these things were utterly objectionable, but the U.S. government had its hands completely dirty,” Rosenbloom continued. “The government was in a bad position to start getting all self-righteous about this.

  “The Antilles could have gotten a decent treaty that would have let them carry on doing business in some form. I was prepared to compromise. I didn’t think we had the gumption to do this.”

  Yet the Dutch Antilles overplayed its hand. “They were holding out,” Rosenbloom said. “They thought they could push the United States around in treaty negotiations. They wanted more of this and more of that, and this benefit and that benefit . . . they just held tough on all sorts of positions that we couldn’t accept.”

  American corporations grew skittish. And out of the commotion, a new approach was hatched: From 1984, the United States would bypass the Antilles irritant entirely and waive the 30 percent withholding tax under a new loophole.22 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.

  It was a classic tax haven gambit: plug the deficits by exempting foreigners from tax, and watch as the world’s hot money rolls in. It was just as the memo handed to Hudson in the elevator had anticipated.

  The loophole was supposed to be available to foreign investors only. Unscrupulous wealthy Americans, of course, got around that simply by covering themselves in a cloak of offshore secrecy and pretending to be foreigners.

  “The Wall Street types were as happy as clams,” said McIntyre. “The rules were designed to facilitate tax evasion. It was a very hot business: People in high places liked it and fostered it. They didn’t think it was an ethical issue. . . . Nobody seemed to object, except my brother Bob and I.”23

  The effects were immense. Having set up offshore-lite international banking facilities in 1981, America, by 1984, had a thriving homegrown offshore bond market.

  “Suddenly,” noted Time magazine, “America has become the largest and possibly the most alluring tax haven in the world.”

  From then on, a drip-drip of new laws and statutes nibbled away at America’s onshore defenses.

  In the late 1990s, Bill Clinton’s treasury secretary and former Goldman Sachs cochairman Robert Rubin deepened the offshore corrosion with a devious new piece of legislation, the Qualified Intermediary Program. And here lies another nauseating tale.

  U.S. authorities wanted to protect the nation’s own tax base by finding out about American accounts at foreign financial institutions. Yet they could not simply request all the information—about both foreigners and U.S. citizens—then simply sift out the U.S. tax cheats and ignore the foreigners. If it did receive information about foreigners, the United States would be obliged under its tax treaties to tell foreign governments about their citizens’ U.S. investments. Those citizens would then take their money out of the United States and park it somewhere else, where it would remain secret. U.S. deficits would widen.

  The answer was to outsource the screening to foreign banks. They would tell the United States only about U.S. citizens and not pass on any information about foreigners. And if the United States did not have the information, then it would have nothing to exchange with foreign jurisdiction—and it wouldn’t be breaking its treaties. “The rules were designed to make it difficult for the U.S. government to learn who the tax cheats were,” McIntyre explained.24 “This evasion was intended to benefit U.S. borrowers by allowing them to borrow from the tax cheats at a reduced interest rate.”25 It was another classic offshore ruse. A tax haven sets up worthy treaties that require the haven to exchange information with foreign jurisdictions. Then they set up the structures to make sure that they never have the information to exchange in the first place. They keep their secrecy, but by pointing to their treaties they can claim that they are a transparent and cooperative jurisdiction.

  Next, the banks simply lied to the U.S. authorities about what they were doing. 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.

  Rosenbloom encapsulated the cynicism in a nutshell. “The program was not aimed at identifying Americans,” he said. “The program was aimed at protecting the identity of foreigners while allowing them to invest in the U.S.” This narrow focus meant that only very clumsy or poorly advised American tax evaders would ever be caught.

  A veteran official Washington investigator who asks to remain anonymous described how one American lawyer responded to the Qualified Intermediary Program. “This guy has a wonderful practice teaching people how to game the system,” he said. “The first thing he does is put together a PowerPoint to the banks in central European secrecy jurisdictions, on how to get around the reporting obligations.”

  “That sonofabitch yelled at me down the phone,” the investigator continued. “This is such an abuse of part of our legal culture. They fought [the U.S. government] every step of the way.”

  The Clinton administration, to be fair, issued proposed regulations near the end of its second term that would provide OECD countries with information about their citizens’ U.S. bank deposits. U.S. banks, especially those with major deposits in Florida and Texas, lobbied hard against them. George W. Bush’s administration dropped them.26

  The United States sells financial secrecy not just at the federal level but at the state level too. 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. Nevada does not share tax or incorporation information with the federal government and does not require a corporation to report where it does business. The IRS has no way of knowing whether a Nevada corporation has filed a federal tax return. Arkansas, Oklahoma, and Oregon are also routinely used for fraud by eastern Eur
opeans and Russians, and, as noted, Texas and Florida are havens for illicit Latin American wealth.

  In the 1990s, the U.S. government gave millions in aid to help the former Soviet Union countries improve the security at their nuclear power plants. Much of it went missing. When the U.S. Department of Justice went looking for the money, investigators finally tracked it to anonymous shell companies in Pennsylvania and Delaware. Most cases involving financial market manipulations that the FBI has studied have involved U.S. shell companies from these states. The notorious “merchant of death” Viktor Bout, inspiration for the character played by Nicholas Cage in the Hollywood film Lord of War, alleged arms runner to the Taliban and other murderous organizations around the globe, operated through businesses in Texas, Delaware, and Florida.27

  “US shell companies are attractive vehicles for those seeking to launder money, evade taxes, finance terrorism, or conduct other illicit activity anonymously,” said Republican Senator Norm Coleman, then chairman of the U.S. Senate Permanent Subcommittee on Investigations. “Competition among States to attract company filing revenue and franchise taxes has, in some instances, resulted in a race to the bottom.”28

  A New York Times article from 1986 describes the antics of one Delaware lieutenant-general who flew to Taiwan, Hong Kong, China, Indonesia, Singapore, and the Philippines, clutching a pamphlet boasting that Delaware could “Protect You from Politics.”29 The official was, the article noted, “looking forward to a rich harvest of Hong Kong flight capital” after the British pullout in 1997. “You don’t have to tell us the details of your business; you don’t have to list who’s on your board or who’s holding office; and you don’t have to use your name and address—just use your Delaware agent’s.” For an extra $50, you could get this in 24 hours.