The Moral Hazard of Modern Banking

Article excerpt

In his Essay on Duties, Marcus Tullius Cicero tells a story about Cato the Elder, a wealthy man renowned as a landowner, who lived a century before Cicero. One day Cato was asked, what is the most profitable aspect of property ownership? Cato answered, "Raising livestock with great success." He was then asked about the second most profitable aspect of ownership. "Raising livestock with some success," he answered. And what about the third most profitable aspect? "Raising livestock with little success." And the fourth? "Raising crops." Then his questioner asked, "What about money-lending?" Cato replied, "What about murder?" (1)

It's a telling little story, revealing the West's traditional disdain for money-lending, but also its embarrassed dependence upon the same. Cato, you see, made his fortune through money-lending. His favorite business was investing in ship bottoms. Bottomry, as it's called, was very risky, so to reduce his risk Cato sought out many partners and invested his profits in land, preferring land offering natural resources like minerals, timber, fish ponds, and pasturage--assets that could not be "ruined by Jupiter," as crops and ships could be. (2)

This all sounds innocent enough in the twenty-first century, but, as we can see from the story, Cato himself recognized the danger of money-lending and was ashamed to admit his involvement in it. Today, however, even amid the collapse of many of the world's largest banks, few people recognize the inherent danger of money-lending, and no one is ashamed to admit that he does it.

Throughout history, banking has posed a moral hazard to society, but only relatively recently have people lost sight of the dark side of banking and surrendered themselves entirely to debt. Even in the current crisis, criticism of the banking system has focused on the "irrational exuberance" of particular banks, abetted by well-meaning but misguided government policy, rather than on the inherent personal and political dangers of debt. The Marxist anti-capitalist critique of banking survives and is perhaps making a comeback in South America and elsewhere. But here in the United States, at the center of the financial universe, we hear only a popular plea for mortgage relief and an elitist insistence that the government must do whatever necessary to keep banks in business.

I won't venture an opinion on what to do about the current mess. I will, however, admit that banking is absolutely essential to our national and international economy. Without debt, we would all be a lot poorer, and not just materially. Our capitalist economy thrives on faith in the future, trust that most debts will be paid, and an optimistic outlook on life that inspires entrepreneurs to risk time and money to create new goods and services and that empowers people to pool their resources for great cooperative ventures that make dramatic improvements in the way we live. This faith, this trust, this optimism depends upon the rule of law and a sophisticated legal system providing secure title to property, so that property can be used as collateral. A sound system of property law is the major difference between the thoroughly capitalist economies of Europe and North America and the merely market economies of much of Asia, Africa, and Latin America, where there is plenty of buying and selling but little accumulation of capital.

Yet this sound legal system protecting both lenders and borrowers evolved over many centuries within a civilization that held usury in suspicion, and for good reason. (By usury, I mean simply lending money at interest, whatever the rate.) The usury of Roman senators was not always as benign as Cato's investments in bottomry. The Roman Republic was a giant protection racket. Conquered territories were made to pay indemnities they could only afford by borrowing from wealthy Romans, and very often the person imposing the indemnity was also the person collecting on the loan. …