What’s Wrong with the World

Without detracting from the validity of your observation that the economic crisis has been precipitated or at least accelerated by markets in fake commodities, the error in St. Thomas's analysis seems to be that he does not account for the time value of money (and neither did any of his contemporaries---it's not really his failing). What the person who loans money is doing is selling the right to use the money for a specified period of time, thus foregoing other opportunities that he could have pursued with it; he is thus entitled to compensation for the foregone opportunities (which have been, one could say, consumed). As i understand it this is why Thomas's condemnation of usury has not translated into an enduring prohibition on all interest.

I agree Paul. Many people even today see money as something which is consumed, but that isn't really an objectively accurate picture of how things objectively go. If I buy a factory with money, I now have a factory worth that much money - which I can sell to recover that much money if I choose - and I also have the production of the factory, which produces an income stream. So it just isn't true that every use of money is consumption. I think Belloc understood this:

Supposing a man comes to you and says: "There is a field next to mine which is a very good building site; if I put up a good little house on it I shall be able to let that house at a net profit — all rates, taxes and repairs paid — of £100 a year. But I have no capital with which to build this house. The field will cost £50 and the house £950. Will you lend me £1,000, so that I can buy the field, put up the house, and enjoy this nice little income?" You would presumably answer, "Where do I come in? You get your £100 a year all right; but you only get it by my aid, and therefore I ought to share in the profits. Let us go fifty-fifty. You take £50 every year as your share for your knowledge of the opportunity and for your trouble, and hand me over the other £50. That will be five percent on my money, and I shall be content."

This answer, granted that property is a moral right, is a perfectly moral proposition. The borrower accepting that proposition certainly has no grievance. For a long time (theoretically, forever) you could go on drawing five percent on the money you lent, with a conscience at ease.

Now let us suppose that man comes to you and says: "I know the case of a man in middle age who has been suddenly stricken with a terrible ailment. Medical aid costing £1,000 will save his life, but he will never be able to do any more work. He has an annuity of £100 a year to keep him alive after the operation and subsequent treatment. Will you lend the £1,000? It will be paid back to you on his death, for his life has been insured in a lump payment for the amount of £1,000." You answer: "I will lend £1,000 to save his life, but I shall require of him half his annuity, that is £50 a year, for every year he may live henceforward; and he must scrape along as best he can on the remaining £50 of his annuity." That answer would make you feel a cad if you have any susceptibilities left, and if you have not — having already become a cad through the action of what the poet has called "the soul's long dues of hardening and decay" — it would be a caddish action all the same, though you might not be disturbed by it.

It seems therefore that there are conditions under which you may legitimately and morally lend £1,000 at five percent in perfect security of conscience, and others in which you cannot.

I am no expert on Aquinas, but it seems questionable to me to assume he was unaware of the various justifications for taking interest on money lent. What other plausible rationale could there be to justify the particular manner of use of money?

Instead, his argument seems to rest on the nature of money itself, which rests on the purpose of its creation. This is an argument which renders irrelevant rationales describing the possibilities of money's use, for it is certainly possible to use something contrary to its nature. The point isn't whether it is possible and justifiable based on utility with respect to a standard of economic growth, but what uses conform to the nature of money itself.

Here, Aquinas appeals to the Philosopher's wisdom concerning what money is and is for. There's not enough here to discern why the Philosopher believed what he did about the nature of money, or why Aquinas agreed with him, but that seems necessary to understand before a judgment on what usury is can be made.

But when we look at the current crisis it sure does seem like a lot of consumption driven by an economic engine which was busily selling things which don't exist, or selling the same thing multiple times.

What was sold that didn't exist? What was sold multiple times? What are you talking about?

Aquinas' argument here strikes me as odd. For one thing, unlike food, money is not, in fact, generally consumed by its use. It's traded for something else.

And note, it's not the case that if I use money to buy a consumption good (like, say, a hamburger) then the money is consumed, but not if I use it to buy a capital good (say, a hammer). In both cases, the money I spend is not consumed but traded. If may be that I plan to consume the thing I am trading the money for, but that doesn't mean that the money is consumed, any more than the fact I trade some baseball cards for a CD means I am listening to music on my baseball cards.

What was sold that didn't exist?

And note, it's not the case that if I use money to buy a consumption good (like, say, a hamburger) then the money is consumed, but not if I use it to buy a capital good (say, a hammer). In both cases, the money I spend is not consumed but traded.

Albert:

Instead, [Aquinas'] argument seems to rest on the nature of money itself, which rests on the purpose of its creation.

If money is an artifact, that is, a human creation, then its purposes are human purposes. Its human purpose is exchange, and if exchange is not in fact always consumption then Aquinas' conclusion - that no loans for interest at all are ever morally licit - wouldn't follow from the premise that usury is selling something which doesn't exist (like selling the use of wine separately from selling the wine). Belloc's understanding - that unproductive loans for interest are always morally illicit - would follow though, by applying Aquinas understanding of usury to a different understanding of the nature of money.

I'm really not reaching for a particular conclusion or theory here though. I haven't done enough research or study or thinking on the subject to be "there" yet. Mostly this is interesting because it puts the lie to the idea that Belloc's 20th century view of usury was something he made up out of whole cloth, rather than a traditional understanding of usury applied to a particular understanding of the nature of money.

One of many things which were sold but did not exist, in the precipitation of this crisis, was the capacity to make good on credit default swaps.

I don't know that anyone sold the capacity to make good on credit default swaps. A lot of people did sell credit default swaps, but that's not quite the same thing.

Truthfully, Aquinas' notion of selling something that doesn't exist is rather mysterious to me. It's easy to think of examples of selling something that doesn't exist that involve fraud (selling ocean front property in Arizona, and whatnot). But if I try to think of an example that doesn't involve fraud of deceit, All I can come up with are examples of things that seem pretty clearly legitimate. A writer, for example, might sell to a publishing house a book that doesn't exist (because he hasn't written it yet), and there's nothing wrong with doing so, as far as I can tell.

The same goes, mutatis mutandis, for the idea of selling the same thing twice. Absent cases of fraud, it's hard to find examples of cases of this actually ever happening, and when it does, the cases turn out to be legitimate. I suppose if Starbucks wanted, they could charge $2 for a cup of coffee with a $2 surcharge if you wanted to drink it, but functionally it would be hard to see how this would be any different than just charging $4 for a cup of coffee. The closest I can come to example of this would be things like shipping and handling fees. Amazon charges you $15 for a book, plus $3.50 to deliver it to you. I suppose one could argue that this is an example of what Aquinas was talking about, but does anyone really want to argue that such fees are intrinsically unjust?

BA:

I don't know that anyone sold the capacity to make good on credit default swaps. A lot of people did sell credit default swaps, but that's not quite the same thing.

Truthfully, Aquinas' notion of selling something that doesn't exist is rather mysterious to me.

Suppose that you sign a book contract with a publishing company, then a week later are hit by a bus and can't produce the book. Usury?

Zippy: To clarify what you're saying, am I understanding you correctly that you consider selling insurance when the insurer doesn't have the resources to make good on their end in the event of a loss ("the capacity does not exist") to be one example of usury?

In one sense, all insurance (including credit default swaps) is the same because the capacity does not exist to make good on a loss for everyone. Insurers rely on the probability that only a small percentage of the insured will use it at any one time.

But this is not different for CDS, right? So in condemning CDS, would you not be condemning virtually all forms of insurance today? I neither agree nor disagree, but wondered whether you really thought this.

Suppose you sell an insurance policy with no capacity to pay up in the case of a loss. Suppose you call it a "credit default swap" in order to avoid the regulation and reserve requirements ordinarily concomitant to selling insurance. Suppose you disconnect the owning of the insurance from the owning of the insured item, so that many parties can insure the same asset over and over again, to the tune of a notional value orders of magnitude higher than the actual value of the asset. Suppose you do that over and over and over again, to the tune of tens of trillions of dollars in supposedly covered losses which are not in fact covered, creating a global 'market' for this nonexistent insurance coverage with a notional value of $62 trillion.

That's usury.

I already said I don't have a theory which I can apply to every concrete case and get a concrete answer. I don't think contracting to do something productive in the future like writing a book is necessarily usury offhand, but without a theory to apply I can't say for sure.

My post really has three specific points, all of which I have only really just discovered for myself:

(1) Aquinas understood usury as selling something that doesn't exist (e.g. decoupling a bottle of wine from its use and selling both separately);

(2) Belloc also understood usury as selling something that doesn't exist, he just had a somewhat different understanding of the nature of money than Aquinas. Therefore claims that Belloc's understanding is a whole-cloth novelty with no connection to the Tradition are flatly false; and

(3) The current meltdown involves the sale of tens of trillions in notional value of CDS's and other derivatives which appear to meet Aquinas' understanding of "things which don't exist."

Beyond that, I'm pretty open to discussion and ideas.

Albert:

So in condemning CDS, would you not be condemning virtually all forms of insurance today?

Right on, Zippy.

I'll add that the extraordinary levels of abstraction here are vital to at least my use of the term usury, and I'm glad to have some support in this perception from the Dumb Ox.

We refer to CDS as insurance because it is useful for explanatory purposes. But it's not really insurance; it's a credit derivative known as a swap where abstracted chunks of risk are manipulated and traded. The counterparties swap aspects of the risk on bonds. The seller gets a regular premium to absorb the buyer's risk of default. (But of course, the buyer need not even be exposed to that risk because he need not even hold the underlying bond.)

If I contract with a company to insure my house against loss in a fire, that's one thing. With CDS we're talking about "insuring" securitized debt against loss in a default event -- insuring what is already an abstraction. And we're talking about opening that market to trade totally isolated from the ownership of the securities.

Nor is that all. We're also letting the sellers of these packages of abstracted risk, these swaps, pool the revenue streams from them, thereby confecting whole new debt securities for sale to other buyers.

Nor is that all. We're also letting the CDS market (barely ten years old) function as the primary data foundation for mathematical risk formulas for the whole investment world.

In other words there is a great abundance of things being sold that did not exist.

Suppose you sell an insurance policy with no capacity to pay up in the case of a loss. Suppose you call it a "credit default swap" in order to avoid the regulation and reserve requirements ordinarily concomitant to selling insurance.

Here's the problem: while insurance companies are subject to certain reserve requirements, these requirements aren't anywhere near 100% (nor could they be if the insurance companies were to remain in business). And once reserves are below 100%, the insurance company lacks the capacity to pay out all the claims it has written. True, one can say that this is unlikely based on mathematical modeling. But then, that's what they said about credit default swaps too.

The key element of ethical insurance that seems to be missing from the CDS market (and this is true of many other investment derivatives, though not all) is the concept of insurable interest. When insurance was just getting going - when it was still being administered at coffee houses - it was quite common to write life insurance contracts on public figures. One could buy a policy on the life of the Prime Minister, with no necessity to prove that one would be directly harmed by his death. Once written, such policies - called tontines - were freely traded in a secondary market. But participants in the insurance market quickly realized that to write a tontine was tantamount to putting out a contract for a hit. A Nash equilibrium instantly formed, and no one can any longer buy life insurance on anyone, without the consent of the insured; even then, the buyer of the policy must demonstrate to the insurer that he has a personal insurable interest in the life of the insured.

One effect of this is that the insurance market naturally works in such a way as to limit the overall insurance benefits that can possibly be written on a given risk to the actual economic harm that society will suffer in the event of its realization. Insurance applications all ask about all other coverages in force, to try to ensure that no economic asset is overinsured.

Now, once a policy is written, it may be traded to another owner without limit (although not without tax consequence). Still, the insurance market has mechanisms in place for most lines of coverage that generally prevent the total benefit issued on a risk by all insurers from exceeding a rough estimate of the actual value of that risk.

None of these natural limits appear to have been at work with the CDS market. The result? Massive moral hazard. Everyone in the market became systematically interested in increasing valuations of the underlying real assets insured, and systematically uninterested in seeing that assets were properly valued. A classic speculative boom was the natural result, with everyone who jumped in planning on being followed by an even greater fool.

I do believe that, while Aquinas was not quite correct about money and interest - and that Belloc is closer to being correct about them - the current meltdown is attributable to usury in the Thomist sense. But it would perhaps be better to call it by its true name: fraud. To sell someone a pig in a poke is simply to lie. To charge more than fair value is to lie. The run-up to the crisis saw massive trading in assets that were sold as less risky than they really were. The Thomist sin lay in selling an asset of risk x, when that asset didn't really exist; rather, the asset that was actually sold had risk of x + y. Layers upon layers of derivatives obscured the true character of the asset actually being sold: a stream of future payments supported by the ability of a human being to service a loan - his moral and economic character - and the value of the loan's collateral. The smokescreen of derivatives obscuring these real factors is a reason for a lot of the mispricing, but not an excuse.

These real considerations were dealt with by hand-waving references to the law of large numbers. But this was an instance of the flaw of averages, a cognitive error that is easily seen in the old joke about the statistician who drowned wading across a river with an average depth of 2 feet. Collateralized Debt Obligations were bought, and then traded, by people laboring under the misapprehension that the average outcome (correctly) derived by application of the law of large numbers prevented them from suffering from the disaster that would ensue if actual experience happened to fall far out on the leftward tail of the normal distribution.

In short, this all gets back to imprudence driven by greed. Imprudence generally boils down to a refusal to face reality and behave appropriately thereto.

Apologies to the great Thomas, but money is and can only be, a representation, otherwise it would have no value. So it's true value lies in the similitude it has to to objective value, to objective good or goods. Usury may then be stripped of it's negative connotations and seen for what it it is, the price paid by those willing to value higher, those particular goods or goals above the value placed by others to the same goods or goals.
That is. it is a function of the price mechanism.

Here's the problem: while insurance companies are subject to certain reserve requirements, these requirements aren't anywhere near 100% (nor could they be if the insurance companies were to remain in business). And once reserves are below 100%, the insurance company lacks the capacity to pay out all the claims it has written. True, one can say that this is unlikely based on mathematical modeling. But then, that's what they said about credit default swaps too.

This. Zippy, I think CDS is the same as any other insurance: pooling risk in the event of a Black Swan happening to an individual. If catastrophe just happened to a few CDS holders, the insurers would in fact be able to payout. Sure, CDS insurers could never pay out $67 trillion and thus lacked capacity and were therefore selling someone they didn't have, but neither could State Farm or GEICO pay out $XX billion in the event of a systematic auto failure. Or any other insurer for their respective sectors.

Whoops, that should be "selling something they didn't have."

Albert:

I think CDS is the same as any other insurance: pooling risk in the event of a Black Swan happening to an individual.

What this all may imply is that certain kinds of existing insurance are immoral usury. I am certainly amenable to that conclusion. Natural disaster insurance, for example, tends to be more of an all or nothing thing: you either have to pay all policy holders or none, so having less in reserve than basically the entire amount would be usury. Life insurance not so much. Everyone isn't going to all die at once, so it is perfectly reasonable to conclude that the insurance company has the capacity to make good on its commitments: it is selling real commitment and protection for individuals, actually and in reality protecting them from (or mitigating the effects of) individual disaster, not illusory commitment and protection.

...neither could State Farm or GEICO pay out $XX billion in the event of a systematic auto failure.

I should add, though, that given this understanding of usury the agents of an auto insurance company (or health insurance company etc.) which goes to great lengths not to pay claims, as we know some of them do, are engaged in usury.

What has led to much confusion is the idea that foreclosure levels have been exceptional. They are comparable to similar crises in the 80s and earlier. Where the problem has arisen is that many of these securities have been leveraged upwards of 20:1 and sometimes 40:1. It doesn't take long to lose a whole lot of money (or make money) with that kind of leverage. Add in an unfaithful partner (not the homeowner but another security contractee) that was supposed to cover some of your risk, and you have a financial meltdown.

Just as a note to someone above: European banks are more comparable to Morgan Stanely and Goldman Sachs than they are to Wells Fargo.

In regards to the insurance discussion, the companies are bonded in states they operate and regularly audited. In most places, rates aren't even allowed to be set at whatever the market demands like with financial instruments. Typically a company must publish their rates with state regulators and the underwritten premium must be within x% of the premium on file with the State. Every policy has a defined dollar limit in collectable damages. Most policies are standardized with defined perils, the most notable exclusion being HO-6 forms that cover all perils except those specifically excluded. Swap contracts are not likewise standardized.

There's not enough here to discern why the Philosopher believed what he did about the nature of money, or why Aquinas agreed with him, but that seems necessary to understand before a judgment on what usury is can be made.

One must keep in mind concerning the stark differences between our current economy (which now supposedly rests on the tenets of Capitalism) and that which came before during those times (which principally revolved around those concerning fuedalism).

Dr. Carson, a Protestant convert to Catholicism, has thus elaborated on the topic of Usury as it concerns the Catholic Church herself here, taking into consideration exactly the difference between those economies:

EXCERPT:

"[L]et's look instead at one that is often cited in polemical contexts: the teaching on usury. This is a nice example because most Catholics can agree that God is a Trinity, and that the Spirit proceeds from the Son, but there are some Catholics who think that the teaching on usury has substantially changed over time, and in this they disagree with their own Church, which maintains rather that the teaching on usury has developed over time...

This is where the real arguing starts. The Church used to say that charging any interest whatsoever on a loan was usurious and, hence, sinful. Now the Church says that there are certain forms of lending in which it would not be usurious to charge interest, just so long as the interest rate meets certain criteria, hence not all lending at interest is sinful. The critics who claim that the teaching has changed say that the Church went from saying "All lending at interest is sinful" to saying "It is not the case that all lending at interest is sinful", and that is indeed a formal contradiction...

The defender of doctrinal development says that the Church now teaches, and has always taught, that "All usurious lending is sinful", but the prudential understanding (not the formal, de fide, teaching) of what the definition of "usurious lending" is has developed in response to the rise of a capital economy beginning in the 17th century. Hence there is no formal contradiction at all, only an explicit recognition of new historical conditions under which usuriousness is present only under certain empirically testable conditions, not all of which include the presence of interest on a loan...

Lending at interest is only usurious if the interest rate represents an unfair burden on the debtor. Prior to the advent of a capital economy, any interest rate could reasonably be regarded as "unfair", in the sense of placing an insurmountable burden on the debtor. This was true because, in a feudal economy, there were very few, if indeed there were any, means by which a borrower could hope to make some sort of a return on money he had borrowed. This is because money was not itself the kind of commodity that it has become. Since the advent of capital economies in the 16th-17th centuries, the function of money itself in the economy has substantially changed. The sin of usury, by contrast, is no different than it has ever been: just as in feudal times, so too today there is still such a thing as a sinfully large rate of interest, and it is still possible to make loans that are usurious: all you have to do is charge a rate of interest that nobody could reasonably hope to pay. This is something that I believe the mob is rather famous for. However, there are certain rates of interest that do not represent anything like that kind of unfair burden, at least in certain kinds of cases, hence it is not by definition usurious to lend money at interest.

The point of the development is precisely this: historical conditions, including the intentions of lenders and economic viability of debtors, determines the conditions under which a particular rate of interest is to be regarded as "usurious". Prior to the advent of a capital economy in the 16th-17th centuries, any lending at interest could be counted as usurious (sinful); but after the advent of a capital economy not all lending at interest was usurious because someone who borrowed money could treat his loan as a commodity and invest it for a return. In short, the burden on the debtor is not at all what it had been under a feudal economy. The sin of usury is not defined as a sin of charging a person a fee for giving him something (namely, money), it is rather a sin of placing an undue economic burden on another person. What has changed is not the sin of usury, but the economic conditions under which money is loaned.

So what appears to be a contradiction turns out to be merely an appearance. Hence the content of the teaching did not change (there is now, and always has been, such a thing as sinful, usurious lending [namely, charging an unfair fee for a loan], and the Church opposes it), but historical conditions have arisen under which the application of that content will be affected (if, in a capital economy, you lend money to someone who is going to be able to invest that money and earn more, then it is not, in fact, unfair to charge a certain level of interest).

This does not strike me as a particularly difficult problem (indeed, I have never understood why the Church's critics have so often chosen this particular example to work with, when the explanation is so obvious). Indeed, it is true of many other sorts of cases. Take, for example, something as straightforward as the commandment that we are not to kill. Scripture itself makes it clear that historical conditions determine the application of this commandment, since Scripture itself commands the Hebrews to kill certain people who have committed certain crimes, and the Church has always accepted the legitimacy of killing in defense of the common good when serving in a duly appointed military capacity. Do we say that the teaching on "not killing" has changed, or that it changes from time to time based on what seems expedient? Not at all. We say that the meaning of the commandment depends upon certain empirically observable conditions, including intent, the nature of the threat, etc."

OK, lets try to avoid posting really long excerpts from other Internet commentators, not least because it isn't fair to the commentator. A link and a few sentences would be fine.

While I concur with Carson's take on development of doctrine as excerpted here, he seems to disagree with Aquinas and Belloc about what it is that makes a particular loan (in Aquinas' case all loans; in Belloc's case unproductive loans) usurious. Notice that under Belloc's understanding even a productive loan with too high of an interest rate might be usurious: if the lender is taking a share of the profits of a productive enterprise it is not usury, but if the lender is taking more in interest than the enterprise produces in profits that would be usury. And of course if the loan is for something other than a productive enterprise it is usury, in Belloc's view. This has the advantage of making sense in the light of the encyclical Vix pervenit where it says:

”But by this it is not at all denied that sometimes there can perhaps occur certain other titles, as they say, together with the contract of lending, and these not at all innate or intrinsic to the nature of a loan, from which there arise a just and entirely legitimate cause of rightly demanding something more above the principal than is due from the loan. Likewise, it is not denied that many times one’s own money can be rightly invested and expended in other contracts of a different nature from the nature of lending, either to secure an annual income for oneself, or also to practice legitimate commerce and business, and thus procure an honest profit.”

(It is probably worth noting that Carson's post seems to be more about development of doctrine than about usury and that he has just taken a fairly conventional understanding of usury as an example. So again, excerpting someone like this might be unfair with respect to his original purposes in posting, and I agree with his central point about doctrinal development).

In Aquinas' and Belloc's accounts, what makes a loan usurious is the fact that the acting subject is selling something which doesn't exist. Now it may be that there are other species of selling things which don't exist, species which are not usury. Perhaps as a definitional matter we should only say that it is usury when it involves a loan of money wherein the lender is selling something which doesn't exist, and other things like CDS's aren't usury per se but are of the same genus as usury. That is just a matter of semantics, and it isn't surprising that the semantics of something like usury are in a shambles in a society which has effectively ignored the subject for centuries.

Does fractional reserve banking fall into this area?

Aquinas' argument here strikes me as odd. For one thing, unlike food, money is not, in fact, generally consumed by its use. It's traded for something else.

And note, it's not the case that if I use money to buy a consumption good (like, say, a hamburger) then the money is consumed, but not if I use it to buy a capital good (say, a hammer). In both cases, the money I spend is not consumed but traded. If may be that I plan to consume the thing I am trading the money for, but that doesn't mean that the money is consumed, any more than the fact I trade some baseball cards for a CD means I am listening to music on my baseball cards.

http://www.newadvent.org/summa/3078.htm#article1
Now money, according to the Philosopher (Ethic. v, 5; Polit. i, 3) was invented chiefly for the purpose of exchange: and consequently the proper and principal use of money is its consumption or alienation whereby it is sunk in exchange. Hence it is by its very nature unlawful to take payment for the use of money lent, which payment is known as usury: and just as a man is bound to restore other ill-gotten goods, so is he bound to restore the money which he has taken in usury.

Does the physical artifact go out of existence? No. But this is to take apply a strict definition of consumption to cover all cases. What Aquinas is saying that if I consume/use/alienate money, I no longer have it (as it has been given to someone else in exchange), just as if I eat something, I no longer have it (and cannot use it again). “You can’t eat your cake and have it too.”

Gintas:

Does fractional reserve banking fall into this area?

I'll emphasize again though that my own thinking on this is not the product of long study and careful thought; so I was more just trying to pass along how commensurable Aquinas' and Belloc's views were on usury, even though they came to somewhat different conclusions about loans-for-interest specifically.

Does fractional reserve banking fall into this area? Yeah. Commercial banking is really a form of insurance - i.e., of shifting risk. You don't want to risk the loss of the currency you've saved under the mattress, so you shift that risk to the bank. You don't want to control the risk to your currency by becoming a merchant banker yourself - i.e., finding credit-worthy counterparties to whom you may prudently loan your money - because that's even risker. So, again, you shift that risk to the bank. The latter risk being so much greater than the former, the bank can earn such good premiums - i.e., interest - on its loan assets that it can afford to take the first risk over from you for a negative insurance premium, which also neatly compensates you for the company risk you assume by depositing your currency in the bank. The bank can play this game because it can usually rely on a predictable flow of demands from depositors, just as a life insurer can usually rely on the average death rates for its population of insured lives. But for either sort of institution, events far out on the tails of the normal distribution are to be expected. Thus prudent insurers control their own risk by buying reinsurance on big exposures, retaining only a portion of them. Insurance companies spread big risks in this way to the whole insurance market, so that no one of them is taken out by, e.g., a hurricane. And banks do the same, reselling most of the loans they originate to other banks, Wall Street, or Fannie and Freddie. But if the hurricane is big enough, it can overwhelm the financial resources of the whole market. This is what has just happened. At such points, social insurance appropriately steps up to the plate: the Fed becomes the lender of last resort, so that the financial system can limp past the outlier event back to the center of the bell curve.

Anytime you shift risk to another party, you take on a new risk: that the counterparty will not be able to perform on its side of the contract. The net premium you pay, or earn, is a measure of the net risks each party to the contract has assumed thereby.

When you earn an investment return, you are "paying" a negative insurance premium to compensate for your assumption of risk.

The whole thing works fine as long as everyone involved either has a good handle on risk - i.e., as long as the search costs entailed in measuring the risk are not overwhelming - or can trust that most of their counterparties do (as when we trust a mutual fund, an insurer, etc.). This breaks down when the situation is so noisy that the search costs are practically insuperable. When the Fed and Congress introduced noise to the loan underwriting process (as with NINJA loan qualification requirements), they drove investor search costs for mortgage risk through the roof. But returns on sub-prime mortgages were attractive enough, compared to those on well-understood risk, that plenty of investors opted to trust their counterparties, instead of performing prudent due diligence. The message thus sent to commercial banks and Wall Street: "go for it."

The boom and bust that ensued in the capital markets were analogous to the boom and bust cycle in the property and casualty insurance business. An earthquake strikes, and almost every carrier drops out of the earthquake insurance market. Only a few players are left, who are thus able to set premiums very high, earning huge profits by doing so. After a while, other carriers take note of those profits, and re-enter the market. Premiums are bid down. More insurance is bought; more carriers start to sell it; the premiums go down further (in exactly the same way that expected stock returns fall as P/E rises). Then the earthquake hits again.

Again, with the difference that in the case of a CDS there is no reserve requirement nor is there any concrete actuarial data. We know about how often a car accident is going to happen, etc.

Just because there were no reserve requirements does not mean there were no reserves. Two different questions. Similarly, there either is actuarial data that is reasonably good or there is not. Why do you think there was not any such data? Certainly companies keep these records confidential as a part of their business; it's a bit uncharitable to suggest they had no good data. CDS sellers believed their actuarial data was good enough and that their reserves were accordingly sufficient. In fact, they were sufficient, except in the event of systematic losses in the markets which *no one* believed would happen and were therefore unreasonable.

All this is not to say that CDS are okay. But it seems your framework suffers from a necessarily ex post facto evaluative capacity. How do we know whether reserve requirements were reasonably sufficient and therefore whether the practice constitutes usury? If the data was reasonably good enough and the reserve requirements reasonably high enough. How do we make that determination? If it works out in the end. Again, this might be true, but it is unhelpful for the present time.

There doesn't seem to be a way to determine whether a particular instance of insurance constitutes usury apart from have a 100% reserve. This understanding of a moral requirement seems best.

Neither would they have the reserve to pay if an asteroid hit the earth and wiped out civilization.

Come on, Zippy. In the event of death, the law is no longer binding =P

This statement:

There doesn't seem to be a way to determine whether a particular instance of insurance constitutes usury apart from have a 100% reserve.

Come on, Zippy. In the event of death, the law is no longer binding =P

As for the former, while it is true that a 100% reserve ought to meet any requirement, it isn't obvious that that is necessary in order to avoid "selling what does not exist". To conclude that a 100% reserve is therefore a moral requirement might be an instance of rigorism, in the technical sense. That is, it would make a moral requirement of the most conservative opinion simply because it happens to be the most conservative opinion; and we know that rigorism is condemned as false.

(I'll further point out that even 100% reserves do not eliminate all risks, any more than money in a mattress eliminates all risks.)

Zippy, the second statement was a joke because it ought to have been obvious that the same incident that rendered it impossible to pay out made it impossible to collect. I'm uncertain as to what you're getting at, but at any rate it wasn't a serious thought.

Insurance sellers are selling their capacity to provide compensation in the event of some loss. They make this agreement with every purchaser. But if the reserve is/falls below 100%, then the capacity no longer exists for all the purchasers. Therefore, they have sold something that they do not/no longer have.

By the way, the "100% reserve capacity is necessary" theory is still just a working one.

You didn't address my comments regarding your working theory, namely the inability to gauge whether particular insurance scheme is usury except in so far as it works out or does not work out. Just wondering if you had thoughts about that.

Albert:

...the second statement was a joke...

But if the reserve is/falls below 100%, then the capacity no longer exists for all the purchasers.

You didn't address my comments regarding your working theory, namely the inability to gauge whether particular insurance scheme is usury except in so far as it works out or does not work out. Just wondering if you had thoughts about that.

I think it was Kristor who suggested that selling CDS's which don't actually provide the protection for which they are sold is at least morally, if not legally, a form of fraud. And it may be that usury is a subcategory of what we might reasonably refer to morally, if not legally, as fraud.

A 100% reserve requirement *prevents* insurance. Under such a requirement, the cost of $100,000 of insurance benefit would be $100,000, making insurance – and banking – a non-business, and eliminating most risk-taking activities – i.e., most transactions.

All economic transactions involving derivative instruments entail the exchange of some real economic value for some kind of promise to deliver values in the future, or else of one such promise for another. By "derivative instruments," I really mean any instrument whatsoever; i.e., anything other than an actual good or service. If I meet with Joe on the street and we immediately exchange a bushel of apples for a bushel of wheat, no instruments are needed. Any other sort of exchange whatsoever involves a promise of some kind, even if that promise is no more than an oral agreement that I will deliver to Joe a bushel of wheat tomorrow afternoon in exchange for his bushel of apples delivered to me today. Promises and agreements are derivative instruments, in the sense that they derive from – stand for, represent – concrete goods or services, real matter and real work, which they oblige to be delivered in the future. Some such instruments are memorialized in material form. The most basic concretely instantiated promise is money.

So, there would seem to be ontological room for Thomistic usury in almost every market exchange, because almost all such exchanges are mediated by agreements of one kind or another. Any good faith promise may happen to fail in the execution of fulfillment – may turn out to be nothing. I may promise to pay your life insurance benefit, and then come to find at the time of claim that I cannot perform in producing it. There is ineluctable risk entailed in making or crediting any promise; thus there is ineluctable risk in market instruments; thus there is ineluctable risk in commerce per se. Any attempt to eliminate such risk (as with, e.g., 100% reserve requirements), and thus ipso facto to eliminate the possibility of Thomistic usury, would bring all mediated economic activity to a halt.

If Thomistic usury is selling something that doesn't exist, then all mediated economic transactions are usurious by definition. The capacity to perform on a promise may exist right now, but there is no way that the promissor can guarantee its permanence – can, i.e., show that he has met and will always continue to meet a 100% reserve requirement. The only way to come close to doing so would be to keep the assets needed to perform on the promise in a hole in the ground, which is as Zippy points out a risky plan.

Especially so, when we consider the Parable of the Talents (MT 25:14-30), wherein Jesus disagrees with Aquinas’ total prohibition of interest. The lazy servant in that parable maintained a 100% reserve requirement. He failed to dare, which is as much as to say that he failed to trust. The search costs involved in not trusting any counterparties at all are practically infinite. Even barter occurs under conditions of practically infinite uncertainty. We therefore trust perforce that others will almost always behave honorably. So markets, and all creative enterprise, supervene upon trust. This is to say that markets supervene upon a prevalent predominance of virtue in the moral character of our fellows.

So then, Thomistic usury can’t consist merely in selling something that doesn’t exist. It must rather consist, not in only in selling something that does not exist, but in doing so with an intention to deceive one’s counterparty about the true state of affairs so far as one now understands it, and thus in a knowing lie about one's own character and purposes. It is a representation that one intends to perform when one does not, or that one can perform when one knows – knows to a certainty – that one cannot. Bernie Madoff is an usurer; some sub-prime borrowers are usurers. Is AIG? Harder to tell.

What then is usorious interest? Interest is a premium earned by and in compensation for the assumption of risk. The greater the risk, the greater the premium. Properly speaking, then, usorious interest arises from the knowing and intentional exaction of interest for the assumption of risk one knows does not exist, or has not truly assumed. If the risk of a given deal, as one truly understands it to be, is fairly compensated by an interest rate of x – fairness being a function of the fair market value of a similarly risky deal on an efficient market – then any interest rate actually charged in excess of x is usurious.

But it would seem that there is a problem with this idea: if I strike a usorious deal, my usorious price *just is* the fair market price, until the next such deal is struck, at which point my deal is superseded. But in an efficient market the problem is self-correcting, because such markets involve numerous agents, each bidding and asking. My usorious bid, being extra-profitable, will attract competitive bids, which will drive the market toward the lowest rate that any trader on the buy side finds worthy of execution; and that rate is highly likely to be quite an accurate approximation to the non-usorious rate. It is anyway the closest we can come to the truly fair interest rate, unless God enters a bid.

Kristor:

If Thomistic usury is selling something that doesn't exist, then all mediated economic transactions are usurious by definition.

Maybe part of the problem we have in understanding it is our own modern tendency to think in probabilities, and to filter everything through a kind of Bayesian filter.

So then, Thomistic usury can’t consist merely in selling something that doesn’t exist. It must rather consist, not in only in selling something that does not exist, but in doing so with an intention to deceive one’s counterparty about the true state of affairs so far as one now understands it, and thus in a knowing lie about one's own character and purposes.

Under such a requirement, the cost of $100,000 of insurance benefit would be $100,000, making insurance – and banking – a non-business, and eliminating most risk-taking activities – i.e., most transactions.

Thanks for your thoughts, Kristor. I'm not sure 100% reserve requirements eliminate the possibility of insurance or banking as a business. What it does do is require capital up front to guarantee deposits. This is what I mean.

For example, under my system, if I and my bank started with $100,000 in capital, I would morally be able to take ten deposits of $10,000 each (=#100,000 total). I would then be able to lend out the $100,000 of deposits while still maintaining the capacity to return the ten deposits of $10,000 each at any time. The $100,000 lent for productive purposes would return interest, say of 15% = $15,000. I, as the bank, could $10,000) as profit and distribute the other $5,000 as interest to the depositors. When the loan is repaid, I would hold $110,000 plus $105,000 in deposits, and therefore be able to take $5,000 more in deposits. Rinse and repeat. A similar situation would work for insurance.

Obviously, this scheme would engender slower growth due to a lack of leverage. Personally, I find that attractive in this moral climate of no self-restraint. Nevertheless, it seems false to believe that banking/insurance could not exist as business. The key is simply having the capital beforehand.

FWIW, I addressed what seems to me to be a genuine ontological difference between a contract and the 'cost' of a foregone opportunity in the other thread.

Kristor: One more thing: the parable that Jesus tells is interesting.

He also who had received the one talent came forward, saying, 'Master, I knew you to be a hard man, reaping where you did not sow, and gathering where you scattered no seed, so I was afraid, and I went and hid your talent in the ground. Here you have what is yours.' But his master answered him, 'You wicked and slothful servant! You knew that I reap where I have not sown and gather where I scattered no seed? Then you ought to have invested my money with the bankers, and at my coming I should have received what was my own with interest.

In other parts of Scripture, there seems to be no nuance to the condemnation of taking interest, such that even my 100% reserve system would seem to fall short.

If Thomistic usury is selling something that doesn't exist, then all mediated economic transactions are usurious by definition. The capacity to perform on a promise may exist right now, but there is no way that the promissor can guarantee its permanence – can, i.e., show that he has met and will always continue to meet a 100% reserve requirement.

Please forgive me for my third post in a row. This objection is answered by the fact that we are not morally responsible for accidents. It is true that my 100% reserves may be destroyed or stolen. But that would be an accident, for which I am not morally culpable. I am certainly obligated to restore the reserves in so far as I can, but I am not culpable for the actual destruction of the funds.

I fail to see the difference between this scenario and a promise to drive a friend to the mall that cannot be fulfilled because someone totaled my car after I made the promise. It is a failure, but not a moral failure, and certainly not a failure of the "system" of promises. Neither is the fact that 100% reserves cannot be guaranteed a defeater for the morality and goodness of the system itself.

Not 'usorious,' but 'usurious.' I kept wanting to type 'uxorious.'

Zippy, that’s a good distinction you make between the commitment and the capacity to deliver upon it. I agree that the commitment actually exists, just as a proposition entertained actually exists. I agree that it differs from the capacity to deliver upon it, just as the truth of a proposition differs from the proposition itself. But, just as the falsehood of a proposition renders it wrong – as in, “it is wrong to think that this false proposition is true” (a wrongness that carries at least a jot of moral defect) – so the incapacity of an economic agent to perform on its commitments renders them wrong – as in, “it is wrong to say that this unfounded promise is truly (an economic) good.” I may be conflating two different sorts of wrongness, however. Will think about it.

I don’t think that your counterexample of the loan shark really works. Somehow it feels to me as though the loan shark is in a different business altogether than the banker; is not really in the financial business at all. The interest charged by the loan shark has no connection whatever with his cost of capital or the risk he assumes in making the loan; it is, most of it, not really interest at all, but extortion.

Albert, if you had $100K, and you faced a choice between investing it yourself at 15%, or idling it and going to the trouble of servicing and compensating depositors, dealing with the FDIC, &c, so as to earn a net 10% on deposits of $100K, which would you choose? The question answers itself.

With insurance, a 100% reserve requirement would be even worse. The premium for each risk would be the face value of the policy. So long as customers wanted the insurance to continue, they’d have to leave the full amount of the benefit on deposit with the insurer. But if the insured already owns enough money to shell out that benefit, he doesn’t need the insurance.

I agree that the point of the Parable of the Talents is not that interest is ok. But note that Jesus is saying, in effect, that the de minimis service to a master is to invest his funds at interest; even a slothful and cynical servant should at least do that. To invest at interest is the beginning of service, as it were.

Finally, I did not mean to suggest that a debtor is *culpable* for accidents that prevent his performance on a contract. I meant only to show that contracts entail the sale of something that does not exist: the certainty of performance. The question of usury as I have parsed it is precisely the question whether the interest charged upon the contract is fair and accurate compensation for the risk entailing upon entry thereto.

I don’t think there really is a moral difference between a commercial contract and an oral contract to do a favor for a friend. A promise is made either way, right? You may fail to perform on either sort of contract, for reasons that may be wholly out of your control. I.e., your failure may be innocent. Nevertheless, a commercial contract, issued for compensation, that fails in this way is an instance of a transaction where something is sold that does not exist – namely, future performance on the contract.

Lots of insurance policies actually limit the scope of their potential moral wrong in issuing thousands of policies that might conceivably go to claim en masse, by specifically excluding from coverage acts of war or terrorism, or the perils of earthquake or flood.

Finally, I didn’t mean to imply that the fact that promises can’t be guaranteed is a failure of the system of promises. Rather the contrary. Given the impossibility of a perfect (creaturely) guarantee, the fact that we nevertheless have this system of promises – or “societies” as we usually call them – is to me a thing of great moral beauty, and yet another indication that, despite its infection with evil, the world is still preponderantly good. All I meant to do was explore the idea that the sale of a promise is necessarily in some part the sale of what does not exist, or at least of what does not yet exist: the full capacity to perform at maturity. Our system of promises consists then partly in a prevalent trust in and commitment to a future state of affairs that has a shot at being realized only if we are most of us mostly good. And this is a good thing. Which means that St. Thomas can’t be simply right in his definition of usury, but that the notion of interest requires a bit more unpacking before we can begin to figure out what usury might be.

Zippy's concerns re: securitization/credit default swaps could be applied to all fiduciary media, no? Yet contractual paper may be traded/discounted licitly, as famed Jesuit Fr. L. Lessius detailed 400 years ago in De iustitia et iure (1605):

"Dubitatio 9: Is It Allowed Sometimes to Buy Bills of Debt, Also Known As Libranciae, at Half the Price in Case Payment Is Difficult or Uncertain to Obtain?"

The priest's only pastoral concern? Sins against charity (as those Hamilton et al. committed against civil war veterans who were remunerated in such bonds, see http://www.lewrockwell.com/dilorenzo/dilorenzo151.html):

"Nevertheless, merchants often sin against charity if they are not willing to pay a reasonable price to poor soldiers who by severe need are forced to sell their bills of debt, whereas they themselves make enormous profits."

oops my bad - missing citation
http://www.acton.org/publications/mandm/102scholia09.php

Clare Krishnan:

Zippy's concerns re: securitization/credit default swaps could be applied to all fiduciary media, no?