On Morality of Usury

Membership in a large organized group has a variety of health benefits, but creates a pesky byproduct: you have to deal with the party line. So, when the Pope reminds the faithful that usury is bad, bad, bad, what is a good Catholic law-and-economics person to do? Right, he needs to define “usury” in a way that doesn’t offend either Catholics or economists. Steve Bainbridge has tried.

You see, if “usury” is defined as simply lending money at interest, then, one cannot satisfy the Pope while also singing praise to modern capital markets. So, Bainbridge weaves a masterful web of theological analysis, concluding that “usury” means not just any lending at interest, but lending at “unjust or inequitable interest.” Let’s try to disentangle this.

Let’s assume Bainbridge is right and usury in this context in fact means “unjust or inequitable interest.” Are the calls to prohibit “unjust or inequitable interest” much less of an economic quackery than the calls to outright prohibition of lending?

Despite common perception to the contrary, credit markets are fundamentally similar to other known markets. Some people sell bread. Others sell their services as wedding singers. Still others sell short-term rights to live in their apartment buildings. Finally, there are people who sell short-term rights to use their money – that is, they lend. Price controls over bread, wedding singers, and apartment rentals have never done much good – the supply of price-controlled goods and services has always been suboptimally low and their consumption has always been suboptimally high. Distorted production and consumption incentives inevitably result in black markets, boost corruption, generate panic, reduce people’s trust in the economy, and increase reliance on good-ol’-boy networks as a major channel or resource distribution.

Worse yet, mandated price caps do not generate the sorts of wealth transfers that soft-hearted proponents of caps envision and that can be (at least partly) achieved through taxation and spending. Instead of transferring wealth from the rich to the poor, price controls transfer wealth from ill-connected and undesirable newcomers (who have no access to underpriced goods) to well-connected shrewd insiders (who have such access via either social ties or bribes). As the ubiquitous voice of Sarah Jessica Parker pointed in the Sex and the City, great physical beauty is like a rent-controlled apartment with the Central Park view – they both usually go to people who deserve it the least.

So, justifying price controls on either efficiency or distributive-justice grounds is getting increasingly more difficult for anyone who’s had at least elementary exposure to economics. How can we then justify price controls over lending markets? How can we say that it’s not “immoral” to sell bread, wedding singer services, and apartment rentals at a market price, but it’s “immoral” to sell money rentals at a market price?

Bainbridge offers a few authoritative citations as possible answers; I find most of them silly. In one view, lending is only immoral when the rich lend to the poor, but it’s not immoral when a capitalist supplies money to a business – because the latter allows “fair compensation for the time and expenses of the banking business, the risks of loss, and the lenders’ inability to use for their own advantage what they had loaned out to others.”

So, when a poor widow needs a loan to pay for her kid’s medication, it’s “immoral” to provide such loan to her at a market rate because poor widows with sick kids and no pledgeable assets are high-risk borrowers and understandably end up with high interest rates that disturb a moralizer’s sense of decency. (Oh, you think otherwise? You think her high interest rate is super-competitive? You are in the wrong business, dude. Open up your own bank and try to collect debts from people with low incomes and no assets! You’ll make a great living). That poor widow, who might well be happy to take a high-interest loan (because, for example, she expects her older kids to pitch in with repayment once they are done with schooling), should just shut up and eat her plight for the sake of moral society.

Likewise, when a young person needs a private loan to pay for his education (assume no government sponsorship, as with foreign students in US colleges), it’s “immoral” to lend to him, because again, lending against the future income is a high-risk endeavor requiring “excessive” interest rate.

But, of course, it is never “immoral” to lend to a corporation or a wealthy individual. Low-risk borrowers command low interest rates and therefore are never at risk of losing their credit lines on morality grounds. If enough people actually follow these “morality” guidelines, guess who will get squeezed as a result.

Here is another anti-usury tale that Bainbridge cites: “It is immoral to take interest on the loan of a thing that is completely consumed by its use, for which one has no other use, and for which one incurs no loss by lending it.” This definition is intended to exempt all monetary lending from the “usury” claim, but it actually limits the concept of “usury” to, well, a null set of things. The only way to “not incur any loss by lending” an asset is to have a completely useless asset, for which you can’t charge anyone anything. If an asset can be productively used by someone, its ownership has a variety of option values: even if you are not using it today, you can sell it, exchange it for something else (temporarily or permanently), pledge it as a collateral, postpone the use until some time in the future, and so forth. By lending such asset without an interest, you always incur a loss -- you lose the opportunity costs of not lending. Why it is “immoral” to lend such asset (exercise one option), but not, say, pledge it as a collateral (another option), is beyond my understanding.

Overall, I can understand people who haven’t learned anything from grand experiments of the past century and still believe that we can change people’s demand functions by simply yakking about morality. I can also understand people who (a) think that more wealth redistribution is needed; (b) understand that redistributing through taxation is politically infeasible, and therefore (c) promote highly wasteful and unfair redistribution through price controls.

What I can’t understand is how one can announce that market prices are both wealth-creating and superior to any other distribution system, while also believing that there are some market prices that are “immoral.” Perhaps sometimes the party line doesn’t deserve much contemplating about. Perhaps sometimes the party line just plain wrong.

Or perhaps I am simply not ready to relinquish my economics textbooks to some ethics tsar charged with judging the moral adequacy of market prices.

Comments

[anon]

A wonderful, deeply insightful post.

Signed,

An academic with less courage than you.

[Matt]

A couple of quick thoughts. Interesting but there are several weakness in the argument. First, the post talks past Bainbridges argument. Bainbridge's is writing about usury as taught by the Church and not as taught by economic insight. I understand you disagree with him but my reading of your post is that you are writing as if you are comparing apples to apples, when in actuality you are comparing apples to oranges. Of course, there is nothing wrong with comparing apples to oranges, but I think you should be frank about your comparison.

Second, you also make the mistake of assuming the article is consistent with Bainbridges actual belief about lending, rather than his belief about the teaching of the Catholic church.

[Paul Gowder]

Kate:

You're ignoring the possibility that usury laws might compensate for other market failures that we can't capture.

For example, if certain market segments (cough... cough... predatory home lenders, payday lenders, cough... cough... wheeze... credit card companies) are known to make money though semi-deceptive practices (balloon payments, universal default clauses, etc.), and it is known that the classes of consumer who those practices are targeted at (the poor, the uneducated, the young, the unsophisticated) are unable to effectively defend against those practices, then lenders who engage in them will get higher profit than a free market would otherwise provide.

Cracking down on the interest rates might well be cheaper (in terms of enforcement cost) than enforcing the fraud laws.

[oh, incidentally, re: your earlier post -- what's wrong with arbitrage exactly? assuming best buy doesn't mind because of the line factor, it would seem like arbitrage just allows people to pay slightly less than store prices over e-bay but slightly more than staying up all night prices. I'd spend a hundred bucks to not sleep on the sidewalk outside an electronics store]

[David Nieporent]

Paul:

and it is known that the classes of consumer who those practices are targeted at (the poor, the uneducated, the young, the unsophisticated) are unable to effectively defend against those practices, then lenders who engage in them will get higher profit than a free market would otherwise provide.

The best way to "effectively defend against those practices" -- the most effective way -- is to patronize lenders that don't engage in them. If there are no lenders that don't engage in them, then perhaps that suggests that your notion of what "a free market would otherwise provide" is flawed.

[PG]

And how are the poor/unsophisticated/uneducated/elderly to figure out who doesn't engage in those practices?