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Bond Villain in the World Economy: Latvia’s Offshore Banking Sector

Photo by Marco Verch | CC BY 2.0

If the world economy were a Bond movie, Latvia’s offshore banking economy would be its Bond villain. Presently, this plucky state of 1.8 million people on Russia’s border is leading the world’s financial press with two major scandals.

First, there is their long-standing Central Bank Governor, Mr. Ilmars Rimsevics. While Latvia’s population (disproportionally aged, as many of the young have left to find work abroad) only rivals that of Hamburg, but with a much smaller economy, Mr. Rimsevics nonetheless commands a salary bigger than Central Bank heads of most similar sized countries and in 2016 saw the largest percentage salary increase of any EU Central bank head.

Regardless of his super-sized income, Mr. Rimsevics has been accused of using his post as a sinecure to increase his pay by several multiples. His ‘victims’ being the banks in Latvia that he oversees, of which one, Norvik, the provenance of a Russian oligarch in London, protested. Moreover, a photo of Mr. Rimsevics was published by the Associated Press showing him fraternizing with characters of dubious provenance from the post-Soviet world in the proverbial hunting lodge.

In the complex and messy world of Latvian offshore banking, the veracity of this photo is open to question as is whether Rimsevics is being set up for running afoul of oligarchs, or is getting burned for trying to extract too much from them. Mr. Rimsevics claims the episode is a coordinated effort (implying Russia as the culpable figure) to make Latvia look bad in the international community, which while plausible given Russia’s past and present actions, is also convenient as an explanation to clean Rimsevics’ own possible dirty laundry.

The other scandal, more serious, but lacking a face and bereft of central casting’s villainous imagery (e.g., oligarchs at the hunting lodge), is that of ABLV. ABLV is the largest Latvian owned bank. Latvia is a small country with lots of ‘banks.’ ABLV is largely a correspondent bank, or a bank holding deposits of foreigners along with providing them with ‘services’ that conceal the identity of their owners.

Correspondent banking, euphemistically in the ‘industry’ called “wealth management” and “tax optimization,” or what those who, such as former Syriza finance minister Yanis Varoufakis, might ‘rudely’ call “stealing.” Just as Mr. Rimsevics has seemingly been caught with Russian oligarchs, ABLV has been linked to handling money for North Korea’s weapons program. This crossed the line for the United States, which in the main has vacillated between support and tolerance of offshore banking, but who since 9/11 has become wary of its ‘downsides,’ such as terrorists and ‘axis of evil’ states availing themselves of their helpful services.

Latvia has been an offshore economy from the start. This largely is a function of history and location. The Soviet occupied republic of Latvia contained the USSR’s largest sea port for oil exports. As the Soviet Union unraveled, Latvian ports became magnets for corruption, theft and windfall profits that made overnight oligarchs of Soviet professors and hustlers.

Among the first was the former Vice-Rector of the University of Latvia in the early 1980s, Gregori Luchansky. Luchansky was removed from his post for selling university furniture and supplies on the black market. Luchansky responded by moving into more lucrative terrain, chiefly acquiring Soviet oil at subsidized state prices and selling at market prices on the world market. Luchansky later partnered with the U.S.’s infamous Marc Rich in shady oil deals (Rich was later pardoned on tax evasion charges by Bill Clinton on his last day in office, which former President Jimmy Carter called “disgraceful”).

Such arbitrage opportunities were abundant as the Soviet Union was both collapsing and during the chaos years just after its demise. Offshore banks emerged in Latvia to handle the torrents of cash from selling off the former USSR’s oil and metals, directing the money away from taxation to fund social taxes and into accounts concealing the names of their owners.

The largest of these Latvian offshore banks was Parex, which was established by two enterprising Komsomol (communist youth league) figures that created the Soviet Union’s first legal currency exchange. Their business expanded from handling offshore accounts throughout the former USSR, to the 21st century where West African warlords and East Asian capital was brought into their fold. Parex went bust following the 2008 global financial crash, where Latvia saw the world’s largest contraction of GDP.

Yet, tiny Latvia would see its government push upwards of a billion euros to guarantee Parex’s offshore deposits and protect oligarch investors and international bondholder syndicates who pulled above market-rate from it. The purpose of this massive bailout was two-fold: 1) protect Latvia’s ‘core business,’ offshore banking by demonstrating Latvia would bear any cost to protect this ‘industry,’ including imposing punishing austerity on its people; 2) Prevent a contagion effect on European banks by cauterizing the run on deposits that was beginning to bleed over to Sweden’s Swedbank and SEB (where Swedish banks are massively exposed in the Baltic States).

The above described punishing austerity regime restored Latvian macro-economic stability and confidence in its offshore banking. The demographic implications of this restoration through austerity were catastrophic. Young people exited Latvia in the hundreds of thousands, which risks the country turning into a retirement home and nature preserve. The biggest offshore banking player, post 2008 became ABLV, followed by Rietumu. Among scandals after 2008 were Swedish TeliaSonera bribes of nearly a billion euros to Uzbekistan leaders run through Latvian banks; the looting by a Moldovan oligarch of a billion euros passed through Latvian banks.

During the 1990s the United States and the United Kingdom gave Latvia a pass on this offshore activity. Voluminous flows of money flowed from the former USSR through Latvian banks en route to US and UK banks and equity markets. 9/11 changed this for the US and the ‘New Cold War’ with Russia following Russia’s annexation of Crimea and intervention into the Donbass even more so. The US put Latvia (chiefly Mr. Rimsevics) on notice to reign in this offshore sector in if it hoped to join the OECD in 2016. Rimsevics did a boxer’s feign in that direction until OECD entry was achieved and then Latvia’s banking sector punched with its old offshore banking ways, although it has yet to return to its 2015 peak size with offshore accounts and likely will never again.

Latvia possesses an enormous reserve of talent and people of integrity, yet its offshore banking sector, and the macro-economic policies in the service of sustaining it, have fueled corruption and inequality both within its borders and outside them. This has damaged their real economy of legitimate services and goods. Meanwhile, this offshore banking has worked against the political stability created by the post-World War II European Social Model. With this tax evasion infrastructure available throughout the post-Soviet and West European world, it has become difficult to sustain the old Social Europe, let alone build a new one further east. Thus, it should be no surprise that we are seeing the rise of neo-populist rightwing reactions as a result.

John Kenneth Galbraith used to say that “all successful revolutions are the kicking in of a rotten door.” The economies of Europe represent a rotting door that will be kicked down. We should prepare a replacement ‘door’ that ensures Europe returns to economic policy embedded in society, or risk a return to more unpleasant paths Europe has previously traveled to…

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Jeffrey Sommers  is a proud Dairy Stater and Visiting Professor at the Stockholm School of Economics in Riga His book on the Baltics (with Charles Woolfson), is The Contradictions of Austerity: The Socio-economic Costs of the Neoliberal Baltic Model

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