Wednesday, February 1, 2012

All lenders are predatory

When we left off last week, we’d come to the present, in which the Catholic Church still preaches against usury, but no longer inquires too closely into the different loan types to see if extrinsic titles obtain or not.  I was going to go further on this topic; however, Thomas Storck has a better breakdown of the history and current understanding of usury from the Church’s point of view.  Therefore I refer you to him gladly.

(Well, not entirely gladly, since I’d spent fourteen hours writing a post that Storck’s essay made redundant …. Oh well, God is good.)

However, this still leaves room for us to look at the current economic crisis from the standpoint of the financial sector’s involvement.  And when we do that, we find plenty of grounds to indict the credit industry.  In fact, if anything it demonstrates why the Church believed the collection of interest to be a sin.

Saint Thomas Aquinas’ argument against interest still bears repeating: to sell an item is to sell the use of it; so charging interest on a loan is like selling a bottle of wine and then charging each time a glass or sip is taken from the bottle.  This is different from rent, in which what is being used is not being consumed in the process; the purpose of money is to be consumed by exchange for goods and services. (Summa Theologica II:II:78:1, Answer)

The Church’s traditional teaching justifies additional charges (extrinsic titles) under two conditions, denial of the lender’s use and risk of loss.  However, as Storck argues, both presume that the lender is not in the business of lending money; in fact, the first condition, denial of use, presumes that the money would have been otherwise invested in the lender’s own business.  A reasonable charge for, say, administrative costs or a late penalty is justifiable here, or an amount that would reflect a reasonable rate of return had the lender invested the money elsewhere. (Storck, 2012)

As compelling as these rationales are, they don’t quite reach the modern business of lending for one simple reason: prior to your signature on the loan instrument, the money doesn’t exist.  In fact, under current operating rules, the bank doesn’t even need to have sufficient assets on hand for the fractional reserve.  “In practice, banks don’t wait for the reserves to be available to issue loans. They make loans first and then borrow the reserves in the interbank market. The loans come first, not the reserves.” (Harrison, 2011)

Let me repeat that, in case you didn’t quite get it:  Most of the money that you “owe” the bank is created at the time of the loan.  Theoretically at least, under the traditional rules of fractional reserve banking, the bank need only keep enough in its reserves to cover day-to-day operating expenses and normal withdrawals from its demand accounts. (Wikipedia, Fractional reserve banking, 2012)  Under the Federal Reserve’s rules as of December 29, 2011, banks with more than $71 million in daily transactions must keep 10% of its liabilities in reserve, 3% if more than $11.5 million but less than $71 million, and 0% if $11.5 million or less. (Federal Reserve System, 2011)

Now think about this: If every penny registered in every bank account and traveler’s check not issued by a bank represents a claim against legal tender, then there’s only enough cash circulating in the system to meet about 10% of them.[1]  This is actually more than there was in November 1980, when M0 currency was about 7.21% of M2 money stock,[2] or January 1987, when it bottomed out at 6.56%, but less than January 2000 when it peaked at 11.47%. (Bheda, 2011)

When you take out a loan, you give the bank an IOU, and in return the bank gives the seller an IOU in the form of a check.  Assuming that the seller puts it in a bank account with another bank, that bank can write another loan to someone else for that amount minus its fractional reserve.  Keep in mind that, in the example left, Bank A still shows an account that’s plus $100; nevertheless, out of that $100 Banks A through J have managed to create an additional $586.19 and add it to the M2 money stock.

Because the lender has added money to the money supply out of thin air, the loan has the same effect as does counterfeiting: devaluation of currency, leading to inflation of prices and loss of purchasing power.  Based on this transaction, the lender requires more in repayment than what was “lent”.  Furthermore, the longer the repayment term of the loan, the more you pay over and above the nominal purchase price:

Even granting that much of the interest is eaten up in overhead and paying interest — a much lower rate — to the depositors, and that some of the debtors will default, this still generally leaves a healthy profit for the bank when times are good.  However, keeping the system up requires a constant influx of new deposits and new loans in order to pay overhead and deposit interest as principal amortization shrinks interest income.  In this respect, fractional reserve banking is very much like a Ponzi scheme, which leads us to another disturbing realization: It’s not in the financial sector’s interest to let us pay off loansRather, it’s in their best interest to keep us perpetually in debt!

That’s why all lenders are predatory.  They have to be to survive.

So the current system consists of us paying bankers to create money that didn’t exist before, and handing over large sums of cash to have the rest of our money depleted in purchasing power through inflation.  In the (rather incendiary) words of Vladimir Z. Nuri, “In many ways the only difference between illegal counterfeiting and legal privately-owned money expansion is that gains by the recipient in the latter case are officially sanctioned, not indiscriminate, and limited based on the expansion rate. Therefore, paradoxically, privately-owned money expansion is basically equivalent to ‘legalized counterfeiting,’ i.e. a surreptitious state-sanctioned plundering of money holder wealth by private bankers!” (Nuri, n.d., p. 19)

However, we now stand on the edge of a downward slope (see graphic above).  As Comstock Partners explain, we’re seeing a decline in private debt accompanied by an increase in public debt that’s all too reminiscent of the Great Depression, as potential borrowers sit on their hands and the government bails the banks out. (Comstock Partners, 2011) 

Currently, the Federal Reserve is pursuing a “permanent zero” strategy in lending to member banks to keep the market interest rates down and encourage borrowing.  But Edward Harrison scoffs the policy as “toxic”: “Basically, low rates steal interest income from savers and fixed-income investors and give it to borrowers. It’s as if the Fed reached into your pocket and stole money from you and gave it to the over-leveraged guy down the street drowning in a mountain of debt.” (Harrison, 2012)   Moreover, reducing the prime lending rate simply extends the “doomsday cycle” (Boone & Johnson, 2010), which encourages banks to take too many high-risk bets, in the security that their losses will be socialized.

To the obvious question, “How could the banks make the same mistake twice?” the obvious answer is, “What mistake?”  The actions of the banksters were and are quite rational, given the system we have, and they have profited handsomely from both the bubble and the bust.  In truth, the only ones who profited from the bust were the ones who caused it. The “Too Big To Fail” banks are bigger than before, having used government money to buy out smaller competitors.  It would not be true to say that the banksters learned nothing; rather they learned what they already knew: that they could take insane risks, pocketing the gains and socializing the losses.  The only “change” is that things are more like they were than they ever were before. The results, of course, will be the same. (Médaille, 2011)

As much as inflation is a form of stealing value, a period of spiraling deflation would hurt many people more.  Prices may lower, but on a legal contract $100,000 is the same whether milk is $0.05 a gallon or $5.00 a gallon; in a period of deflation, wages and income generally fall as well as prices.  Try making that $899.33/month payment on $8,000 a year rather than $80,000!  Yet that is the direction in which we’re slowly teetering.

In essence, then, by allowing the practice of lending, we have enslaved ourselves and our government to banks, a practice that can no longer be justified by whatever technological and social advances we care to ascribe to this unholy union.  Having become dependent on their success as a junkie becomes dependent on smack, we’re chained not only to their success but to their all-but-inevitable failure as well.

Works Cited

Aridas, T. (2010). Total Debt to GDP (%). Retrieved January 30, 2012, from Global Finance:
Bheda, D. (2011, October). US Money Supply. Retrieved January 30, 2012, from Data 360:
Boone, P., & Johnson, S. (2010, February 22). The doomsday cycle. Retrieved January 30, 2012, from Vox EU:
CIA Factbook. (2011). GDP - real growth rate (%). Retrieved January 30, 2012, from Index Mundi:
Comstock Partners. (2011, September 22). Total Private Market Debt’s Decline Should be a Glaring Warning Sign. Retrieved January 30, 2012, from Credit Writedowns:
Davis, R. (2012, January 27). Headline 4Q-2011 GDP Growth of 2.75% Masks Mixed Signals. Retrieved January 30, 2012, from Credit Writedowns:
Federal Reserve System. (2011, October 26). Reserve Requirements. Retrieved January 31, 2012, from Federal Reserve System:
Harrison, E. (2011, May 10). Banks are never reserve constrained. Retrieved January 30, 2012, from Credit Writedowns:
Harrison, E. (2012, January 27). I repeat: The Fed's Permanent Zero rate policy is toxic. Retrieved January 30, 2012, from Credit Writedowns:
Médaille, J. (2011, November 2). There Is No Such Thing as a Bank Loan. Retrieved January 29, 2012, from The Distributist Review:
Nuri, V. Z. (n.d.). Fractional Reserve Banking as Economic Parasitism. Retrieved January 30, 2012, from Scribd:
Storck, T. (2012, January 30). Is Usury Still a Sin? Retrieved January 31, 2012, from The Distributist Review:
Wikipedia. (2012, January 30). Fractional reserve banking. Retrieved January 31, 2012, from Wikipedia:
Wikipedia. (2012, January 27). Money supply. Retrieved January 31, 2012, from Wikipedia:

[1] As of October 2011. (Bheda, 2011)
[2] “M2 money stock” includes currency in circulation, traveler’s checks not issued by banks, demand and checkable deposits, savings and time deposits less than $100,000. (Wikipedia, Money supply, 2012)