Today there seems to be a broad consensus that a complex financial investigation followed by seizure of illegal assets is the most powerful tool both to control crime and, increasingly, to preempt terror. Such a strategy has led to: the creation of an unprecedented new class of offenses; the conscription of the private financial sector in a way previously unknown even in wartime; a rollback of traditional legal protections combined with a de facto reduction in the burden of proof; a sharp shift in law enforcement priorities towards the money trail; and the introduction of a new complication in international relations. Yet these remarkable initiatives are hardly the product of careful consideration of the nature of a threat and possible responses. Rather they emerged in the 1980s in an atmosphere of inflated fears and exaggerated expectations, and have resulted in a cumbersome, costly, and increasingly intrusive regulatory framework which lacks any defensible criteria by which its success (or failure) can be judged.

The Logic of the Strategy

The U.S. was the first to implement a (more or less) coherent follow-the-money strategy, and remains the sole country with the financial and political muscle to impose some uniformity of standards abroad. The American model is built on five pillars.¹

One is a new crime called money-laundering which makes a set of acts that are in themselves harmless (like opening an offshore account or wiring some money abroad) major crimes if committed by one group of citizens but perfectly legitimate if committed by another, and elevates to the status of serious offenses what were previously seen as minor regulatory infractions (like failure to fill out a form).

Second is a new set of reporting requirements whose purpose is not to help the government protect the solvency and liquidity of the financial system or to achieve macro-economic stability, the roles played by traditional financial monitoring, but to feed information about the citizenry on an on-going basis from the financial sector to law enforcement and, increasingly, to the national security apparatus.

Third, using these new regulations, police and prosecutors prioritize efforts to find, freeze, and forfeit something known as the “proceeds of crime,” a slippery concept capable of multiple interpretations, aided by a progressive loosening of the legal grounds (from criminal to civil to sometimes merely administrative) on which such “criminal assets” get forfeited to the state or its agencies.²

Fourth, in the U.S. “proceeds-of-crime” go to the police forces that do the grabbing, threatening to turn them into self-financing bounty-hunting organizations. In that respect, fortunately, few places have yet followed the American lead.

Fifth, because of progressive liberalization of world financial flows, to work internationally the model demands, if not full homogenization, at least substantial coordination of regulations among countries.

These five features combined have produced a veritable revolution in criminal justice methods. Of course, there is nothing new about financial investigations or even the forfeiting by court order of illegally obtained wealth. However, traditional financial investigations were reactive—a property crime was reported and the police got on the trail. Success or failure was judged on a case-by-case basis. The target was usually predatory offenses, involving fraudulent or forcible redistribution of wealth. And the purpose of an investigation was to seek evidence against perpetrators and to make restitution to victims. By contrast, with a modern follow-the-money strategy, investigations are often proactive. Justice bureaucrats articulate objectives with respect to the criminal economy as a whole. The target is mainly market-based crimes involving consensual exchanges between suppliers and customers. The immediate target is income earned in criminal transactions, not stolen property. Since there are no direct victims to whom restitution is due, seized wealth goes to the state or its agencies. And the ultimate purpose is to deter perpetrators. Taking away the money supposedly removes both the motive (profit) for crimes and the means (criminal capital) with which to commit them. To this is sometimes added that it prevents criminals from using proceeds-of-crime to infiltrate the legal economy.

The Strategy in Action

The operational core of the strategy is a profound shift in the relations of “banker,” client, and police. In the past the police seemed convinced that the typical manager of financial assets and his/her client operated furtively on one side of a brick wall with the police shut out on the other. However in correcting a situation which may occasionally have gone overboard in terms of financial privacy, the pendulum has swung back so far that now it is more like police and banker forming a secret cabal (albeit with the banker often a reluctant participant) leaving the client on the far side of that wall with little or no prospect of a court-ordered window drilled through it. This has occurred because of differences in how various financial-reporting procedures operate.

A Currency Transaction Report (CTR) is automatically required when a deposit or withdrawal of monetary instruments reaches a mandated threshold; the banker asks the client for predetermined information; and the client is fully informed. Thus, whatever its other faults, the process is reasonably objective; and the banker’s role is passive, simply a conduit for information flowing from client to authorities.

However a Suspicious Transaction (or Activity) Report results not from an exogenously determined limit, but from something in the transaction or transactor which appears suspicious to bank personnel. Here the bank is reactive; the information is strictly subjective; and the client is uninformed. Indeed the institution and its staff can land in serious legal trouble if they alert the client.

With Know-Your-Client (KYC) rules, the financial institution becomes proactive, seeking information about the client prior to any transaction with the client again remaining in the dark. In effect the role of the institution is no longer that of a conduit, or even of a police informant, but of a private detective agency, a role which few institutions either wish or are competent to fulfill.

Financial institutions cooperate because failure to do so can bring civil penalties (fines and forfeitures), criminal charges against the institution and/or its personnel, or a major money-laundering scandal leading to a flight of clients, private lawsuits, or the collapse of share prices.

The “Reason” Why

To understand how the criminal justice system got its hands on such a blunt weapon, it is necessary to recall six erroneous or exaggerated beliefs prevalent in the 1980s.

First, reputedly enormous sums were generated by crime. Country after country reported burgeoning underground economies, sometimes exceeding legal GNP. The world’s drug trade was alleged to be turning over $500 billion annually. The fortune of a notorious gangster like Pablo Escobar was pinpointed by police intelligence at somewhere in the $2-14 billion range. And so forth. Such numbers, based mainly on hype and hysteria, quickly became facts-by-repetition, while much more modest ones derived from more defensible methodologies were pointedly ignored.

Second, the threat posed by such sums was presumed all the greater because they were under the control of great “cartels”—large, durable and hierarchically structured transnationals of crime. No doubt occasionally in places lacking effective policing and burdened with corrupt judiciaries and/or complicit politicians, this model might have some relevance. But in most western countries, it was (is) absurd. Even if a big, hierarchically controlled “organization” emerges from time to time, it is highly visible, and police forces target it on a priority basis. In reality economically motivated crimes are largely the work of individuals and small groups who engage in arms-length transactions of an opportunistic nature and generate modest profits.

Third came fears (continuing to this day) that such “cartels” plotted to use their huge profits to capture and corrupt the commanding heights of the legal economy. Certainly criminals from time to time seek entry into the legal economy. They may seek long-term security, available only from legitimate income flows; they may wish to make bequests to biological rather than to criminological heirs; they may want tax cover for their illegal funds by reporting them as legal; or they may want to apply criminal methods to legal businesses to enhance profits. Only in that last case, and only if it is widespread in key sectors of the legal economy, is there a true emergency. So far such an alarming scenario exists mainly in the minds of alarmist police officers and reporters with overactive imaginations. Certainly ample criminal activity exists within the legal economy; but it is mainly the work of bent insiders. Their objective is not to convert illegal money into apparently legal via the formal financial system, but to convert legal into illegal, then hide it somewhere else—precisely the opposite sequence to that used to rationalize the anti-money laundering regime.

Furthermore “infiltration” of criminal money into the legal economy may not always be such a bad thing. Advocates of the anti-proceeds strategy sometimes cite the pioneering example of Italy’s 1982 Pio La Torre law. Certainly that law tried to prevent illegal money from taking control of legal businesses with a view to enhancing profit by applying criminal methods; it also sought to prevent legally-earned money from investing in the higher returns available in the criminal economy. However, to neutralize the adverse economic impact of criminal money, its main intent was to use the threat of asset seizure not so much to confiscate criminal assets as to frighten illegal money to move from the illegal sector, and from legal businesses functioning illegally, into strictly legal operations. In other words, far from blocking the movement of funds from the illegal to the legal sector, the law hoped to encourage just such a flow with the proviso that the money would subsequently behave legitimately.³

A fifth factor, whispered in private conversations rather than spelled out in formal police reports, was the view that bankers by nature were the devil’s apprentices, an opinion reinforced by widely repeated stories about the misdeeds of Swiss bankers in particular.⁴ If banker and client were so intent on forming a secret partnership against the probes of the law enforcement apparatus, it seemed to make sense to have an independent source of data, for example, via a flow of mandatory reports on client activities. But if bankers were normal members of civil society, some upstanding, some dodgy, most simply trying to stay out of trouble, the logic faltered.

Finally at work were corporate-cum-political agendas. American banks were fully aware that if they were precluded from offering as much client confidentiality as their main (British and Swiss) competitors, they might lose business handling the assets of what they euphemistically called the “high net-worth individual.” No doubt the U.S. Treasury was also worried about spooking foreign clients who had been so eager to plant their savings, legal and illegal, in American stocks and U.S. government treasury bills, helping to finance both the budget and visible-trade deficits. The solution was articulated by presidential hopeful, Senator John Kerry. “If our banks,” he said, “are required to adhere to a standard, including offshore, and other banks do not and rush for deposits in those U.S. banks, we will once again have taken a step that will have disadvantaged our economic structure and institutions relative to those against whom we must compete in the marketplace.” Hence the effort to impose the same level of reporting requirements on foreign banks who wanted either to do business in the U.S. or to use the American-controlled international clearing system.

Does It Actually Work?

Finding the numerator of the first, the asset ratio, seems simple enough. Every year the Justice apparatus reports total seized assets. But that data may include materials with innocent co-owners. The authorities might also toss in things like “instrumentalities” of crime (cars, houses, boats, planes etc.) which have nothing to do with the proceeds therefrom, could also be of innocent origin, and in practice could have little or no real functional relationship to the offense. The figures, too, may lump together assets seized under criminal criteria with those seized under civil criteria—common sense suggests they be treated differently. Most egregiously, such data tend to conflate two quite different concepts—the assets of criminals and criminal assets—ignoring the fact that people designated as criminals, too, are capable of holding down a day job and may well have been the beneficiary of the recent demise of a well-to-do maiden aunt. And of course the relevant starting point ought to be assets ultimately adjudicated by courts not those loftily proclaimed in press releases issued by police or prosecutors.

Certainly the numbers reported on the total were alarming. In the U.S. they ran as high as 35% on top of official GNP (or, as is more common today, GDP). Even more alarming figures appeared elsewhere in the world.⁶ What was rarely reported along with the numbers is how they were calculated. Some were based on (highly questionable) surveys to find a hidden labor force. Some were based on (unwarranted) extrapolations from (seriously limited) tax data. Some tried to turn technical indicators (like electricity use) into estimators, a huge stretch. Some were built on a (logically and statistically) problematic notion of a measurable discrepancy between national income and national expenditure. Most popular were techniques based on monetary aggregates that were so flawed as to produce a veritable growth industry just devoted to debating and disputing their results.⁷

Furthermore to figure out how much is actually criminal is complicated because not all economically-motivated crimes are actually part of the underground economy. Predatory crimes involve the fraudulent or forcible redistribution of existing wealth rather than the creation of new incomes. Hence they are neutral with respect to GNP or GDP. Some crimes are commercial in nature, involving business enterprises as perpetrators and/or victims of other businesses. These redistribute existing income flows rather than creating new ones. The only crimes that matter for GNP calculations are market-based crimes which involve the generation of new income flows. But even here there is a fundamental problem.⁸

There is only one sensible conclusion. Although this or that component of hidden economic activity may be estimated from time to time with some degree of accuracy, no one has any idea how big the aggregate underground economy is, or, for that matter, what percentage is actually criminal. Hence there is no basis on which to calculate the ratio of criminal to total income, or the ratio of seized to total criminal assets. Therefore there is no way of knowing whether a follow-the-money strategy can ever work.

The Problem of “Collateral Damage”

On the other hand, there is ample proof of social costs. Far from being aberrant, and therefore correctable to make the strategy work better, offenses against natural justice and common sense are built into the inherent logic of each of the five key components of the American model, the one that has been widely, if not completely, imitated and/or imposed around the world.

First, the new crime of money-laundering has not only elevated regulatory infractions to the status of high crimes but has so distorted natural justice that today handling the money ostensibly generated by a crime can lead to much tougher sentences than the underlying offense. Furthermore the law is unnecessary. Existing legal concepts of aiding and abetting or accessory-after-the-fact or even criminal conspiracy could do at least part of the job. Or the underlying offenses could be rewritten to make handling the money part of the primary crime. A stand-alone offense called money laundering makes as much sense as would a crime called driving-the-get-away-car for bank robbery cases.

Second, this new crime has rationalized a regulatory apparatus that has turned the domestic, and increasingly the international, financial system into a global espionage apparatus. It puts financial institutions in a position of conflict of interest between their responsibilities to clients and shareholders and their duties to police and national security agencies. It produces a self-defeating deluge of information, particularly with the CTR. It puts a premium on rumor, bias, and stereotype, especially with the STR. And it tries to convert financial managers into private detectives, as with modern KYC rules. (A KYC rule was originally supposed to help to protect an institution, for example against potential fraud by clients—now its main intent is to protect “society,” a dramatic and not very well-considered shift of mandates.) The resulting information passes through the financial institution’s internal hierarchy before being sent to some government bureaucracy, which sifts through it then, in turn, passes tidbits on to the fiscal authorities, police forces, or national security agencies, a remarkably indirect and cumbersome method of generating usable information. To work, it must also be broad and indiscriminate. Yet if the citizenry at large are really as inclined to violate law as such a sweeping reporting regime seems to imply, the state has a much greater problem than the criminal justice system is likely to be able ever to resolve.

Fourth, in the U.S. (with police in other jurisdictions agitating for like treatment), seized assets go to police forces. This puts a premium on cultivation of paid informants, detaches police budgets from real logistical needs, subverts community control, shifts attention from violent to wealthy offenders, and leads to (amply documented) instances of police corruption.

Fifth, to function, the model has to be imposed on the rest of the world even though legal traditions, institutional capacities, and social priorities may be radically different. And all this with no proof that the strategy can actually achieve its goals.

If there is no credible basis for optimism about the policy with respect to crime control, how much more foolish to depend upon it for terror control. The logic of deterrence presumed in the follow-the-money fad is three fold—removing the money takes away the motive for crimes, the means to commit them, and the financial capacity to infiltrate the legal economy. Yet with terrorism, clearly money is not a motive; nor do terrorists have ambitions to take over (as opposed to occasionally bringing down) the commanding heights of the legal economy. All that remains is the means argument—which fails in the face of reality. In case after case around the world, horrendous acts have not required humongous sums. Ultimately the key asset for terrorist acts is determination which cannot be frozen in a bank account.¹⁰

More than Reasonable Doubt?

Some will claim that there is no viable alternative. But presumably it ought first to be genuinely proven that a dramatic policy change was actually necessary. Even if the case can be made for special measures, in recent times various countries, prior to being bullied or bribed into following the American lead, experimented with radically different policies to deal with the problem of “black money” in terms of their own priorities.

Some issued state bearer-bonds to make underground money temporarily available for budgetary finance. Some used tax and cash-deposit amnesties to increase fiscal resources or bank liquidity. Some employed capital-flight amnesties to bring home offshore nest-eggs to bolster foreign-exchange reserves. Some attempted currency demonetizations to wipe out domestically-held black-market hoards. There are many other examples. Each policy option had flaws: but none were any more egregious than those revealed repeatedly by the current freeze-and-seize approach.¹¹

The flaws in the follow-the-money strategy are apparent; the damage done equally so. However once dramatic new directions in law and policy are undertaken, very quickly vested interests build up to maintain them, along with entrenched attitudes based on popular fable which are extremely difficult to dislodge. Particularly disturbing is the recent renewal of a moral panic atmosphere. If much of the original pretext for the strategy was the image of the mustachioed Colombian narco-baron reclining in a gold-plated bathtub lighting Havana cigars with hundred dollar bills while plotting to turn western youth into dope-crazed anarchists, it has now shifted to the bearded Islamic financier-of-terror hiding in a cave in Waziristan while wiring money from his Swiss bank accounts to finance the downfall of Judaeo-Christian Civilization. Today the target is no longer the consequences of something that had happened—i.e., money (however exaggerated the sum) earned from peddling drugs or committing other crimes. Now the objective is to prevent something which might possibly happen in the future. If nothing happens, supporters of the strategy can claim credit for preventing it; if something does happen (and by waiting long enough or engaging in sufficient provocative acts, something probably will), they can claim not that the previous strategy was fatally flawed, but that its laws and penalties were not strong enough.

R.T. Naylor is a professor of economics at McGill University in Montreal, Canada. His books include among others Hot Money and the Politics of Debt, Satanic Purses: Money, Myth and Misinformation in the War on Terror, and Wages of Crime.

Notes

1. For an in-depth dissection, see R. T. Naylor, Wages of Crime: Black Markets, Illegal Finance and the Underworld Economy (Ithaca NY: 2004) Chap. IV.
2. On the controversy over the spread of civil forfeiture in the U.S. see, for example, Leonard Levy, A License to Steal: the Forfeiture of Property (Chapel Hill: 1996).
3. This was explained by Pino Arlacchi, intellectual author of the law, in “Effects of the new anti-mafia law on the proceeds of crime and the Italian economy” Bulletin on Narcotics XXXVI, No. 4, 1984.
4. See, for example, R. T. Naylor, Hot Money and the Politics of Debt (New York and London, 1985, 1986, reissued Montreal 2006).
5. On these issues see R. T. Naylor, “The Rise and Fall of the Underground Economy” Brown Journal of World Affairs XI Issue 2 2005 and R. T. Naylor “The Underground Economy: A Ruse by Any Other Name” Challenge: the Magazine of Economic Affairs 48 No. 6 Nov.-Dec. 2005.
6. In Germany they were in the 15-30% range; in India 35-50%; in Taiwan 25-45%; in Pakistan 20-50%. In Brazil the estimates started at 7% in the early 1980s and shot all the way up to more than 100% by the early 1990s. Mexico in the 1980s saw its underground economy supposedly treble while the legal one registered virtually no net growth. Argentina’s underground economy in the same decade was reckoned to be rising at double the rate of the measured one.
7. See for example the critique by Richard Porter and Amanda Bayer, “Monetary Perspectives on Underground Activity in the United States” in Edgar Feige (ed.) Underground Economies: Tax Evasion and Information Distortion (Cambridge: 1989).
8. Commercial crimes may have indirect effects raising or lowering GNP. But since it is impossible to say a priori whether they do or do not, and since they all take place within a normal business context, it is safer to assume they, too, have no impact on GNP, measured or covert. On this see R.T. Naylor, “Towards a General Theory of Profit-Driven Crime” British Journal of Criminology 43, 2003.
9. On the continued scope for abuse, see Brant Hadaway” Executive Privateers” University of Miami Law Review Vol. 55. No. 1, Oct. 2000.
10. This is the main theme of R. T. Naylor, Satanic Purses: Money, Myth and Misinformation in the War on Terror (Montreal: McGill-Queen’s University Press, 2006).
11. For a survey of these see R.T. Naylor “From underworld to underground: Enterprise crime, ‘informal sector’ business and the public policy response” Crime, Law & Social Change 24, 1996.