Trust in Money Laundering

It is said that there is no honor among thieves. The phrase, as it is used colloquially, refers to any group that engages in criminal behavior. It does not refer only to thieves. The idea is this: if you are a thief, then you never want to trust the word of another thief. You can always assume that the other thief will rat you out if it gives them any sort of advantage. You can find a clear example in the prisoners' dilemma.

Here's an illustration: suppose that there are two thieves, A and B. The police caught A and B red-handed taking property from a house. The police, therefore, has evidence that both A and B have committed theft (defined as the unlawful taking of another's property, without the use of violence). 

At the same time, the police discovered the owner of the house beaten and bruised in an alley nearby. The police suspect that A and B ambushed the owner of the house, stole his house keys, and went on their way to steal from the house. If this were true, then A and B would have committed the crime of robbery (unlawful taking of another's property, with the use of violence) which carries a more severe penalty compared to theft. However, the police has no evidence that this actually happened. 

So, during when the police interrogated A and B at the police station, they offered each thief a deal. If one rats out the other, but the other remains quiet, then the one who rats the other out gets no jail time at all. On the other hand, if both of them remain stubborn and neither confesses to robbing the homeowner, they will still get the penalty for theft. 

In a prisoners' dilemma, the rational thing for thief A to do is rat out their co-conspirator thief B so they don't get a prison sentence at all. They will believe that the deal is too good to pass up, so they'd rather take their chances that B will be quiet. However, thief B is likely thinking the same thing. The equilibrium that game theorists expect is that the thieves will rat each other out. This results in the worst possible outcome for both of them: The police now has confessions from each thief that they conspired to use violence to rob an innocent homeowner. Bingo, they can secure a conviction of robbery for both of them. 

(As a side note: in real life, these confessions would require the presence of a lawyer representing the accused. Otherwise, the confession is not valid. There are also times when the accused waive their right to an attorney. However, the police might have coerced or manipulated the accused to execute the waiver. So, at least in the Philippines, both confessions and waivers of the right to representation have to be made in the presence of counsel. On this point, I really recommend "When They See Us" on Netflix)

There is no honor, no trust, among thieves because when the chips are down, there is every incentive to betray. However, what if there is a system where thieves can cooperate to eliminate the problem altogether? In such a system, it would be precisely trust that could allow a group to get away with crime.

Here, I want to talk about a certain form of money laundering that puts trust in its center: the Hawala system. It is a surprisingly simple method of transferring money, and in fact it has been around for more than a thousand years. Yet, until today, it is extremely difficult to trace the use of the Hawala system.

What is Hawala? 

Hawala (Arabic: حِوالة) literally means transfer or exchange. However, it is also sometimes taken to mean trust or transformation. The system originated in 8th century India, and was made to facilitate trade between merchants who operated via the silk road.

In those days, if one carried around a lot of physical money, there was a high risk of the courier being stolen from. In many classes about the history of money, it is taught that this development was the reason for the creation of checks, promissory notes, and other negotiable instruments that took the place of large quantities of money. That comes with its own problems-- what if the negotiable instrument is stolen? What if you don't trust the ability of the issuer, maker, or drawer of the instrument to pay on the instrument (ugh I spent an entire semester on negotiable instruments-- it was not a good time)? 

To solve for this, the Western financial system created financial intermediaries like banks that people can trust. But there are still a lot of transaction costs involved in banking. A lot of documents are required to set up an account. A lot of regulations are put in place by the government, which increases the costs. Banks are also run by many people, so it is also quite expensive to set up a bank in a far-flung area.

The Hawala system represents a parallel development. It is sometimes referred to as underground banking. It created a solve for all the problems we've talked about above. No papers. Nothing to be stolen. The people who transfer money are absolutely trustworthy because they stake their reputations on the line to facilitate these transfers. No red-tape. Low transaction costs. It can also exist in any community, regardless of its size. 

In fact, for very traditional Muslim communities where women should maintain minimal contact with the outside world, the Hawala system gives opportunities to women to access financial intermediaries without needing to go to a bank. 

Also, and this is the part that makes Hawala so crazy to think about, the system can transfer money from two persons X and Y without the money ever moving. 

How does the Hawala System Work?

Let's say X wants to send money to Y.  X lives in Narnia, which is very far from Gondor, where Y lives. There is a vast sea separating these two countries. Thankfully, they have access to special brokers within the Hawala system, called hawaladars, and there are hawaladars in both Narnia and Gondor. Let's call the Narnian hawaladar XX, and the Gondorian hawaladar YY.

X will give money to his friendly neighborhood hawaladar, XX, saying that it is meant for his Gondorian friend Y. X then gives XX a password like "Elen síla lúmenn' omentielvo," which is an ancient Gondorian greeting meaning "a star shines on the hour of our meeting." X and Y had previously agreed upon this password.

XX calls up the Gondorian hawaladar YY and says "someone named Y will ask for this amount of money, and the password is 'Elen síla lúmenn' omentielvo.'" Y goes to his hawaladar YY and gives the password. YY gives the money over, minus, of course, YY's commission.

Then, it is understood that XX owes YY the money given. 

Thus, there is a transfer of money between X and Y, but no money was actually given by X to Y. On paper, the only transaction is a paper-less "I owe you, I promise" between the hawaladars XX and YY. In this way, the true transaction between X and Y are completely hidden from any official records. 

Here's a more complicated example involving two transactions:

The fact that this system does not require documentation means that it can quite easily be used for illicit purposes. What if X was paying Y to make a contract killing? What if Y was X's supplier of drugs and Y needed a way to get clean money from the sale? All of these are possible with the Hawala system.

This entire system is built on trust. X trusts XX not to rat on X; Y trusts YY not to rat on Y; XX trusts YY to give the money to Y; YY trusts XX to pay him back. There are so many assumptions that we have to make in order for the Hawala system to work. And yet, despite all odds, it works!

In the Hawala system, everyone's interests seem to be aligned. The hawaladars have absolutely no incentive to tattle. In the first place, they had nothing to do with how X or Y used the money. They can't be faulted for anything their clients did. Moreover, the hawaladars need to keep themselves trustworthy to the rest of the network, otherwise they lose a source of livelihood. This assures not only that they will keep the identities of their clients safe, but it also assures that hawaladars will pay each other back. 

X and Y cannot be traced to each other because, again, there is absolutely no proof that a relation between X and Y ever existed. Even if Y is caught by the police in Gondor, there is no reason for Y to rat on X. Why? Because Gondorian police does not have jurisdiction over X, who lives in Narnia. Thus, the police wouldn't even offer a lower penalty to Y in exchange for information about X.

The entire system is based on trust, but because it carefully removes any incentive to betray, it remains stable. And invisible.

Hawala as a way to fund terrorism

To make this situation even worse, the Hawala system isn't just used to conceal money derived from crime. It is also used to covertly fund terrorist operations. In 2017, the Abu Sayyaf Group and the Maute Group laid siege on the city of Marawi. The siege was the longest urban battle in the Philippines' history, lasting more than five months. By the end of the siege, 95% of the structures within the four square kilometers of the main battle had been damaged or had completely collapsed. The siege forcibly displaced more than 200,000 persons, including 2,500 displaced members of indigenous communities.

There were five ways that the Abu Sayyaf Group was able to obtain financing for the Marawi siege: overseas wire transfers, cash couriers in the battle zone, private remittance centers authorized by the central bank, anonymous mobile payments, and the Hawala system. Wire transfers and transactions by or via private remittance centers may be examined and traced by the Anti-Money Laundering Council. Cash couriers (literally stuffing money into a briefcase like in the movies) are more difficult to track because there is no paper trail. However, inter-governmental groups such as the Financial Action Task Force have already created clear steps to combat money laundering through the use of cash couriers. In particular, Special Recommendation IX asks countries to take measures to detect cross-border transportation of cash. Anonymous mobile transfers may also be monitored: many of these are done through mobile applications like PayPal, GooglePay, GCash, etc. All of these are subject to domestic regulation. In fact, PayPal expands on and goes beyond the traditional Know Your Customer collection of data, by also looking at red flags like spending amounts, in addition to compliance with domestic Anti-Money Laundering regulations.

Hawala is the best of these five ways. It is anonymous, which means they have the benefits found in cash couriers and mobile transfers. It is analog and does not have a paper trail, which means it does not carry the same risks found in mobile cash transfers, wire transfers, or private remittance centers. It also does not involve cross-border transportation, which means that the FATF recommendations do not adequately combat Hawala.