Legal Plunder Run Amock

Bank secrecy not an evil

By Martin Hutchinson 

A brief history of secrecy laws - from Mickey Mouse and the honest wealthy to terrorist groups. 

The wolves are closing in on the world's bank secrecy laws. Former bank employees in Switzerland and Liechtenstein have handed lists of depositors to the United States and European Union authorities. 

Following the Cyprus debacle, the EU is seeking to end bank secrecy in the well-run banking systems of its members Luxembourg and Austria. Luxembourg appears to have "compromised" but Austria, bless it, is still holding out (as a former Abteilungsdirektor of the Austrian bank Creditanstalt-Bankverein I declare an interest here). Nevertheless I hope a number of strong-minded but respectable states with few avenues for blackmail keep bank secrecy, for one very good reason: in a modern social-democratic world, it is a key civil liberty. 

The first bank secrecy law was written by Switzerland in 1934 and played a vital role in enabling at least some German Jewish people to preserve both their lives and their assets during the horrors of World War II. The "key civil liberty" aspect of bank secrecy laws thus cannot be dismissed. While we will hopefully never again have a regime as evil as the Nazis, there are plenty of regimes around the world that oppress their subjects, and those subjects need an asset bolt-hole where they can preserve their wealth while they emigrate or simply decide to wait for better times. 

It's not surprising that there were no bank secrecy laws before 1934. The London merchant banks and private banks of the 19th century would have binned immediately a demand from any government other than Britain's for their customers' records. Numerous dissidents such as Louis Napoleon (the future Napoleon III) and Lajos Kossuth, the Hungarian revolutionary, could keep their money in London entirely without fear of expropriation for that reason. As for Britain itself, with income tax at less than 5% for most of the 19th century there was no great incentive for tax evasion, although accounts were occasionally seized in fraud cases.

Even in such cases, fraud itself was rarely prosecuted. Gregor Macgregor, for example, successfully issued bonds in 1822 for a non-existent country, Poyais, publishing a book on its charms, without ever facing prosecution when his fraud was discovered. John Sadleir, organizer of a Madoff-like fraud involving an Irish bank and forged railway bonds, killed himself in 1856 when his fraud was discovered. The Overend and Gurney crash of 1866 involved several transactions including an initial public issue that would certainly be considered fraudulent today, yet no prosecutions followed. 

Thus banking secrecy in 19th century London was in practice regarded as sacrosanct, yet was protected by banking ethics and practices, not directly by legislation. 

World War I changed the situation, primarily by jacking up tax rates to hitherto undreamed of levels. After the war, most countries in Europe (though not Britain) also had exchange controls, while sterling was no longer a secure store of value. The departure of Britain from the Gold Standard in 1931 made stable non-British banks more attractive, as did the bank panic in continental Europe, which wiped out Austria's Creditanstalt and Germany's Darmstadter Bank, as well as several smaller institutions including M M Warburg, sending young Siegmund Warburg to seek his fortune in London. 

Switzerland had a tradition of neutrality and a solid banking system which, unlike Austria's and Germany's, had not been affected by World War I; hence it naturally became a haven for flight capital. Given the political situation in Germany, Italy (another dictatorship), Spain (socialist government followed by civil war) and France (Communist-Socialist Popular Front government from 1936), it's also not surprising that a Swiss banking secrecy law was thought necessary, to prevent bank employees selling customer information to brutal governments. 

After World War II, even Britain had exchange controls until 1979, while its governments, Conservative and Labour, pursued highly repressive policies, with top rates of tax above 90% for almost the entire period, interest rates around or below the rate of inflation, and inflation itself eroding the real value of savings. 

It's thus not surprising that even in that law-abiding society many people found ways to get their money out of Britain's closed economy and into the safe hands of a Swiss or Channel Islands bank. (This is neither a confession nor a claim of virtue - the Hutchinsons were simply not rich enough to benefit much from doing this.) 

The remainder of Western Europe similarly suffered from very high marginal rates of tax after World War II, as did the US (albeit only at very high levels of income). It's thus not surprising that many perfectly respectable wealthy citizens saw Switzerland, Luxembourg, or in the US case, the tax havens of the Caribbean as sensible places to park their money. The eurobond market, in which investments took the form of untraceable bearer bonds denominated in hard currencies, grew up from 1963, with Luxembourg a favorite place to deposit the bonds concerned. 

Government responses were fairly slow in arriving; the US Bank Secrecy Act was passed only in 1970, and even in the 1970s morning trains from Brussels to Luxembourg were full of comfortable burghers (proverbially "Belgian dentists") with bearer bonds tightly wrapped around their upper bodies, going to clip coupons. 

Then some governments reacted the opposite way; Austria passed bank secrecy legislation only in 1978, in an attempt to get some of Switzerland's business. It was said to be tighter than Swiss legislation because you never needed to give your real name, merely show the nationality of your passport. If you said your name was Mickey Mouse the bank staff would accept this, and when you visited the bank cheerfully greet you with "Gruss Gott, Doktor Maus!" 

Of course, this system has been abused. Ethically, in tax systems that are not oppressive, people should pay the taxes they owe. However, when governments levy taxes at rates of 70, 80 or 90%, the ethics become arguable, and you can certainly see the benefits of bank secrecy to people whose home is in a dictatorship, or even a nominal democracy, whose economic policy is appallingly bad (most comfortably off Argentines, for example, have foreign bank accounts). But at the other extreme bank secrecy is only too useful to terrorist and organized crime groups.

In the middle are the dictators themselves, who may be evil billionaires like the Congo's Mobutu Sese Seko, embezzling all the wealth of their country, but may also be largely honest and economically benign authoritarians, like Chile's Agosto Pinochet or Croatia's Franjo Tudjman, who know they can't rule forever and want to keep their modest and mostly legitimate wealth out of the hands of their leftist successors. 

Also somewhere in the middle are the Russian mafia, who can't reasonably claim a need to escape President Vladimir Putin's tax regime, a flat tax of only 13%, but can reasonably wish to keep some wealth out of the hands of Vladimir Vladimirovich's unpleasant cronies. Of course, it was foolish of them to choose Cyprus as their haven, rather than somewhere economically more solid and politically less bully-able. 

Governments and the media will tell you tax havens and bank secrecy regimes should be closed down, but economically and ethically it isn't as simple as that. Even democracies can run into crises, or elect leftists like France's Francois Hollande, whose tax regime of a 70% income tax plus a 1.6% wealth tax meets any reasonable definition of confiscation. 

Even in the US, that supposed haven of wealth and capitalism, polls consistently show at least 60% support for further tax rises on the wealthy, even after the December 2012 deal eliminated the 2001 tax cuts for incomes above US$450,000. You can perhaps argue that a little more US tax on the wealthy would not be harmful, even when you add together the three layers of Federal, state and local taxes, but when President Barack Obama, within two months of obtaining a substantial tax increase on the rich, demands another one, and public opinion generally favors that demand, we can see that in some political circumstances even Americans are not safe from expropriation. 

Lord Salisbury in 1859 defined democracy as "a system of combined taxation and reform, according to which the poor are exclusively to fix the revenue which the rich are exclusively to pay". It was a pretty good description of British government from 1945-79, and indeed much US government since the New Deal. 

In such circumstances, bank secrecy, accompanied by the ethically unpleasant practice of tax evasion, is the only instrument (other than bribing politicians, which few of us have the means to attempt) by which the rich can resist economic oppression, when such is the fashion of the governing class. If we could be sure no Keynesian or redistributionist mania would ever sweep through the political system, bank secrecy would not be necessary, but as it is rentiers have a duty to themselves and their families not to allow themselves to be euthanized. 

Even if Switzerland, Luxembourg and Austria are suppressed by the EU, and the less untrustworthy Caribbean and Pacific island polities are bullied into submission by the US, it is fortunately likely that a few countries, notably Singapore, will combine political independence with probity, thus allowing bank secrecy to remain in place untainted with terrorist financing. Since their service will be scarce, however, it is likely to become fearsomely expensive. 

In the long run, the technology that has allowed greedy governments to make inroads against Switzerland and other secrecy havens will save us. While bitcoins are an undesirable and insecure speculation, it should soon be possible to have encrypted virtual bank accounts, stored if necessary on servers based in international waters or on the Moon, by which the honest wealthy will once again be able to preserve their wealth for themselves and their posterity. 

That development should be welcomed. Once true bank secrecy becomes possible, it should also become unnecessary, since tyrannical taxation, foreign exchange controls and destructive economic policies will become impossible to implement.