Treasure Islands - Nicholas Shaxson [130]
As the 1990s progressed, occasional expert warnings about systemic, debt-related threats from offshore did emerge.
The IMF pointed squarely at the problem in 1999 when discussing the interbank market, where banks lend to each other. “A large part of the growth in OTC trading of derivative instruments may have involved offshore banks,” the IMF said.37 “The interbank nature of the offshore market implies that, in the event of financial distress, contagion is likely…. Offshore banks are likely to be highly leveraged, that is less solvent, than onshore banks.” The report, which contains plenty more along these lines, frets especially about lax offshore regulation. It was a direct warning, long before the crisis struck.
That report followed soon after the implosion of the hedge fund Long Term Capital Management (LTCM), a classic slice-and-dice offshore structure that nearly destroyed the U.S. banking system in 1998 after the fund took on massive risks, covered by near-paranoid secrecy. LTCM’s managers were in Greenwich, Connecticut; the hedge fund was incorporated in Delaware; and the fund it managed was in the Cayman Islands. Yet none of the agonized analyses that followed took any serious interest in the offshore angle.38 And the pattern just keeps being repeated.
The latest financial crisis was incubated in the so-called “shadow banking system”—a vast, unregulated economic terrain containing all manner of Special Purpose Entities (SPEs, also known as shadow banks) that borrowed money to lend out again at a profit but fall outside normal bank regulation, partly by separating themselves legally from the regulated institutions that sponsor them, off their balance sheets.
The shadow banking system is not traditionally described as either an “offshore” or “onshore” phenomenon, but an in-depth 2008 study on SPEs by the Swiss-based Bank for International Settlements is very clear about where the dangerous shadow banks were mainly located.39 “The most common jurisdictions for US securitisations are the Cayman Islands and the state of Delaware,” the BIS said. “The most common SPE jurisdictions for European securitisations are Ireland, Luxembourg, Jersey, and the UK.” Every last one is a major secrecy jurisdiction that used a simple business model: ask the financial institutions exactly what they need, then shape the laws accordingly and without democratic debate.
The BIS report calls Cayman “offshore” and Delaware “onshore.”40 It is exactly this misunderstanding—confusing physical geography with political geography—that has led to widespread claims that the secrecy jurisdictions had nothing to do with this gigantic mess. The Bank for International Settlements, along with every other major international financial institution, needs to understand what offshore is and how it works.
Among the only academic experts to have seriously examined offshore’s role in the financial crisis is Jim Stewart, senior lecturer in finance at Trinity College, Dublin.
In reports in July 2008 Stewart investigated the Dublin International Financial Services Centre (IFSC), a secrecy jurisdiction set up in 1987 under the corrupt Irish politician Charles Haughey with help primarily from City of London interests.41 A showcase for high-risk, Wild West financial capitalism, the Dublin IFSC emerged the year after London’s giant deregulatory Big Bang and now hosts over half the world’s top 50 financial institutions. It became a big player in the shadow banking system and now hosts eight thousand funds with $1.5 trillion in assets. Perhaps most alluring of all Dublin’s lures, Stewart said, is its “light touch regulation.”42
In June 2007 two Bear Stearns hedge funds incorporated in the Cayman Islands announced huge losses, presaging its collapse. Bear Stearns had