Friday, July 07, 2017

Some thoughts about money laundering patterns

This is an offshoot of a discussion with @MWR_DBM on twitter.

As wealth is acquired through illegal means by a criminal, they look forward to enjoying its benefits. This poses two main problems. The wealth many be stolen by the criminal's associates - for example - the guards protecting the ill-gotten cash may run off with it or change loyalties. Or the government may take it all away (i.e. 100% taxation) and jail the criminal.

Coping with these catastrophic risks makes criminals seek out ways of "laundering" the money - i.e. way of making the money less visible to these catastrophic risks.

I feel it is best to divide money laundering into two basic patterns.

1) transferring the money - where the wealth acquired illegally changes form, hands or jurisdiction. The main aim of such operations is to hide the original sources of income. Examples of wealth transferring mechanisms are restaurants, hotels, casinos or strip clubs. Here people come in and spend cash, and there is no way to know how much anyone actually spent. It is easy to claim that people spent more money than they actually did - no revenue intelligence entity ever actually audits the restaurant and the patrons at the exact same time. This turns illegal cash into legal cash.

2) storing the money - where the wealth is kept in a form that is relatively unchanging and slightly growing. The aim here is to create repositories which may be retrieved by their rightful owners at will. There are two main forms of storage which I call "static" and "dynamic". In "static" storage the wealth is converted into an asset which either keeps its value or grows slowly. The ownership of the "static" asset is relatively transparent. The asset is usually a piece of real estate, or a vehicle or a commodity. In "dynamic" storage the wealth is moved around frequently through a range of assets which all appreciate in value. The rapidly rising value of the asset is necessary to the repeated offset transaction costs. The "dynamic" storage can be anything even something as abstract as a cryptocoin.

As most criminal enterprises massively degrade the value of human life, they end up producing large "profit" without visible investment. The amount of money generated is so large it quickly exceeds the criminal's ability to spend and they have find ways of coping with the money.

As the criminal is always shouldering massive catastrophic risks, their investment culture is very different from the normal investor. The normal investor makes money legally and lives without the constant fear of losing everything. The normal investor stores their wealth in stable low risk assets and only a small fraction of their wealth is ever invested in high risk ventures (typically about 1% if you are from Asia and about 10-20% if you are from the US/EU).

A criminal investor can't afford to be so relaxed. One way to think about it is that things that the ordinary investor thinks are risky, are as safe as an FDIC insured savings account to a criminal investor. This changes the investor expectations significantly.

A case in point is real estate investment. Most ordinary people look upon real estate as a place to stay. It is a lifetime investment, and very few people have other investment properties - usually ones that are inherited or bought as a means of generating rent.

While an ordinary investor may balk at the idea of putting down $1M for an apartment in a Trump development, a criminal investor will gladly pour in $3M into three apartments  because they know that Trump will ask no questions about where the money comes from & even if the apartments lose value, they will still be worth more than a room with stacks of $100 bills wrapped in plastic in where-ever-the-fuck-istan. Even at a massive loss of value (~25% for most people during the 2008 crisis), the criminal investor still gets more out of this transaction than they would if the cash had simply sat somewhere.

Now if the real estate values are exploding (as they once did around 2004), then it makes sense to use shell companies to quickly move the real estate asset around. This is an example of "dynamic storage". In this approach, you and a close friend in RU government set up shell companies in Panama and then toss Florida real estate between yourselves. After a dozen swaps and sales, you have effectively confused any investigative agency about who exactly owns the asset and what if any tax obligations they have.

This is one of the many weird ways in which the criminal real estate market differs from the normal real estate transactions market. Given the way the valuations are these days, I feel the criminal real-estate sector probably accounts for ~ 10% of the GDP, i.e about half the money in the RE sector is from conflict economic sources.

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