Chapter 2

The Origins of Residential Finance

Back in the days of Og, nobody borrowed money to buy a cave. You either owned it or you didn’t. In a pre-monetary age – that is, for most of human life on earth – this made sense for many reasons. The future was highly uncertain; the idea that you would buy something and extend payments over thirty years would have seemed ludicrous. Back then, you’d be crazy to lend anything to a borrower who, statistically, might be dead tomorrow. Then there was the question of value. Without an accepted medium of exchange, how could you determine what a cave was worth? A cow? Two cows? Fifty bushels of wheat? Fifty bushels of wheat every year for ten years? Anyway, that last calculation sounds more like rent. Anyone who owned a cave would never dream of giving up ownership and being paid over a period of years.

The concept of buying a dwelling and paying for it over time only begins to make sense when you’ve got a medium of exchange that is universally accepted and endures over time. It works only when you can assign an objective value to something and have some assurance that the scale you’re using is not going to change in ten or twenty years. You need to be able to say, “This cave or this house is worth x pieces of gold or specie, and in the future its value can be measured using the same scale.”

Any discussion of the residential finance industry, and how property is bought and paid for over time, needs to begin with the concept of finance itself. For simplicity, I’ll skip the topic of commodity money, wherein the agreed-upon medium of exchange is not merely representative of something of value (as is the case with our paper money), but actually is something of value. For example, in prisons, where the possession of cash is typically not allowed, inmates buy and sell commodities with agreed-upon methods of exchange such as cigarettes. In the American colonial west, commodities such as beaver pelts, fish, corn, and wampum were mediums of exchange. In South Carolina, rice was used as money, and a standard use of commodity money was tobacco. A pound of tobacco was a unit of currency in Virginia, with warehouse receipts in tobacco circulating as money that was fully backed by the actual tobacco stored in the warehouse.

There’s another very good reason why over thousands of years of human history there wasn’t much borrowing and lending of money. In general, scholars and priests alike condemned the practice of profiting from the activity of lending money – that is, from the charging of interest on loans, which is the basis of today’s residential finance industry.

And here it would be useful to draw a very important distinction between charging a fee for lending, and charging compound interest.

Fee based lending is very simple – I lend you something, and after a period of time you give it back, and as payment for this service I charge you a set fee. Therefore, if I lend you ten cows, at the end of the season you give me back the ten cows plus two calves. If I lend you ten dollars, you pay me back the ten dollars plus a dollar as my profit. It doesn’t matter very much when you pay me back because my fee isn’t going to change.

Compound interest adds the element of time. The longer you keep my money, the higher my fee. My fee is calculated as a percentage of the loan multiplied by the length of time you need to pay it back. The key is that the interest you owe me is added to the principal. For example, let’s say you borrow one hundred dollars at five percent interest, compounded daily. If you repay the loan in one year, you will pay me a total of $105.13. If you pay me nothing for ten years, and then pay it back all at once, at the end of ten years you’ll pay me $164.87.

One problem with compound interest is that over very long periods of time, the numbers become absurd. That hundred-dollar loan at five percent interest? If you paid me back after one hundred years, you’d owe me $14,836.23. After two hundred years it would be over two million dollars. In 1836, an American lawyer by the name of John Whipple published The Importance of Usury Laws, where he pointed out the impossibility of sustaining long-term usury. He wrote: “If five English pennies … had been … at five per cent compound interest from the beginning of the Christian era until the present time, it would amount in gold of standard fineness to 32,366,648,157 spheres of gold each eight thousand miles in diameter, or as large as the earth.”

The practice of charging a fixed fee for loans did exist in ancient times, and was referred to in the Hammurabi Code of about 1800 BCE. Nevertheless, opposition to money lending was widespread, primarily on the grounds that it was unethical to receive value without labor. Attitudes towards lending in general and the charging of interest in particular varied from culture to culture and century to century.

In ancient India both Buddhists and Hindus condemned lending. According to a law set forth by Vashishta, a Hindu lawmaker who lived around 500 BCE, Brahmin or Kshatriya castes were prohibited from charging interest on any loan regardless of amount.

Other religious systems in the ancient Near East, and the secular codes arising from them, did not forbid lending with interest. Some cultures regarded inanimate matter as living, just like plants, animals and people, and capable of reproducing itself. Hence, if you lent commodity money of any kind, it was legitimate to charge interest. “Food money” in the form of dates, olives, seeds, or animals was lent out as early as 5000 BCE. Among the Phoenicians, Mesopotamians, Egyptians, and Hittites, interest was legal and the rates were often fixed by the state.

Aristotle, who lived in the period 384-322 BCE, was opposed to the practice of charging any interest on a loan no matter how negligible the interest rate. Contemporaries who favored legalizing the charging of interest asserted that usury was practiced by Sumerians, who asked for calves in return for the loan of cows. Aristotle argued that unlike cows, money is inert and does not by itself beget more money the way cows beget calves. Aristotle denounced usurers by saying, “Those who ply sordid trades, pimps and all such people, and those who lend small sums at high rates. For all these take more than they ought, and from the wrong sources. What is common to them is evidently a sordid love of gain.”

Cato the Elder, in his book De Re Rustica, wrote, “‘What do you think of usury?’ – ‘What do you think of murder?’”

Judaism’s view of interest was similarly negative. According to the teaching of the Halakha, or the collective body of the Jewish religious law, which included Biblical, Talmudic and Rabbinic laws, the charging of interest was forbidden.

The prophet Ezekiel said, “That has withheld his hand from the poor that has not received from money interest nor increase, has executed my judgments, has walked in my statutes; he shall not die for the iniquity of his father, he shall surely live.” (Ezekiel 18:17)

Some authorities asserted that interest could be charged to strangers but not between Hebrews: “Thou shalt not lend upon interest to thy brother: interest of money, interest of victuals, and interest of anything that is lent upon interest. Unto a foreigner thou mayest lend upon interest; but unto thy brother thou shalt not lend upon interest; that the Lord thy God may bless thee in all that thou puttiest thy hand unto, in the land whither thou goest in to possess it.” (Deuteronomy 23:19-20)

Nevertheless, attitudes evolve, and we will soon see how the beliefs of Jews changed in the late Middle Ages, in part because of persecution by Christians.

The medieval Christian church opposed lending with interest. Clerics were forbidden from taking usury and laymen were condemned if they engaged in it. In 850 CE, the Synod of Paris excommunicated all usurers. Thomas Aquinas, the influential thirteenth century Italian theologian who is considered by many Catholics to be the Catholic Church’s greatest theologian and philosopher, vehemently opposed the practice of charging interest on loans. He wrote in his Summa Theologica:

“Of the Sin of Usury, Which is Committed in Loans:

“To take usury for money lent is unjust in itself, because this is to sell what does not exist, and this evidently leads to inequality, which is contrary to justice…. Now money, according to the Philosopher, 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…”

The argument being advanced is that money had no intrinsic value; it is like the grease that goes between the axle and the wheel that permits movement. Take away the axle and the wheel, and the grease becomes pointless.

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