Sneak Attack.

A stealth campaign by U.S. regulators to turn private bankers into policemen.

The return of Domingo Cavallo as Argentina's finance minister in March resulted primarily from a political backlash after years of economic stagnation and mounting fiscal problems. One factor that intensified the crisis, however, originated in Washington, specifically in the Senate of the United States. A report prepared by the Democratic staff of the Senate Permanent Subcommittee on Investigations ("PSI") made accusations that several Argentine financial institutions laundered money from drug dealing and bribery, creating serious political problems for President De la Rua. The report was a body blow to an already weak government, the mediocre successor to the regime led by the charismatic Carlos Menem. A scolding by a U.S. Senator from Michigan, Democrat Senator Carl Levin, added urgency to De la Rua's appeal to Cavallo, the architect of Argentina's currency peg and previous economic prosperity.

The fact that Argentina is a world leader in money laundering is no surprise to TIE readers. Thanks to the dollar peg engineered by Cavallo, Argentina is one of those nations stable enough to attract anonymous offshore cash, but still corrupt enough not to be particularly bothered about who uses its banks. In 1996, TIE reported on "The G3 Money Launderers" (see The International Economy, May/June 1996) and the growth of venues like Argentina, Israel, and Russia in the invisible world of offshore money havens where legitimate capital flight and the proceeds of drug trafficking and other illegal activities blur, an opaque market built by Wall Street to serve the huge float in offshore dollars. Names like Merrill Lynch and Citibank pioneered modern private banking and offshore trusts, but to be fair, they are just following their clients. If you do a banking business in venues like the Cayman Islands, Mexico City, Nigeria, Colombia, Liberia or the Bahamas, odds are pretty good that many of your non-resident customers are, at best, tax evaders from countries with high levels of government spending and official regulation, like the EU.

What will surprise and even frighten TIE readers and many members of Congress, however, is how Washington has cast aside traditional American values of individual liberty and privacy, and is kowtowing to the ministerial suggestions of European bureaucrats intent upon eliminating "tax competition." In an April 5, 2001 letter to Treasury Secretary Paul O'Neill, influential Oklahoma Republican Representative Steve Largent said of the OECD's effort: "Acting on the rather novel belief that it is unfair for low-tax countries to compete with high-tax countries, the Paris-based bureaucracy is seeking to impose fiscal protectionism on all countries. The OECD initiative is bad tax policy, bad trade policy, bad privacy policy, and bad foreign policy. It would insulate profligate governments from market discipline. Perhaps more importantly, it would undermine America's comparative advantage."

American cooperation with the OECD, which operates under the umbrella of the Financial Action Task Force ("FATF"), has extended to American bank regulators, who are eagerly imposing new guidelines on American banks in direct opposition to the wishes of the majority in Congress. Bankers and their lobbyists in Washington, speaking only off the record because of fear of reprisal by zealous regulators, describe a stealth process where the U.S. Treasury and Federal Reserve are building a system of surveillance, information gathering, and monitoring of law abiding citizens, and doing so without the consent of Congress or the knowledge of a distracted public. Indeed, despite the fact that the Congress declined to explicitly give the regulators further powers, bank regulators are using verbal "guidelines" regarding "enhanced due diligence" to turn your friendly commercial bank into a federal law enforcement agency.

On December 7, 1998, the Federal Reserve Board in Washington, along with the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision, asked for public comment on proposed "Know Your Customer" ("KYC") regulations. The interagency proposals precisely followed the FATF's agenda and were ostensibly designed to fight money laundering and other financial crimes, seemingly reasonable goals. Instead the Fed and other regulators found themselves buried in an avalanche of negative public comments, in part orchestrated by several libertarian groups in Washington led by the Center for Freedom & Prosperity (http://www.freedomandprosperity.org). Texas Representative Ron Paul, a nominal Republican who is among a handful of members who actually questions government intrusions into individual privacy, led the counter attack on Capitol Hill.

Criticizing the proposed rule, House Judiciary Commercial and Administrative Law Subcommittee Chairman George W. Gekas (R-Penn.) said the Federal Reserve, the nation's primary bank regulator, was effectively trying to impose through regulatory fiat the Money Laundering Deterrence Act of 1998, which called for the issuance of draconian KYC regulations. Gegas complained that regulators were trying to outstrip their legal authority and usurp the role of Congress. The legislation passed the House in October 1998, but died in the Senate, in large part because Banking Committee Chairman Phil Gramm flatly opposed the measure. "We didn't even have to see Gramm," recalled one bank lobbyist. "KYC is dead on the Hill so long as Gramm is Chairman."

But unbeknownst to KYC opponents, regulators are unilaterally seeking to make banks and other financial institutions act more aggressively to ascertain the origins of a client's wealth and business relationships, effectively turning your banker or stockbroker into a full-time policeman. "These new rules are coming from Washington and reflect a lack of understanding of the banking business," grouses the representative of half a dozen money center and regional banks. "The Fed people think you can ask customers for excessive amounts of information and not kill our business, but they are badly mistaken."

While the legislation failed and the proposed regulations were subsequently defeated, federal regulators began almost immediately to impose European-style standards on U.S. commercial banks. Under the rubric of "enhanced due diligence," bank examiners from the Fed and other agencies are compelling U.S. banks to greatly enhance scrutiny of customer activities.

Lobbyists for several bankers tell TIE off-the-record that Federal Reserve examiners operating from the Miami branch of the Atlanta Federal Reserve Bank are meeting privately with bankers to force adoption of new diligence procedures that effectively discriminate against new customers based on race and national origin, a type of illegal screening in fact used by many U.S. police organizations in anti-drug operations. "The Fed personnel don't put this in writing, but we have been told to target Nigerians and Latin grocers," complains one banker's lawyer. "To do so is a violation of federal anti-discrimination laws."

The Miami-based effort is reportedly directed by Federal Reserve Board Governor Laurence H. Meyer, a brilliant economist with a monetarist bent but who, like all current Fed governors, has no experience managing banks. Indeed, Fed Chairman Paul Volcker (1979-87) was one of the last governors with operating experience as a banker. At a meeting in January, when one southern banker challenged Fed examiners about the legality of the new "enhanced due diligence" standards and the striking similarity to the failed KYC legislation, a senior Fed official reportedly responded that that the new guidelines "are Know Your Customer." However Richard Small, Assistant Director of the Fed's Division of Banking Supervision and Regulation, flatly denies the existence of a special group of examiners in Miami operating under Washington's direct control.

A letter opposing KYC legislation sent to members of Congress by the Texas Bankers Association stated: "Texas banks already labor under very costly burdens in the production of currency transaction reports (CTRs) and suspicious activity reports (SARs). Last year the U.S. banking industry prepared 12.5 million CTRs for the Treasury Department. Over one million came from Texas. Although these reports take up a great deal of bank employee time, they result in very few prosecutions. H.R. 3886 would allow the Treasury Department to target any area of the country and add an additional layer of reporting requirements. The bill would also require banks to verify the true beneficiaries of their loan and deposit accounts. This will be perceived by bank customers as an invasion of their privacy."

Despite opposition from Senate Banking Committee Chairman Phil Gramm (R-Tex.) and most Republicans in both houses of Congress, the Treasury, Fed, and FDIC are apparently imposing KYC de facto "guidance" on banks and other financial institutions. As the Federal Reserve said in its March 19, 1999 notice withdrawing the KYC rule: "Notwithstanding this withdrawal recommendation, Federal Reserve staff will continue to participate in the government's programs designed to attack the laundering of proceeds of illegal activities through the nation's financial institutions, and to assist banking organizations meet their current obligations under existing federal anti-money laundering statutes and regulations, including the Bank Secrecy Act."

This aggressive behavior by U.S. regulators stems from several issues, including tax evasion, anti-narcotics activities, and national security concerns. The OECD countries, led by such positivist police states as France and the UK, are frequently blamed for the rise of KYC by pushing their policy against "tax competition" at the expense of the low or no tax states, especially offshore money havens but also including the United States. Washington's efforts to stem narcotics activities are another reason for the big push behind KYC, as illustrated by the report issued on Argentina earlier this year. A November 9, 1999 report, "Private Banking and Money Laundering: A Case Study of Opportunities and Vulnerabilities," also prepared by the Democratic staff of the Senate PSI, detailed how Raul Salinas employed Citibank's private banking department to launder over $240 million into Swiss accounts. The Fed and other regulators were badly embarrassed by these scandals, but significantly, the United States never prosecuted Raul Salinas or the officials of Citibank who the PSI identified as being actively involved in the Salinas money laundering activities.

The third pressing concern is the link between international terrorism and money laundering. For example, U.S. officials say the 1991 collapse of the Bank of Credit and Commerce International placed a great financial strain on Saudi millionaire Osama bin Laden's terrorist network, depriving it of its main source of funding. Under the rubric of fighting terrorism and other evils, the U.S. government is now engaged in a range of domestic surveillance activities from monitoring email to watching for "suspicious" financial activities. Agencies such as the Financial Crimes Enforcement Network (FINCEN) act as aggregators of information from dozens of law enforcement agencies, creating a pool of information which, in the wrong hands, could be used as a mechanism of control of the type predicted by George Orwell in his book, 1984.

Senator Levin, the ranking Democrat on the PSI, has been the driving force behind congressional interest in money laundering and legislative proposals to increase government surveillance of U.S. banks. His enthusiasm for added government surveillance of the financial marketplace is not shared by Senate Republicans, however.

"Given the intricate nature of the schemes criminals use to launder money, there are obviously practical limitations upon the intensity of scrutiny that U.S. banks can give to the customers of their correspondent banking clients, or to any particular link in a chain of `nested' correspondent accounts," said Senator Susan Collins, the ranking Republican on the PSI. "A requirement that U.S. banks thoroughly investigate the business dealings of each and every customer of a correspondent banking client--their customer's customers--might well prove burdensome and impractical, doing more harm to the financial industry than good in preventing money laundering."

The managing partner of a large hedge fund in New York that specializes in trade finance arbitrage says that the reporting and due-diligence requirements being imposed on banks, especially foreign banks, have greatly increased the lead-time necessary for transactions. "It now takes weeks for us to get new counter-party approvals from some banks. This means that the time between when we identify an opportunity to the close of the transaction has been increased ten-fold and frequently results in the transaction being missed."

One senior Democratic staffer tells TIE that federal bank regulators are doing more harm than good, and are effectively attacking the over-the-counter markets in bearer securities, commodities, and other private assets. "What the regulators are doing is gradually bringing an end to negotiability of private financial assets. In technology parlance, if you don't have a static address on the global financial network, you will not be allowed to do business in the United States or with a U.S. financial institution." A Senate aide says that, as yet, no bankers have directly approached Senator Gramm or the other relevant members of Congress to discuss the stealth process to impose KYC rules on banks without Congressional authority or legally mandated public comment.

So far, the only Congressional reaction against KYC is visible in the battle being fought regarding the OECD's policy of attacking the bank secrecy laws of any nation that has lower taxes than the authoritarian states of Europe. Three additional influential U.S. lawmakers, including Senator Wayne Allard (R-Colo.), who serves on the Budget Committee and the Banking Committee, have asked Secretary O'Neill to reject the OECD's so-called "harmful tax competition" project.

Jack Kemp, former Republican Vice Presidential candidate and a leading tax reform advocate, likewise has asked Secretary O'Neill to put U.S. taxpayers first and dump the OECD's misguided tax competition project. Kemp notes: "Our tax rates and the overall tax burden may be high, but they are significantly lower than tax rates and tax burdens of other industrialized nations. Combined with our favorable tax treatment of foreign investors, the OECD has deemed the United States a menacing `tax haven,' which is not only inaccurate but insulting."

All of this is fine, but members of Congress may need to directly deliver the same message to Federal Reserve Chairman Alan Greenspan and his colleagues on the Federal Reserve Board.