It’s all a matter of semantics – semantics that are, I should say, a matter of heaven or hell to some people. Of course, beyond semantics, there’s the question of efficiency. In the scenario you have laid out, the owner has to retain the title and collect money from you reliably every month, plus worry about insurance, plus all the tax consequences of this arrangement, etc. Whereas with a large bank issuing mortgages, a lot of this is routinized and automated, and you get significant economies of scale. There is a good evolutionary reason why we use interest as a kind of shorthand for profit, just as there is for using cash as opposed to barter.
Actually the inefficiencies you mention prove that this is more than a semantic distinction; the way I propose it (which may or may not be the way that the HSBC does it), the inefficiencies underscore the fact that rent-to-owns and mortgages are different arrangements that differ in almost every particular except that you live in a house that you pay regularly for until you own it. And I image that if loans on interest were disallowed (as this thread is theorizing about), not only would these distinctions be made very clear, but the banking system would probably take rapid steps to smooth over some of the inefficiencies you mention.
Look, of course it’s possible to have a society where usury is illegal. But we’d have equivalent, although usually less efficient and transparent, mechanisms to allow lenders to make a return from a loan, such as we see in Islamic countries.
The Islamic arrangements perform the same economic function as interest, the person giving the loan gets more money back than they lent out, the person taking the loan pays more money back then they got in the first place. But there are economic costs to this roundabout way of doing things, markets are less efficient, fewer people are able to get loans, both lenders and borrowers have more risk, capital is used in other ways.
So if we can have economic transactions that fulfil the same function as interest, although less efficiently and less easily and with more risk, what purpose is served by banning interest? Obviously, if God said you can’t eat pork and you can’t charge interest, it doesn’t matter that bacon tastes good or that interest is an efficient way of organizing the economy. But absent a direct commandment from God, what purpose could be served?
And if you want to ban all forms of earning a return from capital we’d pretty much have to do away with money. Is it immoral to buy 10 goats in Damascus for 150 dinars and sell them in Beirut for 160 dinars? Is it immoral to buy a factory for 1000 dinars if that factory produces an net income of 100 dinars per year? Is it immoral to buy half a factory for 500 dinars and get half the net income of the factory at 50 dinars a year, then after ten years your partner buys back your half of the factory for 500 dinars? What if he pays you 600 dinars for half the factory?
It just makes no sense. If you try to make interest illegal you’ll just get the same thing less efficiently under other names, if you try to make the same thing under other names illegal you’ll send the economy into a tailspin.
We wouldn’t have today’s modern economy and, by that extent, not have today’s technological innovations if interest had never existed, or was banned before modern (or even somewhat modern) banking practices (think late 1700’s with letters of credit). I can’t even think where to begin to describe what society would be like. There would be high pressure to spend, because the only real way for banks to make any money, especially early on, is to take a cut of the deposits. People wouldn’t want to hold to any money that they couldn’t safely guard themselves.
The economy would definitely grind down and chug along at a snail’s pace. Raising capital would be ridiculously difficult because people themsleves didn’t have a lot of money (and many still don’t). VCs would have to go straight to the people and sell shares. I don’t see banks taking on ownership because their own risk analysis wouldn’t allow it. Banks first and foremost do not want to get into business with anyone, just like they do not want your house if you foreclose. So, measuring risk (or at least, a rate of return to offset risk) is going to be near-impossible.
A giant holding industry will then probably mushroom as the economy develops. Dollar (or some type of monetary unit) standards will be common, because floating exchange rates won’t make any sense. There will also be massive, massive inefficiencies in markets and huge boon/bust cycles. Socialism/Communism/Centrally planned economies will look even more attractive. Countries will embrace dollar (or whatever currency unit) protectionism that makes China’s practice look like kid’s play. This will definitely be a huge boon to people who have money and can exploit markets (protectionism will make it easier, or more apt, prevent access to markets by capital holders). I’m sure there’s a lot more, but that’s what’s off the top of my head for the moment. Imagining such a world is a lot more difficult to conceive. In fact, any society who developed or allowed interest rates would immediately have the upperhand and eventually become a world leader in economic development.
I have to agree that’s a little abstract. Why should I specifically lend money?
I don’t know that society would be improved. Interest lending allows greater liquidity. Assuming I am responsible, instead of saving for six months or living paycheck to paycheck, I can purchase something on credit before I receive my paycheck with the understanding that I will be charged extra if I fail to pay it back at the end of the month.
Where people get into problems is when they think a credit card is free money or don’t understand the basic concepts of interest, principle and time value of money.
There is a way to handle this mathematically. We let the value of $1 increase exponentially over time at the usual rate of credit card interest. Thus, I can safely lone you $1 indefinitely with no interest. Things like factories depreciate exponetially, but make up for it by producing commidities with independent value (which depreciate even more rapidly). Thus, if you want to buy my factory from me, you can have it for $5000 today, or for $4500 you can have it next year, or for $4200 the year after that, etc. Banks will make their profit by giving you progressively less than the money you put into the bank, depending on how long you leave it in. With credit cards on the other hand, you are required to pay back exactly what they loaned you. That way, in 6 years when you finally pay it back, they’ll be able to buy a lot more stuff with the money because everything else in the world will have depreciated.
I believe that if you really enforced a law of no usery world-wide, this is exactly what the economic outcome would be – nothing would really change, but store owners would have to keep lowering their prices, and your income would go down, year after year (unless you were extremely successful).
My understanding is that loans are required to all be zero interest to comply with Islamic law. There are financiers that arranges these loans. And of course they charge a fee for their services and the fee is directly based on the amount of money being loaned.
You say interest. They say service fee.
shrug You have no involvement in the corporation other than putting capital into it. You get money back based on the amount of capital you put in. Applying a sort of economical Turing test, that looks like interest to me - I can’t tell whether it’s a corporation or an interest-bearing account on the other side of the wall; all I see is the movement of the money.
Naturally no-one is going to lend money at no interest when he has some other means of putting it out to grass, whether we say the magic word “interest” or not. The only question I was answering was whether there would be any benefit to capital-holders to make their capital available at no interest if they had no other means of making money on it, and there is: the general betterment of society, not just in terms of public welfare but of availability of desirable things.
There’s still collateral on loans, so it’s risk free; it’s just that you don’t get paid interest based on some idea of being compensated for “risk” when there isn’t any. F’rinstance, I presently get charged interest on my mortgage although the lender has a claim on my house if I default and both I and the house are insured to see that they get paid in case of disaster. The only other rationale for their charging interest is that if they didn’t make money off the money they’re lending me, they could make money on it elsewhere. Why should you lend money? Why should you not? It’s not doing anything sat where it is except lend you a sense of security that, with a slight modification to society :), you wouldn’t need.
Granted that we might need for the whole country to be run on Utopian lines before this worked, but it’s not inherently absurd.
Well, no. I don’t get money back based on the amount of capital I put in; I get money back based on that and on how well the company is doing, and on the decisions of the Board of Directors. If the corporation has a bad year, I might not get anything; a so-so year I might get the equivalent of 2 or 3 % return; a stellar year, and I might get back 20%. And even if the corporation has a stellar year, the Board of Directors can still decide not to offer a dividend this year, because they think the corporation’s best interest would be in using the profits to retire debt, or invest in plant, or in R&D, or so on. That’s their choice - I normally can’t force them to declare a dividend.
However, as a shareholder I do have an involvement with the corporation - perhaps a small share, depending on how many shares I own, or a very large share, if I own a lot of shares. As shareholder, I can vote for the Board of Directors as well as other rights given by the particular class of shares. If I have a very large block of shares, or there is a powerful shareholders’ association unhappy with the decisions of the Board of Directors, we may be able to influence the Board’s decisions.
That’s not how it works with debt instruments, such as bonds. All they give is interest on money loaned, with the interest rate set by the contract of loan. I buy a bond from a company, and they agree to pay me interest on the loan. Even if they have a bad year, profits are tanking and their shareholders are screaming, they still have to pay me the rate of interest set in the contract. If they don’t I can sue them in court on the contract.
The debate here is on interest and I think we have to use the generally accepted definitions of what interest is, and what equity is, to have a meaningful discussion.
shrug, again. Fine. I knew all that. So the argument is simply “If there’s no interest on loans, people will invest their money otherwise than in interest-bearing loans, and so no-one will be able to borrow money. He said interest, so my argument’s the only one that’s valid”? I was sort of expanding on the theme to the effect that there would be no way you get given money for having given someone else money - and I thought that was quite as “meaningful”.
Returning to the OP, in a word, ‘No.’
Here in Saudi Arabia, interest is of course forbidden. That being said clever people have clever ways of wordsmithing their way out of the issue. My checking account for example is ‘fruit-bearing.’ When you pay for a car here, you have to rent it from a company who presents it to you for free when you make a certain number of payments.
So no interest is paid (wink, nudge). The fact these work-arounds exist in the most Islamic nation in the world is an indication how important interest is in the modern world.
Even religious rulings bicker over the meaning of the prohibition. Is interest forbidden or is ‘usury?’ Hard to say. It is a matter of debate.
Now I understand - you decided to answer a question that the OP didn’t ask, and to use the term “interest” in a way that you knew was inaccurate. Got it. Thanks for playing.
Eh, not really. Check out post #6 and you’ll see I was answering one particular question in a highly specific way: “There are incentives, other than receiving interest, for lending money”. Sam Stone decided to muddy the waters by saying “but no-one would do that, because they could still make money another way!”. Not my idea. Functionally the receiving of a return on stocks is the same as receiving interest, despite procedural differences that mean you may get less money or more, or lean on the directors. Someone’s “playing” here, but it’s not me.
But no one would lend their money out interest-free for the betterment of mankind when they could be earning some sort of income on their money in other ways. So no bank would loan a new business money, instead they’d become partners with the new business and take a cut of the profits. It’s not a choice between lending money for the betterment of mankind or stuffing it under a mattress, its a choice between buying land and businesses or stuffing it under a mattress.
But this is much more risky for the bank than a regular loan. Right now there are thousands of banks who will offer a business loan. There would be a lot fewer banks offering venture capital for small businesses. Which means that only people with a large amount of capital saved would be able to start a business. Which means a lot more economic stasis, capital owners become rent seekers rather than entreprenuers, and we’re back in the feudal system economically.
Why shouldn’t I lend it out? Because I’m not in the habit of shitting money away.
The most important concept you need to grasp is “opportunity costs”. That means if I lend you $100,000, I might miss an opportunity to turn that into $110,000. Lending you money has actually COST me $10,000. While you have my money I can’t buy stuff I want and I can’t invest in things I want to invest in.
Let me give you another example. I rent from a landlord who requires a deposit. I get that deposit back but in the meantime, I could be earning interest on it, investing it in stocks, making money in Vegas or whatever. That’s why the landlord is required to pay me interest on it.
Because the very act of lending you money incurs a cost to me, I am going to charge you for the use of that money.
You make a good point though about I should lend it out instead of letting it sit there. Money is best used when it is being used, not just sitting in an account.
And there is always risk. What if you’re house burns down? What if you skip town?
Yes it is.
So what have we learned here today:
-Interest is a fee charged for using someone elses money
-It is desireable to charge higher risk borrowers a higher rate to a) discourage their borrowing and b) mitigate losses if they default
-Interest is used to cover opportunity costs
-Interest encourages lending
The problem is, if person X has to decide to lend the money interest free to build a better mousetrap, he won’t do it, since persons Y and Z who don’t lend the money get the same benefit without the risk. It’s not a loan, it’s more like philanthropy.
Now, some might offer interest free loans. For instance a builder who spends $100K to build a house might be able to sell it for $150K to someone, and finance it interest free, making money on the increase in value. (Not too different from what seems to happen in Moslem countries.) This is fine in the steady state, but where does he get his initial investment? And, has been mentioned, he has to jack up the selling price to compensate for the loss of use of the money during the term of the loan.
At the risk of being cast into the Gorge of Eternal Peril, I’m going to disagree with the prevailing view. If interest were prohibited (actually prohibited, including the workarounds and wink-winks) capital still would be accumulated and often invested. It simply would be invested as equity. Would this have ramifications? Of course. But maybe not so much as people think. Notice, for example, how much more capital is already invested as equity as compared to, say, just fifteen years ago. To my eye the biggest impact would be on major consumer purchases, which would have to await savings. Plainly that would slow the economy, at least during the transition period. Also, public works projects would be tricky. Probably those would be excepted from the ban, though some might built privately (as toll roads and bridges often used to be). But the economy wouldn’t come screeching to a halt. It’s the production and accumulation of a surplus that makes or breaks an economy. The particular path by which the surplus is exploited isn’t so important. IMHO.
How would this equity market work?
I can think of three types of equity today. Equity in the stock market works because there is a market, and the market as a whole does not depreciate. How would one use equity to finance the purchase of capital equipment, say, which does.
The second is equity investments in startups and the like, for which there is no market. This only works because of an eventual market. There is a much higher barrier to getting investment in this kind of equity than in a stock or in something that is financed by borrowing today.
The third type is home equity. Homes don’t depreciate, but are somewhat illiquid. Today, except when people move, equity is converted into cash by loans, or by reverse mortgages, which is a kind of a loan.
There is another problem. I’ve been reading behavioral economics papers, and one of the findings is that people assign different values to things they own vs. things they don’t own. In one experiment a teacher gave coffee mugs to half the students, and then polled all the students on how much they’d pay to get a mug vs. how much they’d require to give it up. Classical economics say that these should be the same, but in reality those with the mugs wanted a lot more for them than those who didn’t have the mugs were willing to pay. (This was not a bargaining situation, so there was no negotiations involved.) I’d guess that people who saved money would be much less willing to buy stuff with it than people are borrowing to buy things. That’s good in the sense (but why save if your money is not going to increase in value) but it will cause consumption to crash.
Not sure I understand the question, but I’ll do my best.
Category 1. Presumably equipment leasing companies wouldn’t be permitted, so there would be no question of being permitted to invest equity in those. But companies who need equipment could raise equity capital to purchase same. Yes, the equipment would depreciate. Presumably in the meantime, it’s helping generate profits (net of depreciation). If not, they shouldn’t have bought the equipment in the first place. Am I missing something?
Category 2. Agreed, that sort of equity capital isn’t easy to come by. But, if anything, it’s more difficult to come by debt capital for such ventures, even in the present system. What would happen is similar to what happens today. You need stuff (a facility, inventory, a “nut” to tide you over till revenues exceed operating expenses). To get that, you need investors. If only equity is allowed, that’s what they take. What did I miss?
Category 3. No argument. This would be a problem. I consider homes a consumer good, so that’s where this slots into my original post. The upshot is that few people would own homes. Although, over time, homes would become (as they once were) a more important aspect of inherited property. In any event, that doesn’t bring the economy to a halt. Just slows things down (which I acknowledged).
As for your final point, I’m afraid I don’t understand what that has to do with the viability of an equity-only economy. Please explain. When you do, bear in mind that economic theory only predicts that, on average, sellers and buyers value things at the same amount. (Actually, that’s not quite accurate in a very important way; it assumes buyers value more than average and sellers less, else neither would bother.) It undertakes to say nothing about those neither selling nor buying. In the scenario you describe, no mugs would trade hands. Where’s the surprising part?
BTW, just to be clear. I’m not defending an equity-only economy as a goodness. The roots of the Muslim prohibiition, for example, as I understand them, have to do with not taking advantage of your friend and neighbor. I don’t agree that collecting interest is taking advantage. But, the proposition has been floated, and widely accepted, that such an economy isn’t viable. I don’t agree.
Is the equity in the equipment or in the company? If the former, how can we assign profits to a particular piece or set of equipment? I’ve been attempting to calculate return on R&D investment for over 20 years in real companies, and I assure you that it is not easy. If the latter, the original investors equity is diluted every time the company must buy new capital equipment.
If you guarantee a rate of return for the investment, it becomes almost like interest, of course.
For large, risky, startups, it is easier to get equity funding, since VCs accept a higher level of risk, which they reduce in the whole by financing a wide range of companies. Winners make a lot, and make up for the losers that make nothing.
But what about small startups - say a new mom and pop store. They are small enough so that a funder would have to fund lots of them, and, since there is no promised return, would have to be involved in lots of them which is impractical. These things get financed by loans today - there is a reason for that. It’s possible that VC funds for small businesses would spring up, but that they haven’t now shows that they’d be less economically efficient than what we have today.
The numbers I gave were median numbers. The point is that experiments in behavioral economics show that classical economics is wrong in predicting what people do. Classical economics is correct in computing the optimal strategy, but people don’t adopt the optimal strategy. (That new game show Deal or No Deal looks like a classic example.) There are lots of other examples also. For instance, the effective discount rate that you can calculate based on how much someone would require to postpone a good thing into the future or postpone a bad thing varies with time and is different for good and bad things, which is not what classical economics predicts.
The point is that a no-interest economy would be even worse than classical economics would predict. I don’t know what you mean by viability. If you mean that we won’t regress back to the Stone Ages, I agree. A truly no-interest economy, however, would reduce the average standard of living and economic efficiency, for very little benefit. What would actually happen is the growth of an underground banking economy, and the exploitation of loopholes. In the '20s we had rum runners, here we’d have loan runners.
Good sf story, at least. 
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