Money Market Violations and the Money-Laundering Events - Assignment Example

 Abstract The paper discusses some of the major events pertaining to money market violations in the last few years. Money laundering issue as well as illegal fund transfer methods is detailed in the paper. Moreover, the recent JPMorgan financial debacle as well as the US Credit Rating Crisis is discussed. Finally, the paper delves into the London Interbank Offered Rate (LIBOR) controversy and gives a synopsis of the primary issues related to the same. TABLE OF CONTENTS 1. Introduction 4 2. The Money-Laundering Events 4 3. Transferring of Funds from Sanctioned Countries 5 4. Taking Excessive Risks in Derivatives by JP Morgan 6 5. US Crisis and Credit Rating Agencies 7 6. Responses from the Regulatory Authorities 8 6.1 Bank Solvency and Capital Replenishment 9 6.2 Failures and Bailouts of Financial Firms 9 6.3 Judicial Investigations and Responses 10 7. LIBOR 11 7.1 LIBOR Calculation 12 7.2 How LIBOR was Utilized 12 7.3 Importance of LIBOR 12 7.4 Reliability and Scandal 13 7.5 Criminal Investigations 14 7.6 Reactions and Impact on Banking Regulation 15 8. Recommendations 16 9. References 17 1. Introduction The act of hiding the money source that was earned via illegal means is often mentioned as money laundering. There are lots of methods in which money can be laundered and this could range in sophistication. According to the estimation made by many government authorities, lots of money has been laundered both worldwide and within the nation. According to a survey made by the International Monetary Fund in the year 1996, laundered money occupied 2 to 5 percent of the world economy (Molander et al, 1998). FATF which stands for Financial Action Task Force on Money laundering is an intergovernmental body which has been formed to fight money laundering (Witherell, 2002). It believes that getting a reliable estimate on the magnitude of money laundered is quite difficult and hence it generally doesn’t publish any numbers regarding the money laundered amount. The same situation is prevalent among the academic commentators who are unable to give any estimate on money laundered amount. Even though the exact measurement of estimating the money laundered is difficult, there are still millions and millions of money laundered every year (International Monetary Fund, 2005). This has been a great concern for creating financial policy by the government. This has resulted in lots of international organizations and government to take efforts to counter money laundering, to deter money launderers. Prevention and detection of illegal transactions has been a primary priority of financial institutions and this is also emphasized by the government as well saves their company's reputation. The below four acts have been building blocks in UK for preventing terrorist funding and money laundering: Terrorism Act 2000 Anti-terrorism, Crime and Security Act 2001 Money Laundering Regulations 2007 Proceeds of Crime Act 2002 Serious Organized Crime and Police Act 2005 2. The Money-Laundering Events The financial system of the UK is well protected by various money laundering regulations. These regulations control a business, which in turns prevent illegal transaction of funds. The anti money laundering legislation according to the Proceeds of Crime Act 2002, would demand for an explanation by the authorities for any illegal activity by the customers of the regulated sector (Ewerhart et al, 2007). The regulated sector would comprise of investment, money transmission and banking. UK has given wide importance in money laundering (FATF, 2004). Any involvement with any assets involved in the crime is treated to be money laundering offence. Any possession of the one's own assets involved in the case is also considered to be money laundering act of UK. The traditional meaning to the word money laundering would be a process which involves the source of the proceeds to be hidden or disguised and they are made to be appearing legal. The jurisdiction of the UK is different from that of US, where the money laundering offence is not limited to any amount of money and any proceeds of crime not to any purpose of action. The money laundering crime actually need not involve only money but also can involve other types of assets. According to the UK legislation, if any person enjoys any kind of benefit that is not accepted legally, then he would be considered to do a money laundering crime. The actual benefit that he received need not be only money (Taylor and Williams, 2009). A person who also declines to take his liability like not getting taxed would also be considered to do money laundering. He would be expected to pay the amount of liability that he has declined to take on his shoulders. Around 14 years of imprisonment is granted to a money launderer (Roth, Greenburg and Willie, 2004). The threat to the financial system of the UK is managed by the treasury and it protects the country from money laundering and provides a framework to combat illicit operations of finance and this would include both proliferation and terrorist finance. The EU Third Money Laundering Directive in December 2007 was implemented as a part of Money Laundering Regulations 2007.The major step behind UK's measure to fight money laundering is this act and this act has global standards that are regulated by the Financial Action Task Force. 3. Transferring of Funds from Sanctioned Countries Home office closely associated with treasury work plays a major role in the procedure of Crime Act 2002 and Terrorism Act 2000 and this adds to play a main role in maintaining shareholder position in crime and Terrorism Act (European Central Bank, 2009). Money laundering has been tackled efficiently by the home office with the help of MLAC (Money Laundering Advisory Committee). MLAC provides a great platform for government, industrial sector, public representatives and law maintaining agencies in controlling Money laundering activities inside the country UK (McSkimming, 2010). The critical information has been eliminated by wire stripping. The countries that are connected to the US banks are disallowed from doing any business are maintained by OFAC and the countries would include North Korea, Iran, Sudan and Cuba (Madinger, 2006). Funds are in general transferred trhough accounting "book transfers". If a fund has to be send from a bank to which a customer has no relationship, then it should be facilitated by correspondent bank. The originator and bank information are contained in the wire and the transaction is facilitated by this. Thus any transaction that originates is required to be processed in the US (Ahn and Choi, 2009). In this case, a wire stripping is popularly used. The key piece of information is eliminated in a wire stripping. The originating bank and originator details are eliminated for sanctioned countries. The stripped information is then replaced by an originator so that they would not raise any questions. This type of practice is opposed to the US. There is a good amount of transaction fees involved in transaction and the banks put a good profit via these transactions. All these processes have been documented in order to bring a systematic attempt to prevent any violation. There are lots of cases that have been identified and this brings the need to reconsider certain practices followed by the bank. 4. Taking Excessive Risks in Derivatives by JP Morgan The anti-money laundering laws of the US are strictly followed by the JP Morgan Chase & Co and are reviewed by banking regulator. The largest bank has been brought under case study to identify the transactions that are involved in drugs. JPMorgan's system has been examined by an independent arm of the treasury named "Office of the controller of currency" (The Economic Times, 2012). These systems have been designed for transaction monitoring and filtering. This information has been confirmed by a source that has much familiarity in this subject. Understanding the bank's size of potential liability and the inquiry scope has not been fruitful. There was a press meet with Joseph Evangelisti, the JP Morgan spokesman, who had declined to comment anything on this topic. A heightened scrutiny of its adherence to its compliance laws were expected by the company and this would include both the new and prevailing regulations as well as in the areas of anti-money laundering. The regulators have been putting down lots of efforts to track the money transfer across various banking networks and also fund flow from countries from international sanctions like Iran. The Department of Justice wants criminal case numbers that it brings under Bank Secrecy Act to be ramped up. It has taken this problem to be of primary focus and it has been concentrating on Bank Secrecy Act, which is a law that would require financial institution to take action in preventing money laundering. $700 has been put aside by British bank holdings this summer in order to cover the investigation and this could result in a big settlement (The Economic Times, 2012). This has been criticized to be a polluted culture of the bank. Transactions tied to Saudi Arabia, Mexico, Iran and Cayman Islands have been examined by Senate panel. Large trading losses have occurred last April and May at JP Morgan's Chief Investment Office and these were based on the London branch's transactions. The "hedging" strategy would consist of a series of transactions and this would include credit default swap (Eisinger, 2012). Outsized CDS position in the market was accumulated by the trader Bruno Iksil who is also nicknamed as London Whale. The final loss is expected to be a large one and the trading loss is announced to be around $2 billion (The Economic Times, 2012). The organization's risk-management's system and its internal control will be examined by several investigations. The systematic risks by financial institutions that were regarded to be "too big to fail" are considered as the best moderators by the lawmakers. 5. US Crisis and Credit Rating Agencies The Subprime mortgage crisis in the US has led to a sequence of events like pack of cards which has created a financial crisis round the globe level and this led a big recession in 2008 (Taylor and Williams, 2009).There were a lot of subprime mortgage delinquency and foreclosure and this has resulted in a decline of security backed by the mortgage. Lots of financial institutions have collapsed in the year 2008, and this has led to a considerable disruption in the credit flow to various businesses and this scenario has led to a worldwide global recession. The commentators have been blaming financial institutions for the crisis. The blame is shared among regulators, financial institutions, credit agencies and also consumers and government housing policies. This has been leading to a subprime lending. There has been a increase in low quality subprime mortgage from 8% to 20% in the year 2004 to 2006 (Zdanowicz, 2009).The adjustable-rate mortgage were huge in number in the year 2006.The higher-risk mortgage and lowered lower lending standards are a part of a wider trend. There were good amount of debts among the households and the ratio of the debt to personal income rose from 77% to 127% (Taylor and Williams, 2009). Prices of house peaked high during the initial period of 2006 and the price nose-dived at the later part of 2006. The erratic fluctuation happened in house rate led to difficult task of refinancing the individual money management commitment. The interest rate started rising, which not only burdened the EMI of individual but also the value of mortgaged property started to decline (US Department of the Treasury, 2007). Worldwide investor didn't show interest to buy mortgaged property from the bank/private institution. The above situation collapsed the US financing credit rating and also paved way for the slowest economic growth in US. There were several consequences created by this crisis that were long-lasting in the US as well as in the European countries. A deep recession entered the U.S and around 9 million jobs were lost in the year 2008 and 2009.This led to a reduction of 6% workforce (McSkimming, 2010). The housing prices in the US fell down to nearly 30% and the stock market prices were lessened by 50% in 2009.There was a good recovery in the stock market value in the year 2013, but there was not much rise in the housing prices in the US. The unemployment rate still seems to be prevalent. The economic crisis had not only affected the US but also the Europe in its own way. 6. Responses from the Regulatory Authorities The government took many reforms after the crisis hit the US since August 2007. During September 2008 the world market faced financial instability which created global awareness to the all countries to take step towards crisis (Chaikin and Sharman, 2009). Every government including politicians, government officials worked round the clock to face the subprime crisis efficiently. Central bank of USA partnered with federal reserve and took many steps which paved a major role in addressing the crisis.US government also spent billions and billions of tax payer's money to take remedial steps to deal the subprime crisis. The Fed has reduced the target for Federal funds rate to 2% from 5.25% whereas the discount rate has been changed to 2.25% from 5.75%.The changes were implemented in six steps from 18 September 2007 to 30 April 2008 (McSkimming, 2010). The target for federal funds rate was again revised in December 2008 falling in the 0-0.25% range, which is 25 basis points. Implemented together with different central banks with open market operations ensures that the member banks could remain liquid. In effect, these are short-term loans given to the member banks with government securities offered as collateral. Central banks have reduced the interest rates (termed in the US as discount rate) being charged from the member banks having short-term loans. They have also created different types of lending facilities so that the Fed can provide loans directly to banks as well as non-bank organizations, with specific collateral type of varying degree of credit quality being applicable. These would include the TAF (Term Auction Facility) and TALF (Term Asset-Backed Securities Loan Facility). In November 2008, the Fed declared a program to acquire the MBS of the GSE amounting to $600 billion in order to reduce the mortgage rates. However, President George W. Bush had also signed an economic stimulus package of $168 billion on 13 February 2008, which was mainly through checks for income tax rebate. These were to be mailed directly to the taxpayers (Bahena, 2009). The mailing of the checks began in the week starting 28 April 2008. Although, around the same time; there was an unexpected increase in the food and gasoline prices. This obviously led some to doubt whether the stimulus package will serve its purpose or the consumers will end up spending their rebates to compensate for increased fuel and food prices. The U.S President Barack Obama on February 2009 signed a stimulus package for $787 billion called the American Recovery and Reinvestment Act of 2009. It was signed with a broader view of tax cuts and spending. More than $75 billion of this stimulus package was specifically meant to help homeowners struggling with their mortgage and was allocated for them (Taylor and Williams, 2009). This program is called as the Homeowner Affordability and Stability Plan. 6.1 Bank Solvency and Capital Replenishment Many financial institutions suffered major losses due to mortgage based securities and other such assets acquired using borrowed money thus dramatically reducing their capital base. This has rendered many of them bankrupt or incapable of lending money. In many cases the government has provided necessary funds to banks and other financial institutions. However, some banks have also taken other steps such as acquiring additional money from private sources. 6.2 Failures and Bailouts of Financial Firms Many major financial institutions were bailed out by the government, merged with each other (voluntarily or otherwise) or simply failed to come out of the crisis despite all the help. Although the circumstances varied for different institutes, the main reason was that the mortgage-based securities declined in value, which resulted in either the companies becoming bankrupt, or incapable of getting new investors in the credit market. Typically a large amount of money had been borrowed and invested by these firms, which was very high compared to the equity capital held with them, making them highly vulnerable to extreme volatility in the credit market and unanticipated change. 6.3 Judicial Investigations and Responses The crisis resulted in enormous law enforcement action as well as litigation in many cases. The Federal Bureau of Investigation started suspecting fraudulent practices by mortgage financing agencies such as Lehman Brothers, Freddie Mac and Fannie Mae, also insurer companies such as the American International Group (Acharya and Richardson, 2009). The Federal lawmakers and regulatory authorities are focusing on renewal of financial regulation in view of the multibillion dollar trading losses incurred by JPMorgan Chase. The losses at JPMorgan came as a big surprise, it being the biggest U.S. bank considering its assets. This led to the revival of requests being made by the Obama administration as well as the Democratic lawmakers for stricter overseeing of Wall Street banks. However, the Republicans were convinced that it will not be possible to avoid another crisis with financial overhaul law and it may even drive the business overseas. The regulatory authorities are still in the process of drafting rules for the law and have also been influenced by the big banks to mitigate key areas. Most of the Republican lawmakers had voted against financial overhaul law, which had been drafted in view of the 2008 financial crisis . The Senate Banking Committee held a hearing of the matter during which two major regulators was questioned regarding the losses incurred by JPMorgan, the only big U.S. bank that could stay in profit during the crisis. The Securities and Exchange Commission chairman, Mary Schapiro said that her organization is completely "focused" on the JPMorgan issue. The SEC is closely scrutinizing the disclosures of the trading losses that the bank has made to its shareholders. The trading losses were disclosed by the CEO of JPMorgan, Jamie Dimon, by calling in an urgent conference with the journalist and investors. Dimon had rejected the issues about the bank's situation calling it "tempest in a teapot" , a type of comparison that he admitted to be "dead wrong". Gary Gensler, head of Commodity Futures Trading Commission, said that his agency has begun investigating JPMorgan's ill-judged investment in complicated financial instruments resulted in the trading losses. As per the financial overhaul, CFTC has gained major influence in overseeing the trading practices in derivative indexes (Ball et al, 2011). JPMorgan had invested large amounts of money in an index having products similar to insurance, which protected against defaults by bond issuers. The hedge funds betted that the index is likely to lose value, which made JPMorgan, sell the investments at a great loss. Jamie Dimon, CEO JPMorgan, said that credit derivative trading designed to mitigate financial risk led to the losses and not to make any profits for the bank. Senator Tim Johnson, chairman of the Banking Committee, said the he will invite Dimon to testify in the case in a related hearing being held in the near future. However, the trading losses in this case did not lead to a panic situation seen in case of Lehman Brothers in September 2008. But in any case it did shake the financial industry’s confidence. The stock prices of JPMorgan dropped by about 20% since the disclosure of the trading loss; this amounts to about $30 billion of the market value. It is still unclear if the JPMorgan incident would lead to stricter regulation. 7. LIBOR Libor is considered to be one the most benchmarked standard all over the world for around two decades. The process of rate setting has been highly transparent and this has made Libor an ideal benchmark for various financial products (Kuo, Skeie and Vickery, 2012). According to the argument of this group, there is no other institution that could alter the calculations single-handedly behind the rate. Libor is described by Willem Buiter, the former monetary policy committee member of Bank of England, as a rate at which the banks don't lend money from each other and has demanded for a replacement (Mollenkamp and Whitehouse, 2008). The same description was used by the Bank of England’s governor before the advent of Treasury Select Committee. Even though there has been rate-manipulation scandals around the Libor Integrity is still questioned. Around $450 million has been agreed to be paid by Barclay's in order to settle down accusations by regulators regarding its claim that that bank has used false Libor rates for deflection of criticism about its health. 7.1 LIBOR Calculation More than ten major banks that would include Citigroup, JPMorgan Chase, and Bank of America have estimated the interest rate that they would pay for borrowing money from other institutions. Thomas Reuters have performed the calculations while this process is supervised by the British Bankers' Association. Four highest and lowest submissions are discarded by Thomas Reuters as outliers and the remaining ones are averaged out. The bank submission is considered for the data provider in order to publish the calculation at 11.30 A.M. London time (Kuo, Skeie and Vickery, 2012). The three-month Libor rate of US dollar was at 0.4576% and this is one of the important Libor metrics. The value rose to 5% during the 2008 financial crisis (Snider and Youle, 2010). During those times, lending among banks was considered to be a riskier aspect and thus it was not encouraged until and unless a higher rate of interest in guaranteed. 7.2 How LIBOR was Utilized Borrowers were often asked to pay Libor with an additional amount of interest and this reflected the borrower’s credit risk. Libor is been primarily used by many of the mortgage lenders in the United States for the determination of interest rate for the adjustable-rate mortgage. An adjustable-rate would typically is 2 or 3 percentage points higher than the 6 month Libor rate (Snider and Youle, 2010). A plus or minus of 1 percentage over the Libor will be paid by bigger corporations with strong credits as it is considered to be a safer bet than mortgage borrowing individuals. Libor was mainly created for the purpose to benchmark the borrowing costs and it is still used for the same purpose even today by a larger sub group of financial products. Libor is also used by the banks to set the price on derivatives and other complicated financial areas which are instrumental are determining the price of the commodities, rate of interest and currency. 7.3 Importance of LIBOR American Law is considered to be violated on any manipulations done on Libor. This is due to the fact that Libor is widely used in the U.S derivative markets (Cummings, 1999). .Libor is used as a reference rates for mortgages, student loans and financial derivatives and any manipulation in Libor would have a big effect on consumers across the world. 7.4 Reliability and Scandal There was a controversial study released by Wall Street Journal in the year 2008 that the banks have reported understated borrowing costs to Libor during the credit crunch of 2008. These led to an impression that the borrowing rate of the banks from other banks is at a cheaper rate than the reality. This made a healthier impression on the banking system during the credit crunch of year 2008. According to a study made on Citigroup which is one of the major banks, the borrowing was made at 0.87 percentages lesser than the actual rate calculated by the insurance data (Snider and Youle, 2010). The ways to ensure the strength and competitiveness of the bank has been a strong topic of debate and this nature should not make it complicated to pose a threat tothe financial system when something goes wrong. The massive failure of the JP Morgan which was regarded as too big to fail has changed the perception of financial analysts to "too big to manage". This loss has added a new focus on overhaul law which is called the Volcker rule and this has been formed for prevention of bets on the bank's own profit (Bartlett, 2002). The protection of depositor's money insured by the government is defined by proprietary trading. It emphasizes on tapping the taxpayer's money in case of any scenario where their money has been wiped out. Volcker Rule has been finalized by the regulators and is one of the main vocal critics is 'Dimon'. However the bigger banks of the Wall Street were exempted by the rule (Metz, Kraten and Seow, 2012). Thus the risks involved in both broader as well as individual portfolio have been hedged out. The estimated average interest rate to be given by leading banks on London is offered as the average London Interbank interest rate. This is abbreviated as LIBOR and is officially known as BBA Libor. This is considered to be the primary benchmark for short term interest amount all around the world. Ten currencies are involved in Libor rated and around 15 borrowing periods are considered for it and this may range from overnight times to a year period and Thomas Reuters publishes these rates every day at 11.30am of London Time (Coughlan et al, 2007). There are quite lots of mortgage lenders and agencies who set their rate based on this. $350 trillion dollar worth of derivatives is linked to the Libor. Multiple criminal settlements made by the Barclays Bank made in June 2012 have revealed a big fraud related to rate submissions by member banks and this has led to Libor scandal. A LIBOR transfer oversight to the UK regulators was considered by the British Banker's association and this was recommended by Martin Whatley, the managing director of Financial Services Authority (Shiller, 2008). His review has recommended the banks to submit rates to LIBOR based on the actual market inter-bank deposit transactions and the records of the transactions are expected to be published in about 3 months. Benchmark interest rates are used for manipulating criminal sanctions. A higher volatile hedging and borrowing cost are experienced by financial institution customers after the recommended reforms have been implemented. The review made by Wheatley has been agreed by the British government and the press for implementation. In order to bring this into the limelight, Wall Street Journal has released a report in March 2011 that Citigroup, Bank of America Corp and UBS have been the focus for the regulators (Kuo, Skeie and Vickery, 2012). Determination of Libor rate does not occur in an open exchange and this has made the case to be very difficult. People familiar with this situation have reported that the subpoenas were issued to the above 3 banks. 7.5 Criminal Investigations A Criminal investigation was conducted by U.S Department of Justice on the Libor abuse and this was revealed on 28th February 2012 (BBA, 2012). The accusation was that the traders could be with a direct communication to the bankers before setting up the interest rates and this can allow them to predict the day's fixing. Around $350 trillion were underpinned by the Libor in the form of derivatives. According to a trader's message, a couple of millions of dollars are involved with each basis point that it was moved. A series of illegal action that are connected to the Libor are tied to Libor scandal and this has resulted in a chain of reactions and investigations. The average interest rated submitted by major banks across London constitutes the Libor. The banks have been inflating and deflating their interest rates falsely according to their convenience in order to show more profits or to increase their creditworthiness.They are controlled by British Banker's Association (BBA) and they underpin around $350 trillion worth derivatives. Around 26 direct warnings were issued to the Financial Services Authority for 'lowballing' the Libor rates. FSA has confessed that the 74 phone calls, minutes of the meetings and the email were all connected to it (Kuo, Skeie and Vickery, 2012). No investigation was launched for British-based banks for two years since its first warning in the year 2007. There was hardly any way to spot the rogue traders who manipulate the rates to boost the sales. The Commons Treasury Select Committee chairman, Mr. Andrew Tyrie had concerns that no significant action has been taking regarding it. He also felt the confirmation of Treasury Committee that the FSA was in fact very slow to take action against the evidences that it had received regarding the Libor manipulation. FSA had received around 26 warnings regarding this appalling practice and the other information required to ring the alarm bell (Metz, Kraten and Seow, 2012). The LIBOR has been the key number related to interbank lending rate that is been used by the mortgage for houseowners.US and UK regulators has fined Barclays with 290 million Euros. Similar fines have been granted to Swiss bank and RBS also. Two new watchdogs would replace the FSA, which will be disbanded in April. However the watchdogs were accused to be two years behind the US regulators to launch any investigation. There were numerous warnings from lenders, Bank of England right from September 2007 (Kuo, Skeie and Vickery, 2012). There were revelations by Barclays that they had submitted a lower interest rate in order to make the public believe that they are in a good shape. This practice is called as 'lowballing' and is confined to traders who fiddle the rates for the advantage of their own pockets (Fortune, 2008). Barclays was in a big crisis and this has forced the Middle East Investors to be tapped with 9 billion Euros in emergency fund in order to avoid the British Government from asking for a bail-out. 7.6 Reactions and Impact on Banking Regulation There may be a drive down of profits in finance industry for years due to the penalty and confidence loss in banks. This may cause a huge cost that may actually exceed the asbestos lawsuits. Europe The necessity of bringing the banking reforms into focus in the context of presentt crisis of confidence have been discussed by the Mainland European Scholars. They have been recommending the binding regulations to be adopted which could go deeper than the Dodd-Frank Act and these have been argued beyond legislations in France by the SFAF and WPS. The implementation of these rules should be within the wider context of power separation and this would end the anti-competitive practices that pertains to exclusive dealing and would limit any conflicts of interest as well. After the Libor scandal was revealed, this perspective gained strong ground and there was a call for implementing an EU "Glass Steagall II" by the leaders. 8. Recommendations According to a proposal made by the Martin Wheatley, the managing director of Financial Services Authority, there would be a Libor transfer oversight to the UK regulators. The independent review of Wheatley was published on 28th September, and this recommends an independent organization to work along with the government and form a committee namely the 'tender committee' in order to set up the Libor with good amount of transparency (Zuckerman & Burne, 2012). The submissions made to Libor actually have to submit their inter-bank deposit records. The review of the credit worthiness of the bank based on the records would later be submitted. There is also a possibility of the regulators to demand the bankers to force them to submit their records involuntarily. Criminal sanctions are recommended for any manipulation of interest rate benchmarks. After the implementation of the reforms, the Libor rates would be higher and the customers would in turn experience more volatility in borrowing costs. The UK government has agreed to go by the Wheatley's recommendations. 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