Reflections on Anti–Money Laundering

I want to thank EY and Steve Beattie for the invitation to make some introductory remarks at this symposium on anti–money laundering and financial crimes compliance.

I will reflect on my intersections with anti–money laundering (AML) during my government and post-government career over the past four decades. I will point to a few lessons along the way.

My takeaway lesson is that a lot has changed over the past 40 years. Progress has been made in developing a reasonably consistent and comprehensive global regime to combat money laundering and the financing of terrorism—the global AML regime for short. But more attention should have been paid to what works and what does not work in using the regime to reduce the incidence of the underlying crimes. The focus of enforcement is more on gotcha mistakes by institutions covered in implementing the regime than on using it for the purposes for which it was intended. The community of the regulated should take more initiative than they appear to have to date to encourage senior policymakers to pull back the stormtroopers and to give greater attention to the basic objectives of the AML regime.

I am conscious of the fact that I am delivering these reflections five days after the tragedy in Orlando, Florida. That horrific attack again focused national attention on terrorism—one of the predicate activities addressed by the global AML regime. As best we know no financial transactions, other than purchases of guns and ammunition, were involved in this case. Nevertheless, public opinion and the authorities understandably will now reexamine policies and attitudes including toward privacy and responsibility—issues with which the global AML regime has wrestled repeatedly. The apparent absence of a connection between the financial system and the Orlando shooter also is a reminder that the global AML regime is principally an imperfect means to the end of detecting and deterring the underlying, or predicate, crimes.

Turning to my first indirect encounter with the topic of this symposium, in the mid-1970s, Senator Frank Church held a series of hearings on international bribery by US corporations. The hearings took place in the context of the Watergate scandals. They led to the passage of the Foreign Corrupt Practices Act (FCPA) of 1977. The FCPA was criticized then, as it is now, as an exercise in US extraterritoriality and as an impediment to US businesses.

The FCPA was an exercise in US extraterritoriality, but viewed with the benefit of hindsight it also demonstrated US leadership. We used our power and influence to raise international awareness and standards. It took a while. The Anti-Bribery Convention of the Organization for Economic Cooperation and Development (OECD) came into force only 20 years later. The convention, in turn, was slowly implemented by some of the original signatories. For example, the implementing legislation in the United Kingdom only entered into force in February 2002, in the wake of the 9/11 attacks in the United States.

A parallel interest of Senator Church to the topic of international bribery was the international activities of US banks. In the wake of the collapse of the Bretton Woods regime of fixed exchange rates, the oil crises, and the temporary build-up of so-called petrodollars, and financial crises in countries like the United Kingdom and Mexico, Church was critical of the fact that US bank supervisors did not have complete information on the international activities of US banks. This concern provoked the US supervisors to initiate the country exposure lending survey of US banking organizations. Today the surveys compile exposures from banking offices abroad as well as in the United States to a variety of clients, such as banks, governments, nonbank financial institutions, and corporate and other borrowers. Previously available information on international lending by banks was based on their geographic residence and was assembled largely for purposes of compiling balance of payments statistics and enforcing capital controls.

I was marginally involved in designing this initiative. I was more involved in subsequent years in persuading other jurisdictions to cooperate via the Bank for International Settlements (BIS) in expanding the collection of global banking and other financial statistics on this consolidated basis.

What I learned was how stubborn government statisticians can be. More important, I learned the importance of good data for good policy. When Korea experiences a financial crisis, one would like to know total US exposures to various Korean borrowers, including Korean banks located outside of Korea. But one would also like to know the extent of the exposures of financial institutions of other countries that may be affected by the crisis.

My second encounter with the broad topic of anti–money laundering was in late 1986 or early 1987. The 1986 US Money Laundering Control Act (MLCA) made money laundering a crime in the United States. The Congress recognized that money laundering is a global phenomenon that does not respect borders. Dealing effectively with the phenomenon requires international cooperation to address the practices, to reduce regulatory arbitrage, and to produce a level playing field for financial institutions. Consequently, the MLCA required the Federal Reserve to consult with other G-10 central banks on the AML measures applied in their jurisdictions and to frame a common approach.

I accompanied Paul Volcker, then chair of the Federal Reserve Board, to a meeting of the governors of the central banks of the G-10 at the BIS at which he raised this issue. The initial reaction was horror. The view of other governors was that banking supervision and regulation was about the safety and soundness of individual institutions and not about law enforcement, which should be left to the police and judiciary. Fortunately, calmer heads prevailed and the Basel Committee on Banking Supervision in 1988 issued guidance about the obligations of banks to know their customers, avoid certain transactions, and cooperate with the law enforcement authorities.

The lesson that I took from this experience was that national supervision and law enforcement cultures differ in many respects. This fact poses a challenge to the establishment of a common set of standards and practices and in ensuring consistent compliance with those standards.

The same issue of the intersection of law enforcement with global standards arose a decade later when, in the wake of the Asian financial crises, the International Monetary Fund (IMF) and various other organizations were encouraged to promulgate and assess compliance with important internationally agreed standards and codes. The Financial Action Task Force's 40 recommendations on national AML regimes were included on the IMF's list of 12 major standards and codes that would be subject to review under the IMF's Financial Sector Assessment Program (FSAP).

However, IMF staff were not to be involved in reporting any criminal activities uncovered during such reviews—the IMF is not a law enforcement organization. A case can be made that a financial institution's direct or indirect connection with criminal activities poses a threat to its financial stability and potentially to the stability of the financial system as a whole. That case is broadly accepted today, but when I made that case in our 2004 book on money laundering, my coauthor Peter Reuter said that I was making a stretch.

Returning to the mid-1990s, in the aftermath of its financial crisis, the Mexican government relaxed its restriction that foreign banks could not own the largest Mexican banks. Several banks were bought by foreign banks. One of those Mexican banks also had US offices. However, for US regulatory purposes the change in control had to be approved by the Federal Reserve Board. Prior to that approval, an AML examination was required. However, other elements in the US government asked that the Federal Reserve not do so at the time. It developed that the reason for the delay was preparations for the infamous Casablanca sting operation—the entrapment in May 1998 of 26 Mexican bankers and three Mexican banks laundering money.

About six months before the trap was sprung, the head of banking supervision and the general counsel at the Federal Reserve Board explained to me why the takeover was delayed and outlined the potentially explosive nature of the Casablanca operation. The morning of the operation the head of banking supervision called me because he was concerned that the indictments would be announced at noon Pacific Time in order to make the evening news. The US offices of one of the banks would still be open, and his concern was that there could be a run.

I called Tim Geithner who was then Assistant Secretary for International Affairs at the Treasury to ask him to warn his colleagues and plead for a delay in the announcement. He and the rest of the international staff at Treasury knew nothing about the operation. It had been treated as very "close hold" by Secretary Rubin and the enforcement people at Treasury. Tim did reach the enforcement people. He was unable to persuade them or Secretary Rubin to change the timing of the announcement. Fortunately there was no run on the bank.

The lesson for me was that in international enforcement cases one should bring in sufficient senior people on the policy or substance side of the house or houses as a check on what is planned. Doing so in this case probably would also have saved considerable embarrassment in US relations with our NAFTA partner.

Later in 1998, I replaced Tim Geithner as Assistant Secretary when he moved up to be Under Secretary. As I already commented, in the wake of the Asian financial crises in the late 1990s, the focus of international financial cooperation turned to the prevention of such crises, in particular crises that affected banking and financial systems. This led to the establishment of a number of international standards, the encouragement of countries around the world to adopt them, and the enticement of organizations like the IMF to monitor progress in their adoption.

In 1998, the US Congress also passed the National Money Laundering and Financial Crimes Act. It mandated that the US Treasury transmit to the Congress an annual National Money Laundering Strategy (NMLS). I was a participant in this activity. (We were amused that what was mandated was a money laundering strategy rather than an ANTI-money laundering strategy.)

During this period, a number of foreign countries went through political crises and changes in government. In several cases, the new people in power wanted to gain access to assets that allegedly had been stolen or otherwise misappropriated by the kleptocrats in the previous government. They asked the United States as well as other countries for help. Requests to the US government might be addressed to the President, the Secretaries of State or Treasury, the Attorney General, or some combination. The challenge was that not only did we not have much in the way of legal authority to identify or freeze such assets, in particular where the request contained no specifics, but also we did not have an interagency procedure to respond punctually to requests for help. Consequently, replies were delayed and the relevant parts of the government were not always in sync on their content. My memory is that the reply to Indonesia took more than three months to get out, and some replies took a year or more. Therefore, as part of the 1999 NMLS we set the goal of creating a system to deal with these requests. We were eventually successful. The lesson for me was that interagency cooperation is complex even on such a simple issue.

It would be a bit of a stretch to say that the Stolen Asset Recovery (StAR) Initiative by the World Bank and United Nations was an outgrowth of our exercise, but I think that we were responding, relatively early, to similar pressures.

The basic problems are two: First, different countries have different legal procedures. Second, what constitutes a "stolen" asset differs in different legal systems. Nevertheless, it is fair to say that kleptocrats today have a more difficult time hiding their booty.

After I joined the Peterson Institute for International Economics (PIIE) in 2001, we were approached by the late Rod Hills to study money laundering. He raised some money to support this initiative. The topic was linked to Rod's concern with public corruption, but he also felt that these issues had received less attention from economists than they deserved. I drafted Peter Reuter into collaborating on this study because he was also a Yale-trained economist and I knew of his work on illegal markets. On our project, he was the money launderer and I was the money laundering controller.

Somewhat to our surprise, the book that Peter and I produced, Chasing Dirty Money, a title suggested by our research assistant, has become a relative best seller—more than 5,500 copies. About a year after the book came out, I observed to our publications director that I was surprised that Chasing Dirty Money had sold more copies than my first book on inflation targeting. He informed me that there are more bankers than central bankers in the world. The high point of my career as a think-tanker came a few years later when someone called me and asked if I wanted to work with him in turning our book into a movie. I said no, as did Peter.

In our book, we argued that the implicit economic model underlying the AML regime is flawed. It is based on a hypothetical market for AML services provided principally by specialists in these services. The objective is to drive up the price of these services and, thereby, to reduce the demand for them and the incidence of the underlying crimes. The evidence suggests that any increase in price is small relative to the amounts of money involved—the upward shift in the supply curve was not large—and the demand for money-laundering services was not very responsive to price; it was inelastic in econ-speak. An alternative model is to follow the money. It has been used in some cases of terrorism financing.

When we started our project, Peter said that he would refuse to include in our conclusions any recommendations for an agenda for further research. He was disappointed.

We were distressed, however, to learn that there are few useful data in this area and, more importantly, the limited exploitation of data that could be assembled in order to determine what worked and what did not work in using the AML regime to combat the diverse underlying crimes that give rise to the returns being laundered.

Consequently, the last two paragraphs of our introduction read:

Finally, the global AML regime needs to be strengthened through development of a systematic research program using economic tools, starting with more sophisticated assessment of the costs of the AML regime. Other important research-related activities include creating a database of existing cases that provides a detailed description of the prices, methods, and predicate crimes involved. This would represent a first step toward analyzing the existence and mechanics of the market for money-laundering services. The market-model framework for money laundering needs to be better developed; of particular importance is whether the model can incorporate more opportunistic modes of converting the proceeds of crime into forms that cannot be traced.

Scholars are inclined to emphasize the importance of research, but in the case of money laundering and finding ways to combat it, the need for greater research is particularly acute. The fact is that, to date, an elaborate system of laws and regulations that affects the lives of millions of people and imposes several billion dollars in costs annually on the American public has been based to a substantial degree on untested assumptions that do not look particularly plausible. While the failure to evaluate systematically the AML regime has not as yet impeded its expansion either in the United States or elsewhere, at some stage it should and most likely will. The system needs careful examination before any further expansion is actively contemplated.

In our conclusions and recommendations, we (1) did lay out a research agenda; (2) called for more attention to the actual implementation of the global AML regime and to the assessment of its effectiveness; (3) said there was a need for increased public-private cooperation; (4) stressed the importance of reciprocal international cooperation and paying attention to the costs imposed by AML regimes; and (5) listed five steps the United States should take largely to reinforce its leadership in combating money laundering and the financing of terrorism.

Where are we today? I am not qualified to report in great detail on progress or lack of it in these five areas. I try to keep myself informed about developments in the global AML regime, but over the past decade I have not done additional, in-depth research. With that qualification, I conclude with some observations about progress or lack of it in each of our five areas.

First, I confirmed with Peter, who has continued to work on this and related topics, that our forecast that a lack of research into what works and why would in due course impede the further expansion of the global AML regime has proved to be incorrect.¹ The regime has expanded in complexity, but the quality and quantity of supporting research has been less than spectacular or supporting. But like all good forecasters, we did say what but did not when.

Second, with respect to assessing the effectiveness of the global AML regime, progress also has been disappointing. The Financial Action Task Force (FATF) released in 2012 an updated version of its 40 recommendations of International Standards on Combating Money Laundering and the Financing of Terrorism and Proliferation. (I was amused that the FATF was able to incorporate its nine special recommendations on the terrorist financing, which were developed in the wake of the 9/11 attacks, along with nuclear proliferation within the confines of the famous 40 recommendations.)

The FATF will be conducting a fourth round of mutual assessments. These assessments are intended to focus for the first time on the "effectiveness" of each jurisdiction's AML regime as well as its legal and procedural structure. However, those who have read the FATF's paper on the methodology that will be used are skeptical about the quality of the judgments that can be reached.

Third, with respect to public-private cooperation, you who are involved in the compliance arena would know better than I. My impression is that in the United States the government has increasingly co-opted the private sector in its efforts to expand and enforce the US framework for combating money laundering and the financing of terrorism. At the same time, the government has settled some high-profile cases of violations of laws and regulations, including sanctions, by financial institutions.

One can best describe the relationship between government and the private sector in this country as one of love-hate—the public sector loves to enlist the participation of the private sector in tracking down suspicious individuals, activities, and transactions, but the private sector hates the rules and regulations imposed by the public sector, with some considerable reason. On the other side of the public sector, the name of the game for the public sector is to identify flaws in institutions' AML frameworks rather than drawing the private sector fully into the process of detecting and prosecuting those committing the underlying crimes. Policymakers appear to have taken their eyes off the ball. It would be appropriate, in my view, for leaders in the private sector to raise this perverted emphasis with senior policymakers, who rarely get involved except in the headline cases. Perhaps they have, but everyone is very quiet about it.

Tensions persist in two other areas with respect to cooperation with the private sector on a global level.

For one, the monitoring of money laundering and related activities raises privacy issues. The WikiLeaks release of US diplomatic reports in 2010, Edward Snowden's revelations about US wiretapping activities in 2013, and the expanding global dominance of US social media platforms have uncovered again the sharp differences between countries and cultures on privacy matters. These differences lead to disputes about how privacy should be respected, and they adversely affect cooperation on a range of topics involving not only money laundering and related activities but also issues such as trade agreements.

In addition, with the passage of the USA PATRIOT Act in 2001, the US executive branch gained new powers to use the financial system and the international role of the dollar to enforce a range of US sanctions and violations of our AML laws and regulations by foreign financial institutions.

On the one hand, when US sanctions enjoy substantial political sympathy in other countries or where the instances of money laundering are particularly egregious, our aggressiveness in using this unique tool is at least tolerated. On the other hand, the excessive use of this tool, or its use in areas where substantial de facto international support is lacking, could over time blunt the instrument. For example, we are seeing the development by China and Russia of alternative clearing systems. Some of these initiatives are associated with other aspects of the international role of the dollar and the United States, but no doubt they have been accelerated by our exploitation of the dollar's role to achieve political or noneconomic objectives. This is another area where costs and benefits need to be weighed more explicitly by the US official sector.

Fourth, with respect to intensified international cooperation more generally, Peter and I noted the need for technical and financial assistance for low-income countries that the United States and other advanced countries want to enlist in combating money laundering. In many cases involving corruption or kleptocracy, it is in the interests of the country to cooperate. But the authorities do not always have the expertise or technical capacity to do so.

Technical assistance in this area has been forthcoming, though I am sure it has been inadequate to the task. The StAR Initiative of the World Bank and the United Nations, which I mentioned earlier, has focused attention on the recovery of stolen assets and restitutions related to other financial crimes, such as under the FCPA. No doubt the StAR initiative has recorded some successes. It also has produced a database of cases along with a number of reports.

An area that Peter Reuter and I addressed briefly in our study was the costs of implementation of the US AML regime. We made a back-of-the-envelope stab at estimating the cost to the US government, private sector, and general public of the US AML regime in 2003—$7 billion. But we called for systematic work in this area.

Subsequent developments have identified substantial costs of the AML regimes instituted by the advanced countries for many low-income countries. Those costs are relevant to the global agenda for financial inclusion.

For some countries, financial inclusion is running in reverse. De-banking has led to the closing of foreign branches of many banks. De-risking has severed correspondence relationships and increased the cost of remittance transfers.

An underappreciated feature of globalization and the decades of extensive (if controversial) cross-border migration is the fact that families, and indirectly the economies, in many countries of origin rely on remittances. A global objective has been to reduce the cost of remittance transfers; it is an element of one of the United Nations' 17 Sustainable Development Goals.

You may have seen the June 10, 2016, New York Times piece about how tighter US rules have put many US remittance establishments out of business. Friends and former colleagues have quite different perspectives on this topic within the US Treasury. Daniel Glaser, Assistant Treasury Secretary for Terrorist Financing, with whom I worked closely at the Treasury, was quoted as saying that many accounts and institutions have closed or been closed for legitimate reasons related to suspicious activity or lack of controls. He also noted defensively that the volume of remittances to Mexico has increased in recent years. Nathan Sheets, Under Secretary of the Treasury for International Affairs, and a former Federal Reserve colleague, is on record as praising international efforts to reduce the costs of remittances and has stressed that US and Mexican officials are working closely on this topic. I am proud that he also has called for better data and analysis of these issues.

The final area of our recommendations focused on the United States as a leader of the global AML regime.

We argued that in order to help preserve and reinforce that leadership role, the United States should promptly ratify the 2003 UN Convention against Corruption. The United States tends to take the lead in negotiating these agreements and treaties and then fails promptly or ever to ratify them, or to take the necessary legislative steps to implement them. In this case, ratification came two years later in October 2006.

We also said that the United States should set a good example and not hold itself above a review of its own AML regime by the FATF. With respect to reviews of this type, the United States often uses the argument that other jurisdictions are more vulnerable and should be looked at first or more closely. In 2006, the FATF did conduct a peer review of the United States. Our overall rating was "largely compliant" with the 40 recommendations; we were not [fully] compliant, but were better than partially or noncompliant.

The United States was rated as noncompliant with the FATF recommendations on customer due diligence, record keeping, and suspicious activity reports by some nonfinancial businesses such as casinos, accountants, lawyers, and real estate agents. It was also non-compliant with respect to recommendations on identification of beneficial ownerships.

I understand that there has been some progress, if that is the right word, on the issue of the identification of beneficial ownerships with the recent release by the Financial Crimes Enforcement Network (FinCEN) of strengthened due-diligence requirements in this area. My understanding is that those requirements are not up to EU rules in this area. They probably will not receive a full pass at the next FATF review of the United States. I do understand that this is a sensitive issue in some states, and action at the federal level raises "states rights" controversies. I expect, however, that this topic will receive additional public and congressional attention in light of the revelations in the Panama Papers.

Another leadership related recommendation Peter and I made was that the United States should submit itself to the IMF's FSAP review; those reviews cover many aspects of countries' financial systems, but they also cover AML compliance. Here again, the United States was the driving force behind the establishment of the program, but despite my advice while at the Treasury a review was delayed using the familiar argument. This delay was an issue when the global financial crisis hit in 2008. The IMF later acknowledged that an FSAP review of the United States prior to the crisis would not have identified the problems in the US financial system, but the United States received a well-deserved black eye in any case. In 2010 and again in 2015, US reviews were conducted. They now are required of all G-20 members at least every five years.

We also recommended that the Treasury, in cooperation with other agencies, resume the annual National Money Laundering Strategy reports, which had stopped in 2003. One report was issued in 2007. And in 2015 the Treasury published a National Money Laundering Risk Assessment and National Terrorist Financing Risk Assessment. That report f reviews developments since 2006, the cutoff date for the 2007 NMLS. I have not studied it carefully. No doubt it is a useful document. I did notice that the report identifies as risks the two areas of US noncompliance with the FATF recommendations—coverage and beneficial ownerships.

This finding reinforces the lesson that the executive branch needs a crisis to galvanize the Congress into action. Most of the AML provisions of the US PATRIOT Act had been in desk drawers and proposed pieces of legislation for years.

Our last recommendation concerned predicate crimes for violation of money laundering regulations. When we wrote, the United States identified predicate crimes in only 7 of the 20 categories recommended by the FATF. The number has increased to 18, importantly now including foreign corruption, but US law still excludes piracy and insider trading and market manipulation. I am confident that the US official view is that these "crimes" are covered adequately by other provisions of the criminal code.

We also recommended that the United States identify tax evasion as a predicate crime and step up its international cooperation in this area and practice reciprocity. I am sure you are all aware of the increased international attention to the topic of tax evasion. These concerns have led to a somewhat controversial new set of standards developed under the auspices of the OECD on Base Erosion and Profit Shifting and to an associated Standard for Automatic Exchange of Financial Account Information in Tax Matters. The United States, again, was an active participant in the process that developed these initiatives. They were based in part on the US Foreign Account Tax Compliance Act (FACTA), which had itself attracted a lot of international criticism as another exercise in US extraterritoriality.

However, taxes are a controversial topic in the United States. The United States has endorsed the new taxation standards but has not yet implemented the information exchange procedures. Again, we dictate the terms of agreements but too often then go our own way.

The lesson I take from developments since the publication of Chasing Dirty Money in 2004 is that progress is less than we had hoped and wanted, in particular in the area of serious research into what works and why; progress is slow, which I think characterizes the past four decades as a whole as well.

A final note of recent progress is the decision by the European Central Bank (ECB) to stop printing 500 euro notes because the notes facilitate the financing of terrorism and other financial crimes. When I was at the US Treasury, and the euro was being introduced, we urged the Europeans not to issue 500 euro notes on anti–money laundering grounds, including the evasion of taxes. I was, therefore, gratified by the ECB decision. By the way, I would favor phasing out the printing of our $100 bills and similar actions in other jurisdictions.

Thank you for your attention.

Notes

1. See Michael Levi, Peter Reuter, Terence Halliday, 2016, Governance of the Dirty Money Trail: Data Methods and Flaws in Regulation of Anti-Money Laundering (forthcoming).