The Moral Justice of Moneylending

As the dust settles after the first Republican primary debate of 2016, news outlets and expert analysts have had no shortage of topics to pick apart in the most watched political debate in US history: Fiorina’s surprise performance, Christie’s and Paul’s exchange over NSA surveillance, and, of course, everything Donald Trump. Though the billionaire’s refusal to renounce a third-party run and his blaming Fox moderators for his mediocre performance have dominated news cycles, one comment of his has gone overlooked: that in which he nurtured one of the oldest prejudices in the world by vilifying financiers and those who make a living by issuing loans. “Let me just tell you about the lenders,” Trump said. “First of all, these lenders aren’t babies. These are total killers.” There is room for reasonable disagreement as to whether Trump was characterizing all lenders as “killers” or admitting to having himself dealt with corrupt, vicious parties, but the applause that followed that comment speaks to the popular prejudice against lenders shared by many Americans today.

Finance is perhaps the most demonized industry in the modern world, along with the oil industry. Unsurprisingly, finance is also the least understood of all businesses. From leftist rants about “predatory lending” that seeks to “profit” from debtors defaulting on their loans to distinctly Libertarian lamentations regarding the “evil” of fractional reserve banking, the financial sector never wants for a surplus of enemies out to shackle and destroy it.

For the left, the motive for such destruction is that finance is the antithesis of everything for which they stand. For altruists, finance—if it is successful—does not operate upon the premise of unearned entitlements, of need as the source of rights, of a zero-sum reality, or of sacrifice. For the nihilists, finance is the most visible form of capitalist, self-interested production upon which countless other forms of production rely. Thus, they seek to destroy it along with all else that has lifted man from his otherwise primitive, animalistic existence.

As of late, the opponents of finance have turned toward attacking one of its most fundamental and beneficial tools of production: loans. Such attacks deserve categorical refutation, not merely because they are wrong, but because they strike at the heart of the economic progress that makes modern civilization possible. The cycle of human production is the employment of profits from past production to subsidize ever greater future production. In its most basic form, this is like farming a field, saving some of the crop as reserve seed for the next season, and producing an even greater harvest at a later date. This is the process of finance, as actualized through the use of loans and other tools. This is what must be defended.

First, examine leftist hypocrisy towards loans. The left criticizes lenders’ alleged stinginess in refusing to issue loans, essentially free of charge, for things such as education; in the same breath, it denounces the recklessness with which similar loans are issued for things such as housing. The New York Times, for example, ran one op-ed encouraging students to default on “unfair” student loans and, within a matter of weeks, ran a second editorial entitled “Why Greece’s Lenders Need to Suffer,” which argued that Greece’s lenders deserved punishment for the implosion of socialist Greece’s fiscal state. Nevermind that financing both education and housing is either wholly or overbearingly governed by the state, let alone the Greek government, whose debt is principally financed by other European governments.

But a loan is neither a handout to the undeserving nor a sum of money that one expects to be returned at a later date without interest or legal accountability. To the extent that loans have become such things in the twenty-first century, a government program is almost invariably to blame. In the first instance, merely look at low-interest student loans, issued irrespective of whether a student is a scholar or a sot, whether a he is pursuing a career in engineering or in underwater basket weaving, or whether he will actually produce a worthwhile return on the loan or will simply become a well-educated deadbeat. In the second, look at Fannie Mae, which insures “risky” mortgages and pays banks in the event of a default, incentivizing the issuance of reckless loans that otherwise would not exist.

Instead, loans are merely a trade—one of current value for future value. To truly understand this, however, a brief discussion of money is warranted.

Money is at once a tool of exchange and of storage. It is a physical representation of values that have already been produced but which have not been consumed by the producer, the holder of the money. In non-monetary systems, a man must trade the values that he has produced—whether grain, cattle, pottery, tools, or whatever—directly for other values. These values cannot often be stored indefinitely (e.g., grain or cattle), and those that can be stored (e.g., pottery and tools) are not easily resold for other values. In this way, man is largely constrained to consume what he produces, or else to consume what he can get directly from bartering. His wealth does not exceed what he can reap from a single harvest. Such a system limits man’s ability to engage in long-term, high-value production—first, because he cannot store up enough resources to begin such a project, and second, because any profits above and beyond what he can personally consume would perish and be wasted.

Money frees man of such limitations. It allows him to exchange his goods and services for a non-perishable, redeemable representation of the value that he has produced. It relieves him of the concern of wasted work—overproduction from which he will derive no personal benefit. If he produces more than he consumes, the remainder can simply be stored in the form of money and used at a later date without fear of undue waste. (For more perspective on monetary theory generally, I will direct readers to Alan Greenspan’s 1966 essay “Gold and Economic Freedom,” which can be found in Ayn Rand’s Capitalism: The Unknown Ideal.)

Loans expand this freedom further. Normally, any resources that man could devote toward long-term, high-value production would be confined to those that he personally produced and saved over many years.

Imagine, for example, a man who has the idea to build a large mercantile vessel around the time of the Renaissance. The vessel would be of immense value, transporting otherwise rare and precious commodities long distances much more quickly and securely than by land, and in much larger quantities. The values needed to produce such a ship would be astronomical. Without money, the project would be virtually impossible, requiring several men to forgo their livelihoods while not expecting a return for many months, if not years. Even with money, a man could not be expected to produce and store enough value in his lifetime to pay the wages necessary for the shipbuilders to live and profit during construction.

However, loans are one of many ways individual men can pool the values that they have produced to create something of even greater value. One or several men provide another man with the values that they have already produced for him to utilize in particular project or venture. The recipient, in exchange, promises to pay the principal back fully, plus interest.

The interest serves several functions. First, it secures the lenders against loss—requiring periodic payments of sums in addition to the principal so that, in case of default, the lenders do not suffer a total loss. Second, interest serves as a metric for the level of risk that lenders are taking with respect to a particular venture. If the venture is riskier and less likely to produce a long-term return (at least relative to other available ventures) the interest will be higher. The debtor must then decide, based upon the interest rate that he is offered, whether the returns that he expects from a particular venture will outweigh the risk that his lenders are taking (and the corresponding price that he must pay for it). If not, he must take additional steps to make the venture less risky before accepting the obligations that a loan would place upon him. Third, interest provides the lenders with a profit for their production. Because a loan represents the values that the lenders have produced but not consumed, their productive efforts are contributing toward the venture in a very real way. They are using the fruits of their productive activities—with the debtor as their agent—to produce greater values. This repurposing of the lenders’ produced values is, in itself, production, for which they are entitled to a share of the profits earned by their agent.

Banks facilitate this process by combining the resources of many individuals and investing those resources on their behalves. In essence, savings accounts—properly understood—are loans to banks, which then use the money for further production in the form of additional loans. The interest on savings accounts represents the individual’s share of the risk in the investments that the bank makes. In a free market, individuals would gravitate towards banks that make reasonable investments while banks that make poor investments would fail. Such is the “evil” of “fractional reserve banking” that Libertarians despise.

Leftists often complain that this process is nothing but individuals “making money from money.”  The proper response to such complaints is: “Exactly!” But it is only by divorcing money from its purpose—that of storing already produced yet unconsumed values—that the left can treat finance as some mystic, cosmically unfair system through which those who have “capital” are able to profit without actually doing any work. The reality is that the money represents work already completed, and that the loan is a further exercise of mental labor in distinguishing poor ventures from worthwhile ones. In a free market, success in finance is nothing more than an exercise in justice.

The left, of course, misrepresents the nature of justice as well, and so misrepresents when loans should be issued and on what terms. To the left, it is “unjust” to not issue loans to those who “need” them, and it is doubly “unjust” to collect on those loans when those who “need” them fail to do anything productive with them. This and the last century have seen numerous legislative measures from statists distorting and altering the way loans function—including the manipulation of interest rates, the creation of a national fiat currency, the abolition of the gold standard, public insurance of banks, public insurance of certain loans, public lending, etc. All such efforts have only served to undermine the integrity of the financial system by redirecting loans from productive ventures towards unproductive ones; from those who deserve a loan to those who do not; from those who make proper investments and should profit to those who make poor investments and should fail. In the absence of public insurance for banks, for example, banks who constantly make bad loans would not—as leftists contend—profit, but would instead fail and go out of business.

A loan is not a sacrifice. It is not an exercise of an unearned privilege to gain from the labor of others. It is an investment. It is an allocation of one’s own resources to a cause that one believes will be profitable, and then profiting (or not) from it. To allow, as the government has, investments in something like the education of a D-student in a major like underwater basket weaving, and to give the lenders (the taxpayers) no say in the matter only invites the waste of their resources and the accumulation of debts that cannot and will not be paid.  It violates the rights of the lenders, and it subsidizes unsustainable, unproductive behavior on the part of the debtors—and this is true across all areas into which the government has interfered with the lending process.

Quite contrary to leftist assertions, the solution to the biggest problems that the left decries (student debt, Greek debt, housing loans, etc.) is not more state intervention. The solution is not loan forgiveness, freeing debtors from the obligations that they have contractually accepted. The solution is not increased regulation, preventing lenders from managing their own funds and independently deciding which ventures to subsidize. The solution is to get out of the business of finance, to stop shielding irresponsible lenders and debtors alike, and to hold both parties to the obligations to which they contractually agree. The only role of the state is to uphold and enforce these obligations, to prevent fraud and deceit, and to protect the rights of all involved.

If this is done, then all the problems revolving around finance will resolve themselves. “Risky loans” will not be made, lest the lenders fail. Debtors will not take out loans that they do not feel comfortable paying back, lest their credit be ruined and their lenders seek compensation through the bankruptcy process. Individuals will be free to invest the values that they produce into ever more productive causes. In sum, rights will be protected. That is the end of the state.

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