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How to Launder Money in the Futures Market

by J. Orlin Grabbe

A futures contract is a bet on the direction of price movement of some underlying commodity, financial asset, or index. The contract might involve crude oil, French government bonds, or the level of the S&P 500 stock index. The party that is "long" the futures contract is betting that the price will go up. The party that is "short" a futures contract is betting that the price will go down. If the price moves, there will be, with respect to the futures contract itself, a winner and a loser. If the price of whatever underlies the futures contract goes up, the long side will win, and the short side will lose. If the price goes down, the short side will win and the long side will lose. These losses are incurred every business day the contract is in existence.

For example, at the New York Mercantile Exchange (NYMEX), the crude oil futures contract is based on the price of West Texas Intermediate Crude. Each futures contract represents 1000 barrels of oil. So if the price of crude goes from $22.50 per barrel to $23.00, the long side of the futures contract will gain $(23.00- 22.50)x1000 = $500. The short side will lose $500. As another example, each live cattle futures contract at the Chicago Mercantile Exchange (CME) represents 40,000 lb. of cattle. So if the price falls from 64 cents to 63 cents, the short side of a single futures contract receives $(.64-.63)x40,000 = $400, while the long side loses the same amount.

The key way to use futures contracts to launder money is to arrange things so that the losing side of the contract involves "dirty" money. Michael Sindona, who ought to know, defined money laundering by the statement that "laundering money is to switch the black money or dirty money . . . to clean money." That definition is somewhat circular, but you get the idea. "Dirty" money is money that comes from illegal, or questionable, or unknown activities. Or it may just be ordinary money that one wants to make disappear. "Clean" money, on the other hand, comes from known and legal sources. For example, money earned from a futures contract is "clean" money: its source is well- defined, legal, and known. The terms "dirty" and "clean" are somewhat archaic. Money currently exists mostly in the form of electronic tokens: a digital series of 1s and 0s in bank computers. In this context, dirty money can be thought of as "naughty bits."

For example, in the late 1970s, Hillary Clinton made just shy of $100,000 in the cattle futures market. The source of the money was known: it was clean money collected in her account at the CME. She read the Wall Street Journal and rode the upward wave of cattle prices, she said. (Of course, there is a problem with this explanation. An analysis of her trades shows that most of her profits were made by going short cattle futures. That is, most of her $100,000 was made in periods when cattle prices were temporarily falling during this period of overall rising prices. Tyson Foods' attorney Jim Blair apparently forgot to inform Hillary what trades actually took place in her futures account.)

Now the obvious question arises: how do you arrange to get the price direction right? If prices fall, the short side will gain money and the long side will lose, so you want the long (losing) side to possess the dirty money. If prices are rising, you want the dirty money to be on the short side. Suppose you expect the price of the notional bond contract at the Paris MATIF to fall, so you arrange for the dirty money futures account to be long futures contracts. You also open another "clean" money futures account in another name to be short futures contracts. You then wait for prices to fall, expecting the dirty money to disappear into the black hole of futures losses, while clean money comes pouring into the "clean" account. But, instead, to your surprise, prices rise! The dirty money account thus collects more cash, while clean money is sucked out of the other account. It's a laundry in reverse: clean clothes in, dirty clothes out.

To prevent a problem like this, it helps to have the cooperation of a helpful futures broker. Let's call this broker-facilitator-prestidigitator by the name of Merlin Lynch. Merlin Lynch will create a long futures position to match the position of the party that is short futures, and a short futures position to match the party that is long futures. Merlin Lynch will, of course, extract a profit for itself--let's say in the form of a nice, fat round-turn commission of $13 per contract.

Let's say the dirty money is held in an account under the name of Dirty Dick. It is intended that clean money be accumulated into an account under the name of Clean Jane. Now there will be price fluctuations during almost all trading days, so Merlin Lynch makes matched trades at two materially different prices during the day. Let's say Merlin has customer money that needs laundering, and decides to do it using the copper futures contract at the COMEX. At a random time in the morning, Merlin Lynch enters the market and buys (goes long) 100 contracts, say at a price of 94.20 cents per lb., while simultaneously selling (going short) 100 contracts, say at a price of 94.10 cents per lb. The price of 94.10 represents the market's bid price, the price at which the market will purchase the futures contracts which Merlin is selling. The price of 94.20 represents the market's asked price, the price at which the market will sell to Merlin the futures contracts Merlin is buying.

Later, at a random time shortly before the close of trading, Merlin Lynch sells (goes short) the 100 contracts, say at a price of 92.30 cents per lb., and simultaneously purchases (goes long) 100 contracts at 92.40 cents per lb. Now Merlin is ready to launder some money. Since the price has fallen, Merlin assigns the purchase of 100 contracts at 94.20 to the Dirty Dick account, along with the sale of 100 contracts at 92.30. Since each COMEX futures contract represents 25,000 lb. of copper, the net loss to the Dirty Dick account is $(.9420-.9230)x25,000x100 = $47,500.

Meanwhile, Merlin assigns the sale of 100 contracts at 94.10 to the Clean Jane account, along with the purchase of 100 contracts at 92.40. The net gain to the Clean Jane account is $(.9410-.9240)x25,000x100 = $42,500. The $5,000 difference is the amount paid to the market for the laundering service. In addition, Merlin Lynch gets a brokerage fee of $13x100x2 = $2600, for a net cost of $7,600 to launder $47,500. This amounts to a laundering cost percentage of 16 percent. At these prices, the process is not terribly efficient, but workable in some cases. The natural evolution of the market will be to create more efficient, less costly laundering structures. This can be done in the current example by squeezing commission costs and bid-asked spreads.

To avoid raising eyebrows, the Dirty Dick account should be held by a party apparently unaffiliated with the holder of the Clean Jane account. For example, the Dirty Dick account could be held by Giant Copper Traders, Ltd., while the Clean Jane account is held by Uninsulated Wire Company. The clean cash accumulates to the benefit of Uninsulated Wire Company, who returns the favor by paying premium (above average) prices to Giant Copper Traders for supplies of copper. Uninsulated Wire Company, naturally, will want to gain something for its role in assisting the laundry process, so the premium price they pay for copper should not eat up the entire amount of its futures profit. This will increase Giant Copper Traders' cost of laundering funds.

Of course, if your intent is simply to bribe some politician, then the Dirty Dick account should be assigned to the company or other party paying the bribe, while the Clean Jane account should be assigned to the politician receiving the bribe (or to one of his trusted friends or relatives).

Now. Suppose you believe that all price fluctuations are random, and all people (other than, perhaps, the party with funds to launder) are honest. How do you arrange a structure so that stochastic price fluctuations will accomplish the laundry? No witting brokers, and no trades at artificial prices, are allowed. (This problem is left as an exercise for the student.)

November 24, 1996
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