A Century of Offshore Finance
Of all the countries involved in offshore wealth management, one has been active longer than any other, and it is still the number-one offshore center today. If we take a close look at this country's banking history, we'll reveal the intricate mechanisms of dissimulation that, starting from its center, have spread out all over the world, and the ingenuity of some bankers in safeguarding financial secrecy and fraud. And while tax havens rarely publish instructive statistics, this country is actually the exception to the rule: there is a remarkable amount of data from the country available, which have received astonishingly little attention. This country, of course, is Switzerland.
The Birth of a Tax Haven
The fabulous destiny of the Swiss financial center began in the 1920s when, in the aftermath of World War I, the main countries involved began to increase taxes on large fortunes. Throughout the nineteenth century, the greatest European families were able to accumulate wealth by paying little or no taxes. In France, on the eve of the war, a pretax stock dividend of 100 francs was worth 96 francs after taxes. In 1920 the world changed. Public debt exploded, and the state vowed to compensate generously those who had suffered during the war and to pay for the retirement of veterans. That year the top marginal income tax rate rose to 50%; in 1924 it reached 72%. The industry of tax evasion was born.
The industry's birthplaces — Geneva, Zurich, and Basel — enjoyed fundamentally favorable trends that were already in motion. At the beginning of the century, banks had formed a cartel (the Swiss Bankers Association was established in 1912) and were able to make the Swiss government pay relatively high interest rates, which made Swiss banks very profitable. And since 1907, they had benefited from having a last-resort lender, the Swiss National Bank, which could intervene in the event of a crisis and ensure the stability of the entire system. So by the eve of World War I, Switzerland had a financial industry with clear marching orders and a well-developed network of credit establishments. Also, since Switzerland has enjoyed the guarantee of perpetual neutrality since the Congress of Vienna in 1815, it emerged from World War I and the accompanying social upheavals relatively unscathed.
The boom in the tax-evasion industry was also made possible by the transformation of the nature of wealth. In industrialized countries, financial wealth had, since the middle of the nineteenth century, overtaken that of land ownership. In 1920 the holdings of the richest people in the world were essentially made up of financial securities: stocks and bonds issued by public authorities or by large private companies. These securities were pieces of paper that resembled large bank notes. Like notes, most of the securities did not bear names, but instead the phrase "pay to bearer": whoever had them in his possession was the legal owner. So there was no need to be registered in a cadastre. Unlike individual notes, stocks and bonds could have an extremely high value, as high as several million dollars today. It was possible to hold a huge fortune anonymously.
If you wanted to keep these paper securities at home under your mattress, you would run the risk of their being stolen, and so owners looked for safe places to keep them. In order to respond to this demand, beginning in the mid-nineteenth century European banks developed a new activity: wealth management. The basic service consisted of providing a secure vault in which depositors could place their stocks and bonds. The bank then took responsibility for collecting the dividends and interest generated by these securities. Once reserved for the richest individuals, in the interwar period these services became accessible to any aspiring capitalist. Swiss banks were present in this marketplace. But — an essential point — they offered an additional service: the possibility of committing tax fraud. The depositors who entrusted their assets to them could avoid declaring the interest and dividends they earned without the risk of being caught, because there was no communication between the Swiss establishments and other countries.
Looking for Lost Securities
Up until the end of the 1990s, the amount of wealth held in Swiss banks was one of the best kept secrets in the world. Archives were kept under lock and key, and banks were under no obligation to publish the details of the assets they were managing. It is important to understand, in fact, that securities deposited by customers have never been included in banks' balance sheets, even now, for a simple reason: those securities don't belong to the banks. Since the financial crisis of 2008–9, the term "off-balance sheet" has acquired a nasty connotation, notably referring to the sometimes complex arrangements that were carried out to remove American mortgage loans from bank books. But one of the off-balancesheet activities par excellence — coincidentally the oldest and still today one of the most common — is actually of childlike simplicity: holding financial securities for someone else.
If today we are able to know the amount of wealth held in Switzerland during the twentieth century, it is thanks to two international commissions appointed in the second half of the 1990s. The mission of the first — presided over by Paul Volcker, former chairman of the US Federal Reserve — was to identify the dormant accounts belonging to victims of Nazi persecutions and the victims' heirs. For three years, hundreds of experts from large international auditing firms explored the archives of the 254 Swiss banks that had been involved in managing wealth during World War II, producing masses of never-before-seen information — notably, the sum of assets held by each establishment in 1945. The goal of the second commission was to better understand the role played by Switzerland during the war. Presided over by the historian Jean-François Bergier, it also had extensive access to the archives of Swiss banks, which enabled it to establish the sum of securities deposited in the seven largest Swiss establishments during the twentieth century, which, from buyouts to mergers, became the UBS and Credit Suisse of today.
The statistics produced by the two commissions have limitations. Part of the archives had been destroyed; others were kept beyond their reach. But the information gathered by Volcker, Bergier, and their teams is by far the best we have for studying the history of offshore finance. In particular, the data on the assets under custody are of high quality, because, without publishing them, the banks internally kept a detailed accounting of their wealth-management activities, precisely recording the value of the securities that had been entrusted to them, stocks at their market value, and bonds at their face value.
In spite of all this, up to now that information had never been compared to the overall level of European income and wealth in the interwar period, notably due to a lack of statistics on national capital stocks. This is the first contribution of this book: to bring everything together — and the results deserve our attention, for they challenge many of the myths that surround the birth of Switzerland as a tax haven.
The Swiss Big Bang
The first thing we learn is how extraordinary the rise of Swiss banking at the end of World War I was. Between 1920 and 1938, offshore wealth — meaning that belonging to non-Swiss residents — managed by Swiss banks increased more than tenfold in real terms (that is, after adjusting for inflation): it went from around 10 billion in today's Swiss francs to 125 billion on the eve of World War II. This growth contrasts vividly with the stagnation of European wealth in general: due to a whole series of economic, social, and political phenomena, the private wealth of the large European countries was approximately the same in 1938 as it was in 1920. Consequently, the percentage of the total financial wealth that households on the Continent were hiding in Switzerland, fairly negligible before World War I (on the order of 0.5%), increased greatly to reach close to 2.5%.
Who owned all of this wealth? A tenacious legend, maintained since the end of World War II by Zurich bankers, claimed that Swiss banking owed its rise to depositors who were fleeing totalitarian regimes. For proponents of this thesis, the banking secrecy law that was enacted in 1935 had a "humanitarian" aim: it was meant to protect Jews fleeing financial ruin. And so in 1996 the Economist wrote that "many Swiss are proud of their banking secrecy law, because it ... has admirable origins (it was passed in the 1930s to help persecuted Jews protect their savings)."
This myth has been debunked by a great deal of historical research. The Volcker commission identified more than 2.2 million accounts opened by non-Swiss individuals between 1933 and 1945. Out of that total number, around 30,000 (or 1.5%) have been linked, with varying degrees of certainty, to victims of the Holocaust. The data established by Bergier and his team show that it was in the 1920s — and not the 1930s — that the Swiss "big bang" occurred. From 1920 to 1929, assets under custody grew at a yearly rate of 14% on average. From 1930 to 1939, they grew only 1% per year. The two most rapid phases of growth were the years 1921–22 and 1925–27, which immediately followed the years when France began to increase its top tax rates. Swiss banking secrecy laws followed the first massive influx of wealth, and not the reverse.
What does it matter if reality belies the propaganda put out by the bankers? The legend hasn't died — at the very most it has metamorphosed. These days, as is constantly repeated, most customers are fiscally irreproachable and deposit their money in Switzerland only to flee the instability or oppression of their home country. But, as we will see, more than half of the wealth managed by Swiss establishments still today belongs to residents of the European Union (although the share held by developing countries is rising fast), thus making this assertion as fallacious as the preceding one, unless we consider the EU to be a dictatorship.
In the interwar period, the customers of Swiss banks for the most part were French. For example, at Credit Suisse, at that time the largest bank involved in wealth management, 43% of the foreign-owned assets belonged to French residents, only 8% to Spanish or Italian savers, and 4% to Germans. The geographical percentages are imperfect, because the depositors did not always give their true address (instead, some gave that of a Swiss hotel, in which case the funds were recorded as belonging to Swiss residents), but all the other data collected within the framework of the Bergier commission confirm that the highest percentage of capital came from France. On the eve of World War II, the available data suggest that 5% of all the financial wealth of French residents was deposited in Switzerland.
What did hidden wealth look like? For the most part, it was made up of foreign securities: stocks of German industrial companies or American railroads, bonds issued by the French or English government, and so on. Swiss securities occupied a very secondary place, for two reasons: the local capital market was much too small to absorb on its own the mass of wealth that took refuge in Switzerland, and the returns on foreign investments were more attractive — on the order of 5% for securities from North America versus 3% for those from Switzerland. After financial securities, the balance was made up of liquidity (bank deposits such as saving accounts, which appear in banks' balance sheets) and a bit of gold, but foreign stocks and bonds dominated by far. The same is true today, and it is essential to emphasize this point, because it is a source of recurring misunderstanding: for the most part, non-Swiss residents who have accounts in Switzerland do not invest in Switzerland — not today, and not in the past. They use their accounts to invest elsewhere, in the United States, Germany, or France; Swiss banks only play the role of intermediary. This is why it is absurd to think that Swiss offshore banking owes its success to the strength of the Swiss franc, to the traditionally low inflation rate prevailing in Switzerland, or to political stability, as its apologists continue to claim. Through their accounts in Zurich or Berne, bank customers from other countries make the same investments as from Paris or Rome: they buy securities denominated in Euros, dollars, or pounds sterling, whose values go up and down depending on devaluations, defaults, bankruptcies, or wars. Whether these bits of paper are held in Switzerland or elsewhere doesn't change anything.
For a customer, the main reason to deposit securities in a Swiss bank is and always has been for tax evasion. A taxpayer who lives in the United States must pay taxes on all his income and all his wealth, regardless of where his securities are deposited; but as long as Swiss banks don't communicate comprehensive and truthful information to foreign governments, he can defraud tax authorities by reporting nothing on his tax return.
The First Threats to Berne
At the end of World War II, wealth management in Switzerland went through a crisis. First, there was a lack of customers. The destruction of the war, the collapse of financial markets, the inflation in the years immediately following the war, and nationalization — altogether these factors annihilated the very large European fortunes that had survived the Great Depression. Private wealth on the Continent reached a historically low level — at scarcely more than a year of national income in France and in Germany versus five years' worth today. Switzerland had not been affected by the war, but the rest of Europe was in ruins. Between 1945 and 1950, the value of hidden wealth decreased, which hadn't happened since 1914.
But above all, for the first time Switzerland found itself under the threat of an international coalition that wanted to do away with banking secrecy. In the spring of 1945, Switzerland, which had compromised a great deal with the Axis Powers during the war, sought the good graces of the victors. Charles de Gaulle, supported by the United States and Great Britain, imposed a condition on this rapprochement: Berne was to help France identify the owners of undeclared wealth. The pressure that was exerted then was all the greater in that a large part of the French assets managed by Swiss banks — around a third of the total, according to accounts at the time — was made up of American securities physically located in the United States (conveniently for the banks and their customers, who could thus buy and sell more quickly). But these assets had been frozen since June 1941 by Uncle Sam, who suspected Switzerland of being the sock puppet of the Axis countries. To unfreeze them, the United States demanded two declarations: one from Switzerland revealing who really owned the funds; the other from the French tax authorities indicating that the assets had indeed been declared. For Congress, it was out of the question to send billions of dollars via the Marshall Plan without first trying to tax French fortunes hidden in Geneva!
The history of private banking in Switzerland might have stopped there, because the situation was objectively catastrophic. By freezing assets, the United States had a powerful means of pressure. Swiss bankers, with the complicity of the authorities, nevertheless got out of the predicament brilliantly. How? By engaging in a vast enterprise of falsification, which has been documented by the historian Janick Marina Schaufelbuehl. They certified that French assets invested in American securities belonged not to French people but to Swiss citizens or to companies in Panama — a territory where it was already particularly easy to create shell corporations. The US authorities were duped and, with very few exceptions, unfroze the assets on the basis of these false certifications. Boding well for the future, Swiss bankers used this same fraud again in 2005 to enable their customers to escape a new European tax, as we will see in chapter 3.
From the mythology created expressly to justify the banking secrecy law up to large-scale fraud to cover defrauders, everything points to the dishonesty of many Swiss bankers. And so no solution to the problem of tax fraud can be based on their so-called goodwill, as are, however, all the plans recently devised to fight against tax evasion. For example, according to the Rubik agreement with Great Britain, set up in 2013, banks agree — without any checks in place — to collect a tax on the accounts of British customers and to give the proceeds to Her Majesty's Treasury. But history has proven that this approach doesn't work: agreements of this type are destined to fail because banks will always claim to have no, or very few, British customers and will collect essentially no taxes. Therefore, it is essential to break with such logic and no longer rely on goodwill and self-declaration, but on constraints and objective procedures for verification.