Money Laundering Laws: Ineffective and Expensive

Beginning in the 1970s and 1980s, the federal government (as well as other governments around the world) began to adopt policies based on the idea that crime could be reduced if you somehow could make it very difficult for criminals to use the money they illegally obtain. So we now have a bunch of laws and regulations that require financial institutions to spy on their customers in hopes that this will inhibit money laundering.

But while the underlying theory may sound reasonable, such laws in practice have been a failure. There’s no evidence that these laws, which impose heavy costs on business and consumers, have produced a reduction in criminal activity.

Instead, the only tangible result seems to be more power for government and reduced access to financial services for poor people.

And now we have even more evidence that these laws don’t make sense. In a thorough study for the Heritage Foundation, David Burton and Norbert Michel put a price tag on the ridiculous laws, regulations, and mandates that are ostensibly designed to make it hard for crooks to launder cash, but in practice simply undermine legitimate commerce and make it hard for poor people to use banks.

Oh, and these rules also are inconsistent with a free society. Here are the principles they say should guide the discussion.

The United States Constitution’s Bill of Rights, particularly the Fourth, Fifth, and Ninth Amendments, together with structural federalism and separation of powers protections, is designed to…protect…individual rights. The current financial regulatory framework is inconsistent with these principles. …Financial privacy can allow people to protect their life savings when a government tries to confiscate its citizens’ wealth, whether for political, ethnic, religious, or “merely” economic reasons. Businesses need to protect their private financial information, intellectual property, and trade secrets from competitors in order to remain profitable. Financial privacy is of deep and abiding importance to freedom, and many governments have shown themselves willing to routinely abuse private financial information.

And here are the key findings about America’s current regulatory morass, which violates the above principles.

The current U.S. framework is overly complex and burdensome… Reform efforts also need to focus on costs versus benefits. The current framework, particularly the anti-money laundering (AML) rules, is clearly not cost-effective. As demonstrated below, the AML regime costs an estimated $4.8 billion to $8 billion annually. Yet, this AML system results in fewer than 700 convictions annually, a proportion of which are simply additional counts against persons charged with other predicate crimes. Thus, each conviction costs approximately $7 million, potentially much more.

By the way, the authors note that their calculations represent “a significant underestimate of the actual burden” because they didn’t include foregone economic activity, higher consumer prices for financial services, lower returns for shareholders of financial institutions, higher financial expenses for unbanked individuals, and other direct and indirect costs.

And what are the offsetting benefits? Can all these costs be justified?

The CFPB Should Learn That No Means No

Despite professing a desire for “financial inclusion,” usually understood as better access to financial products for lower income people, the Consumer Financial Protection Bureau (CFPB) has taken aim at a product used extensively by low- and moderate income Americans: the short-term, low value loans known as “payday” loans.  What is even more striking about the proposed rule, however, is the fact that it works as an end-run around an express limit on the CFPB’s power.  The CFPB has spent its short life pushing the bounds of its authority in numerous directions, going so far as to incur a slap from a federal court when it trod on the toes of another agency.  The CFPB could be excused for thinking that at least some members of Congress desired such expansion, given the broad and amorphous authority the Dodd-Frank Act grants the new agency.  But it is hard to justify evading an express prohibition.

Although the CFPB is given the authority to proscribe unfair, deceptive, and abusive practices, the Dodd-Frank Act explicitly withholds from the CFPB the authority to “establish a usury limit.”  The proposed rule does not set a rate cap, but it does make lending at any rate above 36 percent so onerous as to be infeasible.  In fact, it is not clear that it would be even be possible to comply with the rule.

On Friday, I submitted a letter to the CFPB, expressing concern over the agency’s authority to enact the rule as proposed.  In particular, the letter notes that the underwriting process required for loans with an effective annual interest rate higher than 36 percent are not only onerous but require the lender to make determinations that may be impossible to make.  For example, under the proposed rule a lender would be required to “forecast a reasonable amount of basic living expenses for the consumer – expenditures (other than debt obligations and housing costs) necessary for a consumer to maintain the consumer’s health, welfare, and ability to produce income[.]”  This amount can be difficult for individuals to determine for their own households.  My husband and I have an estimate we use to help us save for an emergency, but I couldn’t swear to its accuracy given the vagaries of life with small children.  I couldn’t guess what the right number might be for any other household in my acquaintance.  If I am uncertain what my own family might need, it is difficult to see how a storefront lender could make this determination for a prospective borrower who walks in off the street.  Certainly this level of underwriting, which surpasses even what is required for most mortgages, is not cost-effective for a loan of only a few hundred dollars.

Clinton Breaks Debate Silence on Trade to Call for Steel Protectionism

Until the last few minutes of last night’s debate, Donald Trump had been the only candidate to talk about trade policy during the debates.  At the first presidential debate, Clinton studiously avoided the topic even as Trump used Clinton’s past support for NAFTA and her flip-flop on the TPP to blame her for all the economic troubles he thinks trade has caused. At the vice-presidential debate, neither Mike Pence nor Tim Kaine offered any substantive remarks about trade policy. 

Most of the second presidential debate followed the same pattern.  Trump continued to complain unchallenged that America is losing because of our trade deficit and that Clinton is responsible because of NAFTA and the TPP.

But then in the second to last question of the debate, Trump finally evoked a response from Clinton when he stumbled into some remarks about China and the U.S. steel industry during a longer diatribe about coal and environmental regulations:

We have to bring back our workers. You take a look at what’s happening to steel and the cost of steel and China dumping vast amounts steel all over the United States, which essentially is killing our steelworkers and steel companies.

When it was Clinton’s turn to respond, here’s what she had to say:

First of all, China is illegally dumping steel in the United States and Donald Trump is buying it to build his buildings, putting steelworkers and American steel plants out of business. That’s something that I fought against as a senator and something I would have a trade prosecutor to make sure we don’t get taken advantage of by China on steel or anything else.

You’ll note that Clinton didn’t disagree with Donald Trump’s assessment or criticize his simplistic, zero-sum view of trade.  Instead, she accused Trump of hypocrisy and complicity with the problem and highlighted her own record and promises to protect the steel industry. 


Foreign Policy Schizophrenia

In last night’s presidential debate, policy issues were barely discussed among the conspiracy theories and scandal-mongering. But even the limited discussion of foreign policy highlighted a pretty strange fact: the Republican ticket effectively has two distinct foreign policy approaches. And though it’s hardly unusual for running mates to differ to some extent on issues – indeed, Hillary Clinton and Tim Kaine differ on some key foreign policy points – Trump’s statements last night, publicly repudiating his running mate’s proposals for Syria, were bizarre.

Despite his choice of vice presidential candidate, Trump and Pence have been largely at odds on foreign policy since day one.  Trump’s approach to foreign policy is highly inconsistent but has certainly been unconventional. The GOP nominee advocates a militaristic, ‘America First’ foreign policy, but differs from GOP orthodoxy on key topics like Russia, the Iraq War, U.S. alliances, and trade. In contrast, Pence is a hawk’s hawk, supporting the war in Iraq, increases in defense spending, and further Middle East intervention. In 2005, then-Representative Pence even introduced a House Resolution which would have declared that President Bush should not set an ‘arbitrary’ date for the removal of troops from Iraq until nation-building was complete.

The result has been a curious dichotomy in the Republican ticket’s foreign policy proposals. At last week’s vice presidential debate, Pence ignored Trump’s prior foreign policy statements, advocating for intervention against the Assad regime, the creation of safe zones in Syria, and a substantially harder line against Russia. Yet last night, when moderators pushed Trump on these differences, the Republican presidential candidate bluntly rejected Pence’s stance, noting that “he and I haven’t spoken, and I disagree.”  Trump then further contradicted his running mate, arguing for better relations with Russia, even refusing to attribute recent hacking incidents to Russia despite substantial evidence from the intelligence community on the issue.

You Ought to Have a Look: Big Science, Carbon Taxes, and the Clean Power Plan’s Day in Court

You Ought to Have a Look is a regular feature from the Center for the Study of Science.  While this section will feature all of the areas of interest that we are emphasizing, the prominence of the climate issue is driving a tremendous amount of web traffic.  Here we post a few of the best in recent days, along with our color commentary.

This week we feature a few smart pieces by some smart folks.

First up is an excellent post “Climate Modeling: Settled Science or Fool’s Errand?” by Competitive Enterprise Institute’s Bill Frezza in which he discusses the development of climate models and the reliability of the future that they project. But Bill’s post is really just to provide some background for his Real Clear Radio Hour interview with Arizona State University’s Dr. Daniel Sarewitz, who is the co-director of ASU’s Consortium for Science, Policy, and Outcomes. Sarewitz has a lot of interesting things to say about “Big Science” and the problems that result. Frezza summarizes his interview:

Sarewitz, who was trained as an earth scientist, is terrified that “science is trapped in a self-destructive vortex” that is endangering both science and democracy. In his blockbuster analysis mentioned above, he nails his thesis to the laboratory door, challenging Big Science to get its act together. Politicizing science, he argues, leads to debates about science being substituted for debates about politics. So we end up fighting over unverifiable forecasts about what might happen in the future, rather than wrestling with the complex tradeoffs that attend political decisions on what we should – or could – do about carbon emissions under all the potential future scenarios.

But rather than get discouraged, Sarewitz believes there is a way out of this conundrum. His advice is, “Technology unites while science divides.” He recommends that science “abdicate its protected political status and embrace both its limits and its accountability to the rest of society.” Despite calling long-range climate forecasting “a fool’s errand,” he thinks dumping too much CO2 in the atmosphere will make anthropogenic global warming a long term problem that will eventually require the decarbonization of our energy industries. But he sees this as a process taking many decades, one that can be best addressed not with politicized science, but by letting adaptation, innovation, wealth creation, and economic growth lead the way.

If you have a free 20 minutes or so and are interested in how the quest for policy has derailed the pursuit of science, listening to Frezza’s full Sarewitz interview will be time well spent.

Trump Adviser Peter Navarro: Reagan Critic Advocates Crony Capitalism

Peter Navarro, a Professor at U.C. Irvine, is Donald Trump’s most influential adviser/spokesman on international trade, and the only academic among his 13 economic advisers.   

After a losing campaign to become mayor of San Diego as an anti-NAFTA Democrat running against Republican Susan Golding, Navarro wrote a 1993 book, Bill Clinton’s Agenda for America. It provides intriguing clues about the sort of policy advice he now offers Mr. Trump.

Navarro begins by saying, “if Clinton and Gore carry through with their agenda … we will become more globally competitive, our educational system will improve, better protection will emerge for our environment, our cities will be rebuilt, and, most important of all, hundreds of thousands of jobs will be created.”

He goes on to write of “The Failure of Reaganomics” and the “Trickle Down Rip-Off.” The complaint is mainly about the U.S. spending too much on defense, with Japan financing the resulting budget deficits and aiming to “locate many of their plants within U.S. borders to avoid the certain protectionism they saw coming.”

“Countries like Japan, Germany, France and Taiwan have very sophisticated industrial policies,” wrote Navarro, while “Reagan and Bush Administrations… [were] clinging to a free-trade philosophy.”  Without a protectionist industrial policy the U.S. couldn’t possibly compete, particularly since “Japan and Germany were devoting over 10 times what the U.S. was spending on public infrastructure and new technologies.”

“The essence of a national industrial policy,” Navarro explained, “is a full partnership between government and business… [T]he role of government is to help a nation’s businesses compete by providing technological assistance, subsidies and protectionist measure such as tariffs and quotas.”

The Wealthy Are Not All the Same: A Recent Study Finds Key Differences

Inequality and the “one percent” have generated an inordinate amount of media coverage recently, despite the fact that these topics barely register when people are asked to name the country’s most important problem. The rhetoric often portrays the wealthy as a homogenous group that inherited its wealth, and those that do work operate almost exclusively in the financial sector. A recent study published in Intelligence this year that was highlighted by Tyler Cowen delved into the characteristics of wealthy individuals. The findings run contrary to the commonly held perception that this is a stagnant, homogeneous group. There is a significant amount of diversity when it comes to which industries these people work in, and a much higher share of the wealthy Americans in this sample are self-made compared to some European peers.

In their study, David Lincoln from Wealth-X and Jonathan Wai from Duke University use the Wealth-X database to analyze a sample of more than 18,000 ultra high net worth (UHNW) people, which they define as having a net worth greater than $30 million. Their findings help us get beyond the rhetoric to see how the wealthy got to that position.

Compared to some of the European countries most-often cited as models of equity, the United States has a significantly higher share of UHNW people whose wealth is primarily self-made: 75 percent in the United States compared to just 31.3 percent in Sweden, 42.5 percent in Norway, or 43.6 percent in Denmark.

In fact, only 12.6 of the American individuals analyzed derived most of their wealth from inheritance, a lower share than any European country in the sample besides Finland (9.1 percent, but with a much higher share with their primary source of wealth being a mix between inheritance and self-made) and the United Kingdom (12.5 percent).

Unlike the common portrayal, it is the European countries that has a more stagnant and stultified elite class, while the United States has one of the higher shares of self-made men and women in the study’s sample.

Ultra High Net Worth Individuals by Primary Source of Wealth, Select Countries

Source: Wai and Lincoln (2016), Appendix F.