Feb 23 2011

How tax havens helped deliver financial crisis

Posted by: Nick Shaxson in: Thoughts

In Treasure Islands I wrote a fair bit about this theme of tax havens as roots of the latest financial and economic crisis, most especially in a chapter entitled “Ratchet.” Now I’m going to add some new material, and rely quite heavily on the recent presentation by Andrew Haldane of the Bank of England, which I’ve just blogged.

This blog is a bit longer and more involved than the last one – it does meander around a fair bit, and perhaps gets a bit wonkish in parts – but for those really interested in understanding the roots of crisis, I think it should be worth reading.

As a reminder, here’s a global financial crisis that will have cost the world, according to one of Haldane’s measures, up to US$ 200 trillion.

Take a moment to download his pdf presentation, as the pictures he provides admirably illustrate what he’s talking about.  Haldane starts by describing “a 20 year party in banking” which happened in countries all around the world, and looks at common threads. What struck him was the degree of correlation: “this was a party that was taking place in pretty much every country, same time, same amount.” He also then notes several points to bear in mind, for background:

  • The banks that expanded their balance sheets the most were the biggest ones (see page 11 of his presentation.) This highlights the too-big-to-fail problem: the biggest ones reaped the lion’s share of the implicit subsidy from government, and got most reckless.
  • Increasingly, banks weren’t lending to real businesses but to each other (building up financial candy flosses that helped puff up their profits.) Page 12 illustrates this – the green part of the graph shows banks lending to each other.
  • Over a generation, banking systems became increasingly interconnected. “A furball of banking interconnections by 2008, as they were lending to one another. This was the origins of too big, too interconnected to fail.” Page 13 of his presentation shows this clearly.
  • A picture of banks’ assets relative to GDP more or less flatlining since the 1930s, then suddenly soaring into the sky from about 1990. Page 14. How utilities supposed to help money flow around economies have suddenly mutated into something far bigger (and, I’d argue, rather more monstrous.)
  • A picture of how big banks have become dominant: what share of banking is accounted for by the three biggest banks. It flatlined, then rose by a factor of three or four over the past generation. The same picture could be said for Ireland, the UK, Spain, and other countries. Page 15.
  • Leverage – how banks have used borrowing, rather than equity financing, to grow. (More borrowing, of course, means more risk, and a bigger implicit subsidy from government.) Page 16 shows how capital ratios (which have in an inverse relationship with debt: the more capital you have, the less debt) have fallen over the years.
  • Illiquidity. Banks used to hold 20, 30, 40 percent of their balance sheets in liquid form – things they could sell quickly and easily. These were far safer – but didn’t offer such great returns. The ratio has fallen steadily to a startling 2-3 percent. When crisis came, they couldn’t move quickly and got into trouble. Page 17.

So far, so familiar – though the pictures illustrate the issues brilliantly. Haldane then brings it all together:

So you combine a structure of banking that is big, that is concentrated, that is interconnected, that is debt-propelled, and whose assets are increasingly illiquid, and the consequence will be crisis – in this case not just crisis but bailout.

Now for the tax haven angle. Take a look at this figure from page 13.

This is the “too-interconnected-to-fail” bit. This picture comes from a bigger picture showing how banks became increasingly interconnected across countries over time, from relatively small interconnections in 1985 to very dense connections in 2008 – which is this picture. Now take a look at what those connections are. The biggest ones are, naturally, between the US, the UK and Germany – the big economies. Now I regard the US and the UK as tax havens in their own right. But also now take a look at the next largest connections. KY (Caymans) – NL (Netherlands) – LU (Luxembourg) – IE (Ireland) – CH (Switzerland) – all of these showing much bigger connections than huge economies like Japan or Canada. So there’s something clearly tax haven-ish going on here.

At this point, it makes sense to remind people that – contrary to what many people would have you believe — all of these countries above, with the possible exception of Germany, are tax havens. If you don’t believe me, look at this ranking here. It looks at 60 jurisdictions, and the US is ranked #1, the UK ranked #5, Cayman ranked #4, Netherlands ranked #15, Luxembourg ranked #2, Ireland ranked #6, Switzerland ranked #3. That is – every one of the top six tax havens in the world figures most strongly on the list – plus the Netherlands. Although this ranking measures secrecy, not financial regulation, the point is that all of these things – low or zero taxes, secrecy, lax financial regulation, and more — are symptoms of the bigger thing: that of a state whose legislative and other processes have been captured by the forces of financial capital. (Read Treasure Islands – particularly the section on Delaware and then Jersey – to see what I mean.)

So far, so meander-y. Sorry about that: it’s complicated!

But this, above, is not all. I wrote a blog for the Tax Justice Network recently that showed a somewhat similar-looking picture, in the context of the Greek crisis. This picture, I think, brings out the tax haven element even more starkly. Take a look.

Click that to enlarge it – and note that pretty much every jurisdiction inside that circle (and even those outside but close to its edge: Austria, Netherlands, Mauritius) is a tax haven, or secrecy jurisdiction. It’s a really striking, unambiguous pattern. As the IMF  put it in the accompanying report, this:

“reveals why funding strains in Greece in the first half of 2010, despite being by itself small, might have translated into pressures on other Euro Area peripherals.”

In other words, these tax havens seem to have been serving as transmission belts, amplifying the shocks. Which brings us back to Haldane’s too-interconnected-to-fail point, of course. Everything is run through the tax havens: these supposedly “efficient” financial conduits are anything but efficient. This is hot money at work.

And this is by no means all. I won’t dwell for too long on the many and varied other connections between offshore and the latest crisis, because they are substantially covered in Treasure Islands, and here. The main points are:

  • Competition between tax havens and ‘onshore’ economies forced through processes of financial deregulation, contributing to the crisis.
  • Offshore, financial firms can get around financial regulations and constraints, and they can grow much faster offshore. That’s one of the biggest reasons, if not the biggest reason, for too-big-to-fail.
  • Mutual mistrust and misunderstandings during the crisis, substantially generated by complexity and opacity, helped freeze the financial system. There’s nothing like tax havens to generate opacity and complexity.
  • Tax incentives amplified by zero-tax jurisdictions helped exacerbate the build-up of debt in the system.
  • Tax havens serve as feeders into the big, now messed-up economies. As I outline in Treasure Islands in great detail, the havens fed trillions into London. Similarly, the Caribbean havens in particular helped feed vast sums into Wall Street, puffing it up further – see the KY-US arrows in the blue picture, above, for a visual representation of some of the interconnections there.
  • Illicit financial flows, mostly not measured by conventional methods, aggravated macroeconomic imbalances in the global economy, which were a part of the build-up to crisis. These partly invisible flows were huuuuuge – see here, for example.
  • There seems to be a correlation between the size of the biggest banks in an economy — this concentration, contributing to the implicit subsidy problem, that Haldane talks about — and the number of offshore subsidiaries. Note Citigroup’s 427 offshore subsidiaries, or the 1,000+ subsidiaries of Barclays, RBS and HSBC in the UK. This clearly needs more research. In fact, all the above points do. Who is researching it?

And then there’s the role of offshore in securitisation, one of the big financial candyfloss operations behind the crisis. As the Bank for International Settlements (BIS)  put it:

“The most common SPE jurisdictions for European securitisations are Ireland, Luxembourg, Jersey, and the UK. . . . The most common jurisdictions for US securitisations are the Cayman Islands and the state of Delaware.”

But then the BIS continues:

“The onshore (Delaware) versus offshore (Cayman) decision will generally be driven by factors outlined in the previous section.”

This last sentence, for me, explains why people have so often failed to see the role of offshore. Every last one a tax haven, or secrecy jurisdiction. Delaware is not onshore but offshore. (Read Treasure Islands, and you will be left in absolutely no doubt whatsoever, once you understand the “captured state” foundation of tax havenry, that Delaware is offshore.)

The only problem with analysis like this is – how would one convert it into something that could fit onto Twitter? For that’s the kind of thing we need to do, if we’re to get people onto the streets.

Once we start to understand what offshore really means – that’s when the world will start to get properly to grips with this great yawning faultline down the centre of the global economic and financial system. Tax havens are never the only problem – there are always other factors behind these things. But they are a vast part of how the interconnected global financial machine has managed to grow so powerful, at the expense of most of us.

Nobody said it is going to be easy to address these issues. Not at all. But if we’re going to have any hope at all of taking a shot at preventing the next crisis, at least we ought to understand the issues. More research needed here – and urgently.

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[…] This post was mentioned on Twitter by sean gittins, Nicholas Shaxson. Nicholas Shaxson said: More on Haldane, a furball of bank networks, and how tax havens helped cause the crisis – http://bit.ly/i2h1tQ […]

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