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Money Laundering and the Myth of the Ninja Accountant

EL CHAPO / 11 OCT 2011 BY ALEJANDRO HOPE* EN

Those who think that financial investigations are the key to unravelling organized crime are living in a fantasy world, where drug empires can be taken down with computer bytes, not bullets, argues Alejandro Hope.

The following is InSight Crime's translation of an article from Plato o Plomo, a blog by Alejandro Hope:

Combating money laundering seems to be the idea du jour. Anyone who wants to sound sophisticated in terms of security need only utter two words: financial intelligence (for examples, see here, here and here).

The central assumption is that, to confront the threat from the Zetas or the Mata Zetas, the Sinaloa Cartel or the Knights Templar, does not require more police, more prosecutors and better prisons. All that is needed is an army of ninja accountants and turbo-financial analysts who, from the comfort of their desks, can track the crooks and seize their ill-gotten gains.

The concept would be wonderful (so much better to fight crime with bytes, not bullets!), if only it wasn’t a total absurdity. But how? We are told that drug trafficking affects 78 percent of Mexico’s economic sectors and assets from drug trafficking represent up to 40 percent of GDP. (How Edgardo Buscaglia arrived at those numbers is a mystery wrapped in a riddle inside an enigma.) We are told that dirty money is everywhere and it will take no more than willpower and "financial intelligence" to locate these criminal profits.

I have only one question: if it is so easy to locate illicit assets, why are the amounts seized globally so ridiculously small compared to the estimated income from illegal activities? In the U.S., where there are sophisticated systems to detect irregular transactions and robust legislation that allows even the most modest sheriff to confiscate property, only $2.5 billion in allegedly illicit profits was seized last year. That represents 3.8 percent of the likely value of the U.S. drug market (see the latest estimate here) and a much smaller percentage of total revenues all illicit activity (gambling, prostitution, extortion, etc.). In the UK, where illegal activities may generate several billion pounds, the government managed to seize £317 million in 2009-2010. Even the much vaunted Colombian operation to seize $250 million worth of assets allegedly linked to Chapo Guzman should be put in perspective: the likely profits from trafficking drugs in Colombia is between $3 and $7 billion annually.

Why, then, is it so difficult to find and seize criminal profits? I have no complete answer, but present three tentative arguments:

1) The illegal economy is large in absolute terms, but very small in relative terms. According to a study by the RAND Corporation, gross income from Mexico’s drug exports is $6.6 billion (there are good reasons to think that Mexican cartels do not control internal distribution of drugs within the United States. See my comments here for an explanation ). From this total, we must subtract the cost of paying the Colombians for cocaine and heroin (according to UNODC, this could represent up to half of cocaine revenues). Add whatever you want as income from activities other than drug trafficking, (see my discussion of the topic here) and the figure will probably still be no greater than one percent of GDP. This is a tiny drop in the ocean of the country’s economic transactions and, furthermore, it must be distributed among several thousand participants (unevenly, of course).

2) A significant part of the proceeds of illegal activities could be go on everyday spending that is extremely difficult to trace and impossible to confiscate. (How can you seize a night of drinking with the guys or a couple of hours with some Ukrainian dancers?)

3) Most of the profits of illegal activities will be reinvested in illegal activities.

This last point is subtle, but crucial. Illegal activities and especially the drug trade have two fundamental characteristics:

1) Even adjusting for risk, these activities will as a rule generate a return on investment greater than the lawful activities (if not, they would not exist).

2) These activities require a lot of working capital.

Imagine you're a drug dealer. Even if you’re Chapo Guzman, you cannot be considered a good credit risk: you might be killed or arrested tomorrow, and then who will pay the debt? You will not be able to obtain a revolving line of credit, and your suppliers will not give you marijuana or cocaine on credit: you have to pay in full upon delivery. Nor can you leverage yourself using your employees’ salaries: it is not a good idea to stop attending to the payroll when your staff are armed to the teeth and know too much. Invoicing is not an option, for the obvious reason that there are no receipts. Furthermore, nobody is going to sell you an insurance policy to protect the product; therefore you have to have a financial reserve in case goods are seized, stolen or lost ( planes fall and boats sink).

The only option is to finance your operations with the profits of previous deals. But you do have this; if the product meets a good fate, you will get back more (perhaps a lotmore) than 100 percent of what you invested. Given that, where you would put your money: in Cetes, on the stock market, into the production of serrano peppers, in real estate development, or in the smuggling of illegal drugs? Perhaps you would try to diversify a bit, but in all likelihood the most important part of your portfolio will be the most profitable activity. And how will you preserve your working capital? Most likely, you will want to keep it in cold, hard cash, guarded by some unfriendly thugs: In addition to known risks, you do not want to worry about your bank account being frozen, do you?

So, if the majority of the profits of crime are reinvested in crime, no amount of financial intelligence unit can help: the only way to seize the money is by physically finding it (as in the case of Zhenli Ye Gon). These profits only enter the financial circuits and normal business at the time of final consumption. For that reason, it is a good idea to put certain restrictions on the use of cash (domestic or foreign): there is nothing wrong with making life a bit more difficult for criminals. And no, there’s nothing wrong with having the capacity to investigate assets when the time comes to prosecute a criminal (especially in cases of criminals, like Al Capone, is are dumb enough to have an accountant documenting their income).

But anyone thinks that combating money laundering is a means of drying up the profits of organized crime, and discouraging its members from committing atrocities, lives in a fantasy world where super-accountants defeat super-villians, one Excel sheet at a time.

Translated and reprinted with permission from Alejandro Hope*, of Plata o Plomo, a blog on the politics and economics of drugs and crime. Read Spanish original here.

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