Q&A
Usury and Interest
Written in mid-March AD 2005 but other questions took
precedence
and this was never published in the Parish Bulletin.
A related article, written earlier in time, was published in the April
AD2005 Bulletin and should be read first.
Question: You don’t think interest payments are usury? Have
you any idea what one pays over 30 years to buy a house?!! What happened to the
idea of friends and neighbors getting together to build each others barns?
Answer: For purposes of this discussion, the assumption is
that a fully informed buyer and lender enter freely into a
contract. You can make the interest calculations for yourself to see the effect
of the interest rate and the length of the loan in years. (Those allergic to
numbers can skip the next two paragraphs.)
P = L[c(1 + c)n]/[(1 + c)n - 1]
Where P=monthly payment
L=dollars borrowed
c=monthly interest rate (annual rate /12)
n=number of payments
or you can go to an online calculator such as the one at: www.kbapps.com/calculators/Default.htm
For those of us who usually don’t walk around with $10 in
our pockets, the numbers are awfully large, particularly on a 30 year mortgage.
At 6% a $100,000 loan will cost a total of $215,838.19. Cutting the length to 15
years will drop the cost to $151,894.23. Had the rate been 12% for 30 years the
cost would be $370,300.53. The 6% figure is closer to current market rates, but
12% was not unheard of a few years back—18% during the Carter administration.
Let’s note that 6% for 30 years requires a monthly payment of $599.55; and for
15 years it rises to $843.86. The real question is “are these numbers
unreasonable?”
“Unreasonable” is a meaningless word unless we relate it
to the alternatives. What is “reasonable”?
An obvious alternative is to live with Mom and Dad-but they
may not approve, particularly if there are a number of sisters and brothers—and
they might even want money from you.
Many people rent. Even if they are “saving up to make a
down payment,” they rent until they are ready. Perhaps one could save the
entire amount before buying. The problem there is that rental apartments often
cost somewhere around what a person will pay on a house payment. For many folks,
that doesn’t leave a great deal to save.
Here in Deerfield Beach the average newly constructed home in
2003 cost $118,900.[1] That requires $712.87 at 6% for 30 years. With a few hundred
for taxes and insurance we are at about $1,000 a month. But that is also the
rough cost of a two or three bedroom apartment in the same locale.[2] Now, suppose
you could afford both to rent the apartment at $1,000, and to save $1,000 a
month. Let’s say you can get 4% on your savings—in just a bit over eight years
you will have the $118,000. But are you sure that in eight years your rent will
not rise, and are you sure that the house will still be $118,000? And,
with a $2000 a month payment you could pay off the $118,000 house in seven or
eight years—including $300 to $500 a month for taxes and insurance.
Obviously there are intangible factors that cut both
ways—one
gets maintenance issues right along with pride of ownership. But who is more the
usurer in this example—the landlord or the banker?
Still, a few will question why there should be any interest
charge at all. (Even paying for the house in eight years will add about $31,000
to the $118,000.) After all, “I am going to pay the money back-why should I
have to pay something more?”
To begin with, the banker doesn’t know that you will pay
him back. People do die, go to jail, and disappear into the night. Through
experience the banker knows approximately how many, and passes the cost of those
unpaid loans on to the honest and reliable people. If he didn’t, he wouldn’t
be there to loan the money. He may charge higher rates for purposes he judges to
be more risky, but he knows he cannot collect from the missing or the bankrupt.
But the major factor in interest rates is the “opportunity
cost.” It may be easier to understand if you put yourself in the position of
the lender. Suppose an acquaintance came to you asking to borrow, say, $5000 for
five years. Rich or poor, you probably don’t have it lying around the house.
Maybe you have it in a CD, or you own a few shares of stock—immediately, the
cost of withdrawal penalties or brokers’ commissions enter into your thinking—it will cost you something just to liquidate the money in order to turn
it over to the acquaintance. And then you will ask yourself what you will be
losing in interest or dividends (about $1100 at the 4% we assumed for savings
above). And, finally, you will ask yourself what might be the effects on your
own plans—if, say, you had intended to spend the $5000 on a new roof sometime in
the next two years—what would be the effect of not having your money for five
years? And, no matter who the acquaintance is, the risk calculations will be
going on in your mind if not on paper. Unless you are prepared to make a gift to
the acquaintance of somewhere between $1100 and $5000, you will have to charge
something for the use of your money.
The Commercial banks do look at loans from a slightly
different perspective. Through the magic of the Federal Reserve system, they can
loan the same money out to several customers at the same time. They call this
“fractional reserve banking.” You can’t do this with your $5000, but under
current reserve requirements, your banker can take your checking deposit of
$5000, place $500 in reserve, and loan out $4500. No magic yet, but when that
$4500 gets deposited in another bank, that banker can loan out $4050, which in
turn can back another loan for $3645 ... $3280.50 ... $2952.45 ... $2657.21 ...
$2391.48 ... $2152.34 ... $1937.10 ... $1743.39 ... $1569.05 ... $1412.15 ...
$1270.93 ... and so on to equal $50,000 in loans. Since borrowers generally
deposit the checks they receive from the bank in that bank or another, the money
circulates pretty evenly and it is unlikely that there will be a run on any one
bank beyond the amount they hold in reserve. The reserve requirements, which may
vary from time to time, are set by the privately owned central bank known as the
Federal Reserve (“the Fed”). As of June 2004 they were 10% on checking
accounts and 0% on savings accounts.[3]
There are arrangements for loans from the
Fed if a bank gets in trouble maintaining the mandated level of reserves.[4]
A number of objections can be raised to the Federal Reserve,
not the least of which is monopoly control of the money supply by private
bankers—a money supply based entirely on government debt (No, Virginia, not
gold, not silver, but debt). Fractional reserve banking is one aspect of the Fed
that usually raises eyebrows more than others. It is relatively safe, for the
Fed can pump “money” into the system in general or to specific banks if
there are signs of a run. But our discussion is on usury, and even if loans are
made to fully informed borrowers, there does seem to be something a bit “off”
about the banks loaning the same money ten times over at 6% or whatever the
prevailing rate. That issue could be addressed simply by adjusting the rate—but
it is impossible to determine just what the rate ought to be in the absence of a
free market—the Fed powerfully influences the interest rate via its “open
market operations,” the sale or purchase of US Treasury bonds in order to
raise or lower the money supply; the “federal funds rate,” which banks
charge each other; and, ultimately, the interest rate paid by consumers. The Fed’s
buying of T-bonds increases the money supply and lowers the rates; selling
T-bonds decreases the money supply and raises the rates.[5] The Fed also dictates
the fractional reserve requirement, also thereby controlling the money supply,
and very strongly influencing the interest rate—but changing the reserve
requirement is a lot more bother for everyone involved than open market
operations. What should the interest rate be? Today it is whatever the Fed says
it should be.
Since the money supply is not pegged to any standard of value
there is a tendency toward inflation. If anything, there is a bias in favor of
inflation—as opposed to deflation, recession, or depression—in the Fed’s
thinking. Those living on a fixed income will be able to afford a little less
each month, even though they have the same number of dollars. Those who can will
demand “cost of living raises,” thus adding to the inflation. The T-bond
holders will benefit from a rise in the price of their bonds as the Fed shops
for a few million dollars worth of bonds, and, characteristically, they will
reinvest their inflated profits in other things before the effects of the
inflation propagate through the market (i.e. they will enjoy the proverbial
dream of “selling high and buying low”). Open market operations .are
conducted through normal investment channels. The Fed goes to the large
investment brokers to buy the T—bonds-they too make their profits before
inflation works its way through the economy and can reinvest at rates that are
soon to be low.
The economy is a complex thing, and this writer, a priest
with only moderate experience and education in business, is not qualified to set
all of its problems right; yet others far more knowledgeable and far more
experienced have drawn similar conclusions. But if there is a moral issue in
this, it is not in borrowing of money by people above the lower levels of
poverty voluntarily agreeing to pay interest in return for an improvement in
their condition. The moral question concerns the structures of our
governmentally imposed economic system. “Is it not possible,” we must ask
ourselves, “that a different approach might lead to lower levels of poverty
and a uniformly higher degree of well-being?” There is an undisputable
connection between the fulfillment of basic security needs and the ability to
grow in the spiritual life. Perhaps there is the opportunity here to allow more
people to know God, and to know Him without despair and resentment over their
material condition.
Yes, People Did Help Friends
and Neighbors to Build
Let’s consider Luke Smith, the young man of a hundred years
ago who met Becky Thatcher at the church’s Sunday ice cream social; the third
son of an average farmer, who has decided that he wants to build a new home,
marry Becky, and bring her home to it on their wedding day. Matthew Smith Jr.,
the firstborn, will inherit the family household, and Mark Smith is soon to be
ordained to the priesthood. The father, Matthew Smith, Sr. thinks Becky is a
good girl, approves of their wedding, and agrees to deed a few acres out of his
two hundred to Luke.
With his father’s generosity and approval, at first, Luke
thinks that his problems are all over. Then he gets down to the realities of
what must be done and how long it will take before there is a house which he and
the new Mrs. Smith can safely—let alone comfortably—inhabit. Let us imagine his
planning:[6]
Luke Smith’s ten acre home site is just over the hill from
his parent’s home. That is fine, since he will continue to be a part of the
family farming effort—at his new home he will have to make structural provision
for only a few horses and a wagon, some winter storage, and a few essential
domestic animals; a few dozen chickens, a pig or two, and probably some goats—probably, a structure no bigger than his own house and less expensively
constructed, will suffice.
Luke’s first concern will be with the water supply-where
does he dig the well? No point in building a house where there is no water!
Ezechiah, the local dowser, can usually take a fresh green forked stick, spit on
the short end of the fork, hold the long ends in his hands, and find water on
the first dig. Ezechiah demands two bottles of “liquid corn” for his
services, but has been known to settle for three and a half dozen very
brown eggs. If, after Luke digs the thirty-five foot deep hole, there is no
water, Ezechiah will renegotiate his fee for the second dig. Once the well is
under way, Luke will also have to lay out and dig two other significant holes:
one for a root cellar under the proposed house, and the other for an outhouse,
as far as possible downwind, downstream, and downhill from the water supply.
Luke’s friends and relatives will help him to dig these fairly significant
holes, but he will have just begun to consider the capital outlays necessary to
make the holes and the whole enterprise viable.
Luke probably has to buy some cement and some kiln fired
brick to make his diggings secure and safe for his new family; some bricks for
the walls of the root cellar, and some bricks to encase a well shaft a few feet
in diameter while backfilling the rest of the hole with gravel. Instead of a
bucket on a crank, Luke hopes to have a mechanical hand pump, and a covering
over the well. He would do well to build even the walls of his septic pit with
stone or brick. (There is nothing worse than thinking that one is comfortably
about his business while seated on the deck of an outhouse that is collapsing
into the pit below!) Already there are capital requirements that cannot be
supplied by the labor of family and neighbors.
After digging and reinforcing a significant number of large
holes in the ground, Luke Smith will begin to think about acquiring the
necessary building materials to raise his and Becky’s new home. We’ll assume
that the root cellar is the only thing akin to a foundation, and that the house
will be built, essentially on the ground.
Wooden beams and boards now become essential. The only way
for Luke to acquire them is to fell trees and have someone establish a portable
saw mill on the property. The saw mill owner cannot afford to contract just for
eggs or liquid corn, even if he is a friend or family member, because he has to
provide for the supply and mechanical upkeep of his equipment—beyond his own
physical needs or wants. While the sawmill is being arranged for and set up,
Luke and his friends are feverishly working to fell timber at the correct time
of year, so that it may lie on the ground until properly “seasoned” and thus
be impervious to rot and infestation.
When it is time to invite the friends and neighbors for the
actual construction, an number of capital outlays will have to have been made.
The sawmill operator will probably be able to make or get a good price on wooden
shingles for the roof, but a few roles of tar paper will mean the difference
between comfort and drip. Corrugated tin will work for the stable, but it would
be awfully hot in summer, cold in winter, and terribly noisy when it rains or
hails on the house. Nails for the boards and bolts for the beams must be secured
from a distant factory—metal hinges, as well. There will be a few dozen items
that everyone forgets which will have to be bought and paid for at the last
moment.
When all of the initial work is over, the Smiths will have a
house that is not much more than a big room. Hopefully there will have been
time, material, and labor to raise a wooden floor off the ground. At one end
will be the kitchen, equipped with an enameled sink, piped through the wall to
an adjacent garden patch, and a large black iron stove (two more capital
outlays)—at the other end there will be provision for the future building of a
stone fire place. Until both ends of the house can be heated, walls and doors
will be purposefully scarce. Things in general will look nothing like what you
have seen in Western movies.
The point of this imaginary exercise is that even with free
land, natural building materials, and abundant help from friends and neighbors,
the new Smith family will move into relatively primitive housing that will be
upgraded to more comfortable standards only as years and decades pass. There are
relatively few places left where the local authorities would even permit such
construction—it would certainly be impossible and illegal on a quarter acre city
lot. Most modern Americans would find themselves without the time, the ability,
or the energy to undertake such an effort—-hardly any would give it a second
thought.
The alternative is to borrow the money at the beginning of
construction, build a house that is more or less complete in its amenities, and
spend those years and decades in both making payments and enjoying the home.
Or one might “go back to nature,” living far from
civilization....
NOTES:
[1] http://www.city-data.com/city/Deerfield-Beach-Florida.html
[2] http://www.apartments.com
[3] http://www.ny.frb.org/aboutthefed/fedpoint/fed45.html
[4] http://www.ny.frb.org/aboutthefed/fedpoint/fed18.html
[5] http://www.newyorkfed.org/education/role.html
[6] We can only imagine, for our fictional Luke Smith will have had to deal with
an incredible number of variables, taking time, location, wealth, and technology
into consideration.
