Anti-money laundering overkill? It's time to ask how well the system is working.

• Author: Reuter, Peter

Over the past twenty years, but with a huge increase in prominence since September 11,2001, the United States and the other wealthy nations of the world have constructed an ever more embracing set of anti-money laundering (AML) controls. Their aim is to make it more difficult to finance terrorism, to traffic in drugs, or for corrupt kleptocratic officials in developing countries to rip off their citizens. An associated objective is to make it easier to catch those who commit these crimes. How well is the system doing? Should it be altered and expanded?

LAUNDERING

A starting point for a policy assessment is a good description of the problem. There are no systematic estimates of the scale of money laundering, though large numbers are frequently thrown around without serious support, most prominently the 2-5 percent of global GDP ($800 billion to $2 trillion in 2004 dollars) suggested by International Monetary Fund Managing Director Camdessus in 1998. The oft-cited figure from the United Nations that the illegal drug trade, at the international level, generates $400-$500 billion annually (8 percent of total trade flows) also implies that the amounts laundered are massive. However, that latter figure is a vastly inflated estimate. Total drug sales at the retail level probably total only $200 billion, and the international trade component may be only $10-$20 billion; most revenues from cocaine and heroin go to the millions of domestic distributors at the bottom of the system whose earnings are far too small to require laundering. Terrorist finance, the component of money laundering that generates the greatest social damage, is a pittance by contemporary standards: the operations of supporting dedicated operatives require a few million rather than billions of dollars in donations and revenues. It is fair to assume that money laundering is in the hundreds of billions of dollars annually but probably only several, and it is unlikely to be a trillion.

However, even if money laundering is not extensive enough to be an important international financial flow, it is socially important because money laundering facilitates behaviors that society cares about a great deal. Indeed, anti-money laundering tools provide the means to achieve multiple objectives. The success of the system should be judged not by how much it reduces money laundering but by how much it reduces the criminal activities that generate the laundering, namely drug trafficking, corruption, terrorism, etc. A regime that forces terrorists to avoid using banks and forces them to carry money in suitcases across international borders would only get high marks if it meant that the actual flows of funds to support terrorists were much reduced.

Laundering the proceeds of crime can be as simple as driving cash south over the U.S.-Mexican border to put it into less tightly supervised financial institutions there. It can be as complex as the special purpose vehicles set up in the Caribbean by Enron officials. It can involve institutions as humble as hawalahs and other "'informal value transfer systems" that function primarily to provide low-cost money transfer systems for low-income immigrants or as lofty as JP MorganChase. See the accompanying box for two examples.

Different activities generate different money laundering needs. Drug dealers have the problem of large quantities of cash arriving on a regular basis. Robert Maxwell's needs were very different indeed when he used his newly acquired New York Daily News as a vehicle for washing money that he had taken from the London pension funds of Maxwell Group Newspaper PLC in 1991. A regime focused on catching laundering related to drug smuggling will require considerable adaptation to...