New York-based funds are abus­ing ‘secrecy jurisdictions.’

by Robert M. Mor­gen­thau
Wall Street Journal

A major fac­tor in the cur­rent finan­cial cri­sis is the lack of trans­parency in the activ­i­ties of the prin­ci­pal play­ers in the finan­cial mar­kets. This opaque­ness is com­pounded by vast sums of money that lie out­side the juris­dic­tion of U.S. reg­u­la­tors and other super­vi­sory authorities.

The $700 bil­lion in Trea­sury Sec­re­tary Henry Paulson’s cur­rent pro­posed res­cue plan pales in com­par­i­son to the vol­ume of dol­lars that now escape the watch­ful eye, not only of U.S. reg­u­la­tors, but from the media and the gen­eral pub­lic as well.

There is $1.9 tril­lion, almost all of it run out of the New York met­ro­pol­i­tan area, that sits in the Cay­man Islands, a secrecy juris­dic­tion. Another $1.5 tril­lion is lodged in four other secrecy jurisdictions.

Fol­low­ing the Great Depres­sion, we bragged about a newly installed safety net that was sup­pose to save us from such a hard eco­nomic fall in the future. How­ever, the Secu­ri­ties and Exchange Com­mis­sion, the Fed­eral Reserve Sys­tem, the Comp­trol­ler of the Cur­rency and oth­ers have ignored tril­lions of dol­lars that have migrated to off­shore juris­dic­tions that are secre­tive in nature and out­side the safety net — beyond the reach of U.S. regulators.

We should have learned a long time ago that totally unsu­per­vised mar­kets, whether trad­ing in tulips or sub­prime mort­gages, will sooner rather than later get into trou­ble. We don’t have to look back very far in his­tory to under­stand this.

Long Term Cap­i­tal Man­age­ment, a hedge fund “based” in Green­wich, Conn., but com­posed of eight part­ner­ships char­tered in the Cay­mans, was sup­posed to be the wun­derkind of the finan­cial world. At its peak in the late 1990s, its gross hold­ings were val­ued at $1.8 tril­lion. But, regret­tably, its lia­bil­i­ties exceeded its assets and the Fed­eral Reserve Bank of New York had to step in and res­cue it when the value of its assets plummeted.

Most recently, two Bear Stearns hedge funds, based in the Cay­man Islands, but run out of New York, col­lapsed with­out any warn­ing to its investors. Because of the loca­tion of these finan­cial insti­tu­tions — in a secrecy juris­dic­tion, out­side the U.S. safety net of appro­pri­ate super­vi­sion — their des­per­ate finan­cial con­di­tion went unde­tected until it was too late.

Of course, BCCI Over­seas, which was part of the then largest bank­ruptcy in his­tory, was also “char­tered” in the Caymans.

We have to learn from our mis­takes. Any sig­nif­i­cant infu­sion to the finan­cial sys­tem must carry assur­ances that it will not add to the pool of money beyond the safety net and super­vi­sory author­ity of the United States. More­over, the tril­lions of dol­lars cur­rently off­shore and invested in funds that could impact the Amer­i­can econ­omy must be brought under appro­pri­ate supervision.

If Con­gress and Trea­sury fail to bring under U.S. super­vi­sory author­ity the finan­cial insti­tu­tions and trans­ac­tions in secrecy juris­dic­tions, there will be no trans­parency with the inevitable con­se­quences of the lack of trans­parency — namely, a repeat of the unbri­dled greed and reck­less­ness that we now face. Because of the mono­lithic char­ac­ter of world finan­cial mar­kets, a default cri­sis any­where becomes a default cri­sis everywhere.