Usury law has been around for thousands of years. An eclectic mix of cultures, religions and philosophies have written about usury, from Classical Greek philosopher and teacher, Plato, to the spiritual teacher, Buddha, circa 500 B.C. Usury law is a notion that has had various interpretations and applications. To some, it means resisting charging any interest at all on a loan. For others, it means prohibiting exorbitant interest rate charges on loans. (1)

To name but a few, the following is a list of religious leaders and philosophers from the ancient world, who denounced the collection of any interest on a loan:

Plato, Aristotle, Cato, Cicero, Seneca, Plutarch, Aquinas, Muhammad, Moses, Philo and Gautama Buddha. (1)

In his Last Sermon, delivered in the Uranah Valley of Mt. Arafat, Muhammad said this about usury:

“O People, just as you regard this month, this day, this city as Sacred, so regard the life and property of every Muslim as a sacred trust. Return the goods entrusted to you to their rightful owners. Hurt no one so that no one may hurt you. Remember that you will indeed meet your Lord, and that He will indeed reckon your deeds. Allah has forbidden you to take usury, therefore all interest obligation shall henceforth be waived…” (2)

Like Muhammad, Aristotle was not a fan of usury. He knew that money was sterile and could not produce anything beyond itself; not to mention it was a creation of government. Where seeds yield trees bearing fruit, money is barren. Here are some of Aristotle’s aggravated words regarding usury:

“Money exists not by nature but by law…The most hated sort (of wealth getting) and with the greatest reason, is usury, which makes a gain out of money itself and not from the natural object of it. For money was intended to be used in exchange but not to increase at interest. And this term interest (tokos), which means the birth of money from money, is applied to the breeding of money because the offspring resembles the parent.” (3)

Usury allows a person to gain wealth, in absence of labor. This has tormented many throughout history. Until now. In a capitalist system, it’s perfectly acceptable to only supply the capital for an economic activity. Entrepreneurs provide the ideas; venture capitalists and banks finance the entrepreneurial brilliance. Where credit is certainly vital to an economy, I’m not convinced that predatory lending and shady, overpriced usury is.

Predatory lenders make a living from charging exorbitant rates of interest to their fellow man. The debtors, who are supposed to make timely payments on these loans, generally have lackluster credit and a high risk of default. Some real estate moguls in the United States have made their fortunes by lending money to sub-prime borrowers with healthy equity in their home. They’ll give the home owners money at say, 19% interest, leaving two possibilities: 1) the predatory lender earns a 19% return on their investment or 2) they’ll seize the house and gain a nice equity position, plus the value of their original loan investment. Interest return on money is determined by risk (and time value of money exposed to inflation) and risky borrowers require a greater return. But should human decency kick in at some point, where a risky borrower is simply someone not worthy of a loan?

This piece is not a rant on avarice investors; nor how the U.S. is inherently more evil than any other country; nor the failure of capitalism. Rather, it’s the acknowledgment that in 21st century American capitalism, people will do just about anything to one another to make a buck. Consider it.

The global crisis of the financial system pretty much boils down to contempt for usury law. Greedy financiers made unsound loans to unworthy borrowers, which were then bundled and sold over and over again, tanking the financial system. Then, people made risky bets on assets they didn’t even own. These bets were a specific type of derivative known as a credit default swap (CDS). Derivatives are pieces of paper that derive (note root word!) their value from an underlying asset. For those keeping score at home, a person buys a derivative using Federal Reserve notes (money). Federal Reserve notes gain value because the government declares they have value. More specifically, the notes are “legal tender for all debts, public and private.” The value of Federal Reserve notes is backed by the U.S. government’s power to collect assets, through taxes. The money and assets the government collects are yours and mine. Boom, you have the world’s reserve currency. But as far as CDS’s are concerned, what’s fascinating is that an investor buys a piece of paper, which derives its value from something the investor doesn’t even own, with other pieces of paper that the government only declares has value. And there you have the contemporary global financial system. It sounds a bit more artsy, and somehow better, that way.

By the end of 2007, the CDS market was valued at $45 trillion, more than twice the U.S. stock market, before the bailout of Bear Stearns in March 2008. The CDS market is also valued more than the current U.S. stock market, $7.1 trillion U.S. mortgage market and $4.4 trillion U.S. treasuries market combined. (4)

These derivatives were supposed to act as insurance, in the event that an underlying asset defaulted. A person would take the insurance out, pay a premium every month to the bank and be protected, in the event of the underlying asset defaulting. This allowed Wall Street to earn “easy money”, collecting the monthly premiums. Sounds pretty good. But the CDS market wasn’t subject to any rules. The insurance notes could be swapped from investor to investor without notification to the bank. Through this process, the new buyer’s ability to make the payments, or cover the losses if the security defaulted, were not verified. And banks, also known as the insurer, were able to trade these pieces of paper without any rules, as well.

The U.S. financial services industry, one that trades paper, produces precisely nothing; only bloated GDP figures. Money is barren, to turn a phrase from Aristotle. Yet the financial sector is one of America’s biggest.

Derivatives materialized as a world trend. The total world derivatives market has been estimated at around $791 trillion, 11 times the size of the entire world economy. While a genius way to make a quick buck, derivatives were not so cleverly executed for the long-run health of banks. While some buyers of CDS’s did own the underlying asset, and were simply hedging their own investment, many were investors buying and selling on secondary markets, with no direct connection to the assets in question. The credit default swap is not that different from me, placing a bet with my bank, that my neighbor will default on their mortgage. I don’t own the home in question, the mortgage on the home, nor do I have a personal interest in the endeavor, other than secretly hoping my neighbor goes into foreclosure. (5)

The United States, and other capitalist-inclined countries, departed from the spirit of usury law long ago. As we pick up the pieces of our terminally ill financial system, it is important to retool in a sustainable way, so we may prepare for the coming decades. The debate rages on as to what an ideal economy looks like. It is a discussion worth having as the face of our economy is rapidly changing. Many hard-hitting questions need be answered:

Are markets infallible creations that never get it wrong?
How much government intervention and regulation is the right amount?
Will the public debt, and future obligations like health care, bankrupt the nation?
Are the American people mostly good, and willing to stop hurting one another to make a buck?

Markets do fail at times. But the idea that the United States has “free markets” is laughable. We haven’t had free markets since at least 1933, when central planning took center stage with FDR’s New Deal, which deepened the Great Depression. Wage caps, minimum wage, trade barriers like tariffs, farm subsidies and allowing mortgage interest deductions from taxable income are all examples of the U.S.’ confined, manipulated “free markets.” A true free market experiment really hasn’t been done for some time.

Do government bureaucrats get it right as central planners? I think the answer is usually no, they don’t. Government caters to special interest groups, small sections of society that amass great power by throwing around cash. Politicians also enact policies they think are wise, and in the best interest of the people. Too often, it’s an ideological play or a “shrewd political move”, which drives a politician’s belief of what’s best for everybody else. What we’re left with is a misallocation of resources. Taxpayer funds directed into Fannie Mae and Freddie Mac over the years is a stellar example of such a misallocation, which contributed to the housing bubble.

Why do we have the Federal Reserve? The Fed’s job is to prevent banking panics. There’s also a belief that they can tame the business cycle, by evening out 10-15 year boom and bust cycles. To squash bank runs, the Federal Reserve provides liquidity to banks by providing extra cash. By managing the nation’s money supply, the Fed has the sometimes conflicting tasks of maximizing employment, keeping prices stable by preventing inflation or deflation and maintaining moderate long-term interest rates. Through these acts, the Fed is supposed to create long, sustained periods of prosperity, compared to the natural 10-15 year boom and bust model.

Has it worked, though? In the early 1980′s, prime interest rates were at 21%; and the country had just left the stagflation of the 1970′s. Where I live in Oregon, there was a downright depression in the 1980′s, greatly driven by a struggling lumber industry. 1995-2000 gave way to the dot com boom, followed by a severe stock market adjustment and a minor recession for one year. Next, the economy gave way to the 2002-2007 real estate boom, and then bust from 2007 to now. The stock market peaked again at 14,000 points in October of ’07, only to fall back to 6,627 points on March 2nd of this year. If this is taming the business cycle and bringing long, sustained periods of prosperity, my name’s Elvis Costello. (6)

If some progressives were given truth serum, or named Bill Maher, they’d tell you they prefer central planning over markets because the American people are stupid. The nicer argument goes like this: without an informed society, free market capitalism and democracy does not work. But some progressives think a sizeable contingent of Americans are cretins; morbidly obese, bird-brained buffoons glued to mindless entertainment. And, in many ways, I can’t really blame them. A great number of people don’t have a clue when it comes to important subjects. Is it the majority of people? I don’t know. Any guess of how many of these people frolic about in society would be based on nothing. It’s true, though, a great deal of Americans have no grounding in important things that enable basic functioning in the world: like personal finance, economics, the Constitution, health and fitness or common sense. Many people are ignorant and uneducated. To turn a phrase from Bernie Goldberg, we live in the United States of Entertainment.

Markets are not infallible creations. The wild derivates market is a prime example of that. But government must have a function to better the economic lot of society. Or do they? If you subscribe to freedom, maybe the Federal government’s role should be rather puny. In Freedomland, people fend for themselves, and private enterprise or charitable giving helps take care of those incapable of doing so. Everyone has the right to life, liberty and the pursuit of happiness in Freedomland, which could mean epic failure or phenomenal success (usually plenty of both). Even in Freedomland, credit card companies (who ignore usury law) may solicit consumers with 25-page booklets, making it as impossible as they can to understand the product. In the case of credit card companies, it would be nice for government to provide basic outlines, which would make it easier for the consumer to understand what they’re getting. A one-page description, with a single interest rate and straight-forward fees, would be fantastic. It would even be nice if the government outlawed companies from charging outrageous interest rates and hidden fees, which enslave innocent folks with insurmountable debt. Only two problems: consumers are not innocent and government can’t be trusted to wield fairly open-ended power, judiciously. What is an “outrageous” interest rate? How does that change in two years? Who makes these decisions on the fly? Any revenue-producing tactics the government was to shut down, credit card companies would spend their time finding new, innovative ways to screw the consumer and make up for lost profit.

Consumers have to be educated if they expect to not be taken advantage of. In the internet age, it’s difficult to conjure up a valid excuse for a consumer being uninformed about a product or service. With endless streams of information at our fingertips, including consumer reports that rate, review, explain, analyze and distill every product or service imaginable, a consumer getting duped has no one to blame but themselves.

At this rate, the public debt, and future obligations like health care, will bankrupt the nation. If health care is nationalized, even quasi-nationalized, we’re going to be in trouble. I don’t care how much money electronic medical records will save. The public debt has already enslaved generations of Americans.

American people are mostly good, but no one is either completely good or completely bad. There will always be people willing to hurt others in order to make a buck. Circumstances create incentives, and people are self-serving. The best answer in this time, as in all others, is freedom. Fake free markets, backstopping every huge corporation of any significance; and central planning by bureaucrats, running up debt and printing new money based on nothing, will not work. The government may have a role for reeling in the derivative markets. For example, it may be that a person should actually own, and have a stake in, an underlying asset to purchase or sell insurance on it. But maybe banks who load up their balance sheets with CDS’s, and neglect to record and track them, should fail. Then, perhaps, the government could stand behind FDIC insurance and guarantee bank customers that their deposits would be insured up to $250,000. If a bank run still incited, within a few weeks information would be circulated about which banks were solvent, and which were not. Those that rushed to their banking institution, despite an insurance guarantee on their deposits, and pulled out their money to stuff in their mattress, would soon put it back. Even if that didn’t work, I’d rather have a few banks and companies fail, then add trillions of debt to the books, backstopping firms that still might fail anyway. My guess is that more banks would be providing more credit to businesses today, had the dying banks been put to death or shoved into bankruptcy, in March of 2008.

No matter your feeling regarding economics, my plea to humanity is to treat one another how you’d like to be treated; the golden rule goes a long way. Let’s stop hurting each other in order to make a buck; let’s be educated consumers so we don’t allow others to hurt us. If we pick up the pieces of a shattered economy in a sustainable way, my generation may have a fighting chance.

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(1) Wikipedia – Usury

http://en.wikipedia.org/wiki/Usury

(2) Fordham University – The Prophet Muhammad’s Last Sermon

http://www.fordham.edu/halsall/source/muhm-sermon.html

(3) Money Museum – Aristotle’s View Against Usury

http://www.moneymuseum.com/standard_english/raeume/geld_machen/bank/interest/aristotle/aristotle.html

(4) Time – Credit Default Swaps: The Next Crisis?

http://www.time.com/time/business/article/0,8599,1723152,00.html

(5) Wikipedia – Stock Market

http://en.wikipedia.org/wiki/Stock_market

(6) Yahoo! Finance S&P 500 Stock Chart

http://finance.yahoo.com/q?s=^GSPC