Usury versus Reality

To take usury for money lent is unjust in itself because this is to sell what does not exist.

This is not to rule out lending per se, but to rule out usurious lending. It is not to rule out interest per se, but usurious interest. These distinctions obtain, even granted that money can operate as a store of value (although I would point out in respect thereto that money’s capacity to function as a store of value depends entirely upon its general acceptance as a medium of exchange; “stored value” is just a way of saying “deferred exchange”).

Perhaps the distinction might be made clearer by tracing the aetymology of “usury,” which derives from the Vulgate usare, “to use.” A usurious loan is one in which the lender expects to continue to enjoy the value of the use of his money, *in addition* to his enjoyment of the value of his equity interest in the project for which his money has been lent.

The equity interest of a creditor in his debtor’s project is realized – is implemented in economic history – via the collateralization of the note by some really actual asset belonging to the debtor. In effect, the creditor uses the principal of the loan to “buy” the collateral from the debtor, which the creditor then rents to the debtor in exchange for interest – the interest being the debtor’s rent payment. The asset that the creditor has invested in the debtor’s project, then, is his equity stake. There is no theologically given upper limit to the interest rate that is just under such an arrangement. Rather, the justice of the interest rate will depend upon the circumstances, as justice ever does.

Such “non-recourse” loans are not usurious:

Non-recourse debt or a non-recourse loan is a secured loan (debt) that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the borrower defaults, the lender/issuer can seize the collateral, but the lender’s recovery is limited to the collateral. Thus, non-recourse debt is typically limited to 50% or 60% loan-to-value ratios, so that the property itself provides “overcollateralization” of the loan.

To the extent that the lender has recourse to other assets not specifically collateralized by the note – including the human life value of the debtor – his note is usurious.

Why is such excess interest – i.e., & NB, not “interest that is too high,” but “interest in excess of the creditor’s equity interest in the project” – immoral? Because it represents an attempt by the lender to have his cake and eat it too. How so? “Having his cake” is “having the use of his money.” It is enjoying the option of doing whatever he likes with his money. But once he has invested his money in the debtor’s project, that optionality has utterly disappeared from the world, even as a potentiality. He has “eaten” it, and he is no longer free to have done other than as he has done. The very notion of such a freedom is nonsense. By investing in the note in the first place, he has used up his option to use his money, and it is just gone. It is perverse then for the creditor to expect to be compensated for what no longer exists, which therefore he does not possess.

A proscription of usury would not destroy the credit markets as we know them. It would merely forbid recourse loans. This would prompt creditors to undertake more careful due diligence than they now do, to ensure that the assets they are specifying as collateral do actually exist and are actually worth what their counterparties say they are worth. It would also prevent borrowers from overextending themselves in their use of credit.

But neither of these would be bad things. Indeed, they would be good things. They would have prevented the Crash of 08. They would ensure that we (as an economic polity) did not commit ourselves to funding projects for which the economic resources did not actually exist. They would, that is to say, prevent us from lying to ourselves, or misleading ourselves about what it is really possible for us to undertake, given the resources we have actually on hand. And this would in turn greatly reduce the moral hazard of the credit markets, by reducing the opportunities for misleading others provided by the current prevalence of recourse loans. If recourse loans were proscribed, the risk embodied in the credit markets would be reduced to a fantastic degree. This is another way of saying that such a proscription would increase the perfection of the credit markets, by decreasing the noise to signal ratio of its pricing mechanisms. Proscription of recourse debt would increase the accuracy of the credit markets, and this would tend to prevent booms and crashes generated by misinformation.

Nor would proscription of recourse loans even necessarily reduce the velocity of the credit markets. All it would do is push them away from unsecured lines and toward secured lines, which are next door to preferred stock. The market for preferred stock is perfectly liquid, and the velocity of finance implemented via such instruments is just as great as for common stock. There is nothing, e.g., to prevent a syndicate of banks from agreeing to provide Apple with a secured line; this would be tantamount to an agreement to buy from Apple each day as much preferred stock in Apple as Apple desired to put to them, and sell back as much as Apple desired to take (this would not be a new kind of business; it is exactly what market makers now do on the floor of the NYSE).

A proscription of usury would reduce the size of the fake economy, and increase the size of the real economy; and by reducing noise and moral hazard, it would make the good more apparent to all economic agents, so that over time it would operate to increase the proportion of the real economy that was engaged in the production of real goods, as opposed to evils. It would increase the likelihood that social assets would be invested in such a way as to promote human flourishing.

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29 thoughts on “Usury versus Reality

  1. One of the most convincing “aha!” moments for me was when I realized just how astonishingly healthy it would be for the economy if the government simply refused to use taxpayer resources to enforce deficiency judgments on usurious loans.

  2. Coincidentally, you’ve just described a ‘sharia-compliant’ loan. All loans under sharia MUST be structured this way—to be at least nominally an investment on the part of the lender, where all risk beyond the offered collateral must remain.

  3. Pingback: Usurpalooza « Zippy Catholic

  4. This discussion needs to talk about the Parable of the Talents. Jesus would never use something evil to stand for something good, so “putting money at usury” must in some circumstances be lawful and acceptable for Christians to do. I interpret this to mean that charging interest can be lawful even if excessive interest is sinful; but we need to be careful about the word “usury” itself since in the older English translations it means simply lending at interest in a way which can be morally acceptable.

    • Good point. Remember that usury is not the charging of interest per se, nor is it the charging of interest that is “too high,” but is rather the charging of interest in excess of fair market rents for the lender’s equity stake in the borrower’s project. If that equity stake is represented by the lender’s collateral in, say, a printing press, then the fair market interest rate on the loan is something like the local rental rate for printing presses, perhaps adjusted by a factor for the risk of the project or of the borrower.

      Talents invested with bankers at interest are not ipso facto usurious, provided that the loan to the bankers is collateralized by rights terminating in actually existing assets.

      • Your definition of “usury” as distinct from ordinary lending is coherent (though not easy to implement in practice), but I would like to know where it originates, and what the Church has said on the matter. In the Middle Ages more lending was apparently regarded as sinful than your definition covers, and now less is.

      • Polymath:
        Here is a teaching document of the Magisterium of the Church, promulgated in 1455, that may answer your question about Kristor’s apparent – I would argue only apparent – laxity in permitting “interest” as the leaseback of the lender’s equity interest in the borrower’s project. You will also find that “laxity” in Aquinas distinction in the Summa between a mutuum and the formation of a “kind of society”, that is, a combined equity interest in some specific project, where recourse for recovery of principal and profitable interest is to the assets of the project.

      • Also, I would argue that it is very easy to implement in practice: simply stop using government resources to enforce deficiency judgments.

  5. Polymath —

    How much a comparison to the Middle Ages would clarify is an interesting question, but very difficult to carry off effectively.

    I can assure you that steps toward prohibiting, or even severely constraining non-recourse loans, would have dramatic effects on world financial markets. Thousands of lending institutions (many of them the shadow banks that don’t appear to laymen’s eyes as banks at all) would almost instantly become no longer going concerns.

    Maybe that ain’t a bad thing though.

    And there is also a subtlety introduced by corporate personhood in all its enormous variety. Are corporate unsecured debt instruments usurious? or only those debt instruments that link to real people? Was AIG engaged in usury, or was it just stupid? Commercial paper is after all a very ancient form of finance; I would not say that it is by nature usurious; it began as very informal personal commitments of capital in a sort of gentleman’s bargain, among the Italian maritime city-states of . . . wait for it . . . the Middle Ages.

    • Paul, I’m not disagreeing about the economics but I still want to know the official teaching on what kind of transactions are sinfully usurious and how to recognize them. Do you have a reference?

    • I would say that unsecured corporate paper is not usury, because in the event of default, the buyer thereof – the lender – has recourse to the assets of the corporation, ahead of the shareholders.

      AIG then was not being usurious, but merely stupid. This was not entirely their fault, of course. They were misled. There was a lot of government-mandated lying about the true value of mortgage collateral and creditor risk going on, which made it very hard for a downstream institution like AIG to really know what they were getting themselves or their customers into. There were also the relaxations of underwriting standards, which resulted in NINJA mortgages and loan to value ratios of 100%, all on the one hand forced by the regulators and on the other safely and profitably bought out from the books of the originators by Fannie and Freddie. All of this fed back into increased demand for residential real estate, which pushed up prices, further misleading lenders by artificially inflating real asset values.

      In effect, the Feds said to the market, “Hey, don’t worry about all this moral hazard we are mandating; we’ll shift the risk to us. Just go for it.”

      Is an informal personal commitment between gentlemen usurious? No; only formal commitments, that have enforceable recourse, are possibly usurious. A gentleman’s agreement is not enforceable in a court of law. A gentleman who has welshed on such an agreement is subject to obloquy, and to greater difficulty in future business dealings due to his harm to his own reputation, and at worst to ostracism. But he is not subject to financial or legal penalty.

      • But greater difficulty in future business dealings, harm to reputation, and at worst ostracism is precisely what penalties await anyone who petitions modern courts for “protection” from his creditors. Does not then modern bankruptcy law turn all such lending into “informal” commitments?

      • An excellent question. I don’t think it does. Bankruptcy after all voids formal agreements.

        Bankruptcy is an excellent thing to bring up, because it highlights the injustice of usury. The bankrupt debtor – who is, recall, the usurer, having sold to his lender what does not exist – recurs to the courts when it becomes apparent that he has sold the lender a pig in a poke. The lender is not blameless in the circumstances, for in buying his creditor’s unsecured promise in the first place he has been foolish, or careless, or imprudent, or all three.

        The test of whether or not a contract is usurious does not rest on whether the debtor ever must actually turn over a pound of his flesh to his creditor, but on whether the contract specifies that he must do so. The fact that he has some out, like bankruptcy, does not render such a recourse debt just.

        We should also remember that there is nothing magical about non-recourse loans. They don’t turn lenders into genius businessmen, who never write an uneconomic note.

      • Kristor:
        only formal commitments, that have enforceable recourse, are possibly usurious

        I am going to disagree here. It is the nature of the agreement, not practicalities surrounding enforcement, which make it usurious.

        This may seem in conflict with my practical suggestion that declining to enforce deficiency judgments is a straightforward way to address the usury problem. But that is merely because enforcement is always a matter of practicality. In practice declining to enforce deficiency judgments would lead to a drastic reduction in usury, because in practice people rarely enter into expressly unenforceable business arrangements.

      • Kristor:
        The bankrupt debtor – who is, recall, the usurer, having sold to his lender what does not exist – recurs to the courts when it becomes apparent that he has sold the lender a pig in a poke.

        I think you have that backwards: the lender who demands profitable interest without reference to equity (and its associated particularities, including particular risk) in the debtor’s project is the usurer, attempting to have his money (profitable interest based on incompossible opportunity cost) and eat (lend) it too.

        Now, this isn’t to say that a borrower can do no wrong. If he engages in fraud – say by deliberately hiding material facts about the collateral – that is just as morally wrong as usury, though it isn’t per se usury itself. If he encourages someone to lend at usury who otherwise would not, he does wrong by scandal.

        But in general, usury is an injustice perpetrated on a borrower by a lender.

      • [OK, nested comments do indeed suck. This comment is in response to Zippy's comment here.]

        Zippy, I took “gentlemen’s agreement” to mean “agreement with no recourse to anything at all.” When you loan me $5 today on an agreement sealed by nothing more than a handshake that I will repay you tomorrow and buy you a cup of coffee in the bargain, your recourse is to, er, to … zip. Sure, you can resent me for not paying you back, you can let it be known that I do not keep my word, but you have no legal or moral right, in such a deal, to anything of mine.

        In effect, it seems to me that gentlemen’s agreements are actually gifts. Feeling my way here …

      • Kristor:
        If I understand Aquinas correctly (Article 2, especially Reply to Objection 2), that kind of arrangement is only licit if the parties do not view the cup of coffee as an actual obligation of any sort.

      • [This responds to Zippy here.]

        Zippy: I may of course have this all backwards. But I’m pretty sure I don’t. It is the borrower who has sold the lender on the notion that he can have his money and lend it, too, no? The lender has exchanged something that does exist – his money – for something that does not – the continued enjoyment of the use of that money. It is the borrower who has sold something that does not exist, while the lender has sold something that does.

        What am I missing?

      • If I understand Aquinas correctly (Article 2, especially Reply to Objection 2), that kind of arrangement is only licit if the parties do not view the cup of coffee as an actual obligation of any sort.

        This is what I was getting at, in treating the gentleman’s agreement as an exchange of gifts. St. Thomas says (loc. cit.):

        On another way a man’s obligation to repayment for favor received is based on a debt of friendship, and the nature of this debt depends more on the feeling with which the favor was conferred than on the greatness of the favor itself. This debt does not carry with it a civil obligation, involving a kind of necessity that would exclude the spontaneous nature of such a repayment.

      • Kristor:

        Follow the money.

        The thing that does not exist is the opportunity cost: profits independent of the project. As Aquinas puts it, “But the lender cannot enter an agreement for compensation, through the fact that he makes no profit out of his money: because he must not sell that which he has not yet and may be prevented in many ways from having.”

        Who is paying whom for that-which-does-not-exist? The borrower is paying profitable interest to the lender.

        The lender who demands full recourse profitable interest, independent of the the borrower’s project (which is where the money actually goes, distinct from incompossible opportunity cost), is the usurer.

        This follows reason and is also the tradition. Nowhere in the tradition is the borrower considered a usurer.

      • Who is paying whom for that-which-does-not-exist? The borrower is paying profitable interest to the lender.

        D’oh! Of course. Like I said in the blogpost above …

    • Considering that I had in mind Italians from an age rather more spirited and energetic than our own, I suspect that the man who declined to make his partner whole in a gentleman’s agreement might have indeed faced stiffer penalties (albeit informal) than mere obloquy or ostracism.

      Zippy, under your “no government enforcement” rubric, may we assume you are exempting non-usurious collateral? That is, supposing a debt instrument is secured by real assets, courts would certainly be necessary to enforce those covenants regarding collateral, right?

  6. Paul:
    That is, supposing a debt instrument is secured by real assets, courts would certainly be necessary to enforce those covenants regarding collateral, right?

    Absolutely. I use the nonstandard terms “asset recourse” and “person recourse” (as opposed to “non recourse” and “recourse”) to make this very point as clear as possible. Indeed it is the central point, the key to understanding what is usury and what is not usury: that when the contract unwinds, only explicitly named assets are available to the non-usurious creditor for recovery of principal and interest. Beyond the value of those specific named assets the creditor has no moral or legal right to additional profit or compensation for loss.

    A modern corporation is itself an aggregate asset, not a person, so “full recourse” to a corporation (or more generally a “kind of society” created for some business purpose, as Aquinas terms it) is still recourse to specific named assets.

    Furthermore, as I said somewhere in the other thread, lots of times we use the term “asset” to refer to another level of contract. That is fine too, as long as the “search for assets” for compensation of a creditor terminates at actually existing, real, specific, named assets and not at general obligations of persons to produce creditor compensation.

    If there is – anywhere in the contract web – a general obligation for a borrower to return principal to the lender, independent of or in addition to specific named collateral, what we have is what the medievals called a mutuum. Charging profitable interest on a mutuum is a violation of justice because it involves selling what does not exist: opportunity cost, time independent of content rather than as a convenient proxy for specific work, etc. (That doesn’t make mutuum morally wrong: it makes taking profitable interest from a mutuum morally wrong.)

    At the level of enforcement this is really rather simple: if there are real named collateral assets in the contracts you can go after them for recovery of principal and profitable interest. Interest-bearing contracts which assert a general obligation on the part of a borrower to return the principal amount to the lender with profitable interest will not be enforced. They are like contracts to sell onesself into slavery: whether mutually consensual or not the government has no business enforcing such contracts.

    Footnote:
    Someone might – but would have no business motivation to do so, only charitable motivation, like the medieval Franciscans who lived in vowed poverty and lent money to the poor to help them escape the usurers – enter into a mutuum contract which did not charge interest, yet still did contractually require return of principal. In such a contract the lender might attempt to recover any actual, demonstrable, real losses in addition to principal – not to include ‘opportunity costs’ or ‘time value of money’ or other sophistry which appeals to ontological unreality – when the contract unwinds. This is where the “extrinsic titles” (lucram cessans, damnum emergens, etc) of the medievals apply: to mutuum lending which by its nature cannot justly have a business purpose. This doesn’t apply to much of any lending that is done today, and as a practical matter there is probably no need for the law to address it.

  7. Pingback: Injustice! - Mutual Spiritual Affinity

  8. Pingback: Note as Collateral: Sunday Morning Thoughts 10 February 2013 « Backed by Real Estate

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