THE ABOLITION OF INTEREST ON LOANS


Ardeshir Mehta
March 2008


When any of us takes out a loan or a mortgage - and remember that "mortgage" is just another name for "loan" - to buy a house or a car, a huge chunk of the total payments we make during the life of the loan is the interest on the loan. For example, if we were to take out a loan of $25,000 to buy a car, and pay it off over 5 years at 8% interest, we would have, at the end of those 5 years, paid a total of $30,414 ... which means that over $5 grand would have been paid just in interest!


And if we were to take out a mortgage of $100,000 at 7% interest to buy a house, and pay it off over 25 years, at the end of those 25 years we would have paid a whopping total of $212,034 ... which is more than double the amount we would have borrowed.


This, if you have been paying attention, is like paying a "sales tax" on the house of over one hundred per cent! Except that this is a "tax" paid, not to our government, but to the banks. And on the car, we would have paid to the banks, over and above what we already paid to the government on the purchase of the car, a "tax" of over twenty per cent.


And the bankers simply pocket the money. We, the people, never get any benefit out of it, as we would have had we paid our government this amount.


SAVING IS NO REMEDY


You might think that if you saved your money and only paid cash for everything, including for your home and car, you could avoid paying this huge amount of "tax" to the big banks ... but you would be wrong. That's because - as my son Cyrus, who is a philosopher, points out - pretty much everything you buy is made by people who themselves took out loans to make and sell them! If you buy a computer, for instance, well then you have to remember that loans were taken out by the companies (like Intel and Western Digital) who made the computer parts, by the companies (say, Dell, or Hewlett-Packard) which assembled them, and by the store (say, Staples Office Depot) which sold them to you. Of course all of these companies passed on to you, the final consumer, the interest they paid to their banks. 


So even if you were to save up for everything, you would still be paying through the nose for everything you buy. It's quite possible that more than 50% of the cost of everything you buy goes to pay the interest on loans taken out to manufacture and sell those things! Indeed I suspect that it comes to more than 75%.


THERE IS ABSOLUTELY NO JUSTIFICATION FOR INTEREST ON BANK LOANS


Some people - even eminent economists like Ludwig von Mises and John Maynard  Keynes - have made the specious argument that the money the bank lends us is actually money which their depositors have deposited in the bank, and the depositors have a right to expect more than the principal that was lent out to us, the borrowers, because by loaning it to us, they would have deferred spending all that money on goods and services, and thereby deferred enjoying the results of spending that money. Mises for instance writes, in his treatise on Human Action:


[...] there cannot be any question of abolishing interest by any institution, laws or devices of bank manipulation. He who wants to "abolish" interest will have to induce people to value an apple available in 100 years no less than a present apple.

And Keynes writes, in his book The General Theory of Employment, Interest and Money:


[...] interest is the reward for parting with liquidity for a specified period. For the rate of interest is, in itself, nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time.

Now this is such a blatant lie, and yet is one which most people - including most students of economics - simply swallow hook, line and sinker. (Maybe the "big lie" theory is correct: if you utter a lie so big and blatant that it's actually INCREDIBLE, everyone will believe it!) 


Yes, if you lend a friend of yours some money, you are deferring whatever enjoyment might have been yours had you spent that money on things you probably wanted to buy. But when a bank makes any of us a loan, it does not in fact lend money which has been deposited by anyone, nor does it defer anyone's enjoyment of that money ... and certainly not its own. All the bank does is write us a cheque, virtually regardless of the amount deposited in it by its depositors! In other words, it creates that money out of thin air.


BANKS CREATE MONEY OUT OF "THIN AIR"


You don't believe me? Check out the "Credit River Decision", in which a bank manager admitted that this is "standard banking practice" - and he admitted it under oath, in a court of law, no less!


The Credit River Decision, which was a decision handed down at the end of a court case in which a private American citizen living in Minnesota, Jerome Daly, was the defendant in a law suit brought against him by the bank from which Daly had taken out a mortgage, is well known to those who take an interest in ... uh, interest. Here's an eyewitness account of the decision as it was handed down, the eyewitness being the associate judge in the trial, no less (see <http://educationcenter2000.com/legal/credit_river_decision.htm>):

The banker testified about the mortgage loan given to Jerome Daly, but then Daly cross examined the banker about the creating of money "out of thin air," and the banker admitted that this was standard banking practice. When Justice Mahoney heard the banker testify that he could "create money out of thin air," Mahoney said, "It sounds like fraud to me." I looked at the faces of the jurors, and they were all agreeing with Mahoney by shaking their heads and by the looks on their faces.


I must admit that up until that point, I really didn't believe Jerome's theory, and thought he was making this up. After I heard the testimony of the banker, my mouth had dropped open in shock, and I was in complete disbelief. There was no doubt in my mind that the Jury would find for Daly.


Look it up. Google will offer up hundreds of hits for the phrase "Credit River Decision".


Is it any wonder, then, that economist John Kenneth Galbraith famously wrote, "The process by which banks create money is so simple that the mind is repelled"? Speaking for myself, I am more than repelled: it's a bloody fraud, and I won't even ask you to pardon my language, because that's what Judge Mahoney also called it.


Of course, the question is often asked,


WHY WOULD BANKS LEND MONEY TO ANYONE IF THEY COULD NOT CHARGE INTEREST?


Well, I am not against banks making a reasonable amount of money for taking the trouble to issue a loan to us. Call it a "reasonable profit on a transaction", for example. If the bank that lends us $25,000 to buy a car were to say: "We are willing to lend you this money, but we would have to make a reasonable amount of profit out of the transaction", I'd say: "Okay, fine. So what would be reasonable in your view, given that it takes your people at most an hour to do the paperwork, and after that, there's nothing more for you to do but collect my monthly payments? A law firm might charge me, let's say, $500 per hour at the outside: so, does $500 seem reasonable to you?" 


It sure does to me. Does it not to you?


But does ten times as much sound reasonable to you? Which law firm, no matter how prestigious, will charge you five grand an hour? And yet banks get away with this, and more, every day of the week!


However, there's another way banks can make money on loans: they can look upon it as an investment, and share in the profits of that investment. If a bank issues a loan to a company, that company will, of course, use that money to expand its operations, and thereby make profits. The banks can stipulate, in the loan contract, that they will get a share of the profits. 


The same thing can apply to a mortgage. If you buy a house today for $200,000, and in order to buy it, borrow $100,000 from the bank, and if after a year, because of market forces, the value of your house increases by, say, 3%, the bank can stipulate that it will get a 3% increase on the next year's monthly payments. That seems fair enough, because it isn't as if you did something yourself to cause the value of the house to rise. It was just your good luck.


Of course if that's the way the bank wants to structure the loan, then if the value of the house falls by 3%, the bank must also agree to take a 3% cut in the next year's monthly payments. Sharing in profits means also sharing in losses.


But a bank could make much bigger profits by investing in really promising ideas than it would by charging interest. For instance, had any bank invested in Tesla's idea of alternating current at a time when Edison was promoting direct current, that bank might soon have become the biggest bank in the world! 


Of course this idea would make it imperative for the banks to make sure that the money they are loaning (more correctly, investing) is not going to all go down the drain: they would have to scrutinise every application for a loan carefully, to see if the activity the loan was going to be used for had a chance to render a profit down the road. But what's wrong with that?


This, mind you, is the idea behind Islamic banking, which was proposed by the Prophet Muhammad over 1400 years ago. A very good idea, it seems to me. What's not to like? It's good for the banks, and it's good for the average Joe!


"ISLAMIC BANKING" AS PRACTISED TODAY IS A SHAM


However, as an aside, I would like to mention that what is called "Islamic Banking" today is a total sham, and not at all in keeping with the spirit of Islamic teaching, which is totally against every kind of interest, by whatever name it may be called. In today's sham "Islamic Banking", for instance, if you take out a mortgage from an "Islamic" bank to buy a home, instead of charging you interest, they charge you so-called "rent" for inhabiting the home. Every year you have to pay back, not only the principal, but this "rent" in addition. The implication is that since the "Islamic" bank has put up the money to pay for the home, at least in part, you are living in what is at least partly the "Islamic" bank's home, and not in your own. 


But even a little thought reveals that this is a total sham. If the "Islamic" bank has actually loaned you the money to buy the home, well then the home you bought with the money they lent you ought rightfully to be yours, not the "Islamic" banks, even partly! And you would, as a result, have no obligation to pay rent on it to anyone. Why would you pay rent to an "Islamic" bank to live in your own home? 


Either the "Islamic" bank loans you the money at no interest - in which case the home you bought with it is yours, and you shouldn't have to pay "rent" for living in it - or else they don't loan you the money, but rather buy a home for you to live in ... in which case yes, you would have to pay rent to them. But in the later case, why should they call it a "loan"? It's not a loan at all. Calling it an "interest-free loan" is a sham and a fraud. 


INTEREST AS A HEDGE AGAINST RISK


Another specious argument in favour of interest is this - and it's made by most economists, even some of the "best" of them. They argue that issuing a loan is a risky business for the lender, and the bank is therefore entitled to charge interest on loans to offset the risk. This another sham, fraud and big, blatant lie. In most cases, the bank issues secured loans: secured against some tangible assets of the borrower. That means if you, the borrower, default on the loan, the bank takes possession of those assets, sells them, and recovers the money it loaned you that way. A home mortgage, for instance, is secured against the home itself: if you default on the mortgage, the bank will force you to move out of your home, sell it, and recover the rest of its principal that way. Same with a car, which towards the end of a car loan, is often worth much more than the remaining principal. So there's no risk at all to a bank when it makes properly secured loans.


But, you might say, what about unsecured loans, or loans which are only partly secured: isn't at least some interest justified on them, for the lender does take a risk in issuing them - right? Wrong, and I'll tell you why. First of all, the bank is not lending any money of its own, nor any money of its depositors either: it's lending money that it has created out of thin air! (Remember Judge Mahoney and the Credit River Decision?) So I'd like to ask: What risk is the bank taking, even if the borrower defaults on the loan? (Don't answer that! It's a rhetorical question.)


And secondly, genuine risk is the domain, not of banks, but of insurance companies. If the bank can actually demonstrate that it is taking a risk in issuing an unsecured loan (or an unsecured portion of a loan), then the right thing to do to offset the risk is to take out an insurance policy on it! All other risks, except the risks taken by lenders when issuing loans, are covered by insurance policies: why the hell, then, should the risks taken when issuing unsecured loans not also be covered by insurance policies? A competent insurance company can assess the risk, given the borrower's age, credit history and so on, just as it does for auto insurance, and offer to insure the loan against default for a competitive monthly insurance premium. If you have an excellent credit history, for example, you would qualify for a low low low premium, just as you would for auto insurance if you have an unblemished driving record for many years. And as the principal decreases, the premiums should go down, because there's less and less of a risk to the lender.


INTEREST AS A HEDGE AGAINST INFLATION


Yet another specious argument made in favour if interest is that the value of money could change over time, and interest is the way to compensate for that. Baloney. One can - and should - index every loan for inflation, just as is done with pensions. 'Nuff said!


IMPLEMENTATION OF THIS PROPOSAL


There are several ways to implement the proposal to abolish all interest. One is, simply enough, to pass a law prohibiting the charging of interest on loans, as they do in some Islamic countries. The problem with this approach, however, is that the banks find cunning ways of defrauding the public, by calling what really amounts to interest by some other name, like "rent" or "service charges". Of course, if the law were strictly enforced by a truly independent (and intelligent) judiciary, this could be prevented - but maybe we are asking too much from our judges, who get to the bench by licking the boots of the people in power ... which ultimately means the people who own the most money.


But there's a more elegant way to implement this proposal, one which doesn't require any prohibitive legislation. The government could set up a bank, which would be funded by the government, and which would compete with the private banks in the open market. Call it "The People's Bank", let's say. (I know, I know, it's a corny name - but let's use it for now: we can come up with a cooler-sounding name later.) Now, remembering that the government is by law entitled to create money, the People's Bank could offer to issue loans to all and sundry at zero per cent interest! Were you or I to approach the People's Bank to borrow money, the People's Bank would simply write us a cheque for the amount of the loan, just like any other bank. But in the loan contract it would be stipulated that there would be no interest charged on the loan! If the loan were secured, then clearly nothing further needs to be done; while if the loan were even partly unsecured, the People's Bank would also issue an insurance policy on the loan, and add the premiums on this policy to the monthly payment we would be making to repay the loan. And it would also stipulate in the loan contract that if we defaulted on the loan, we wouldn't get another loan from the People's Bank at zero per cent interest. Of course, it goes without saying that every loan - and, thus, every loan repayment - would be indexed for inflation, so that the amount repaid at the end of the loan period would have a value equal to the value (and not merely the number of dollars, euros or pounds) of the loan when it was issued.


So in a few year's time, the People's Bank would draw away pretty much all the other banks' customers: for who in his right mind would take out a loan on which he had to pay interest, if he could take out the same loan totally interest-free from the People's Bank? Eventually either the private banks would have to follow suit, and offer either interest-free loans (or loans at very tiny interest rates), or else lose most of their customers ... and it doesn't take a rocket scientist to figure out which of the two alternatives they would choose. 


Sure, there would inevitably be some people who would have borrowed from the People's Bank and then defaulted on their loans. If the loans were secured, the People's Bank would simply take away the assets against which the loans were secured, and recover the remainder of its principal by selling those assets. And if the loans were unsecured, it would make up the money by cashing in the insurance policy which was issued against unsecured loans.


In fact, soon enough the People's Bank could issue the insurance policies itself. After a few years of operation the People's Bank could make calculations, based on its prior experience, as to how many of its borrowers were likely to default on unsecured loans, and come up with a reasonable list of insurance premiums it could charge to its borrowers who did not have sufficient collateral to secure their loans. Just like with auto insurance, the premiums would depend on past history. If you had shown that in the past you had repaid all your loans on time, your premiums might be low, while if you were a first-time borrower, your premiums might be high. That would be just prudence on the part of the People's Bank. But as time went on and you proved that you were regular in your loan repayments, the insurance premiums would drop.


THE PEOPLE'S BANK WOULD BE MORE THAN SELF-SUFFICIENT


Note that the People's Bank - yes, I know, it's a corny name, but I await your suggestions for a better one - will be self-sufficient: even more than self-sufficient. It won't need to be funded by the taxpayer. That's because all the money it loans out will be created (drum-roll, please!) out of thin air! It's all done with a stroke of the computer keyboard: for that's how all banks operate. Even if all its borrowers were to default on their loans, the People's Bank would lose nothing.


Except, of course, the cost of doing the paperwork to put those loans in place. But there's a way to offset that too: just stipulate that for every loan, there will be a one-time "paperwork fee", which will be reasonable: say, $500 an hour, just what a good law firm charges! (We ought to compare this work to the work a good law firm does, because, after all, the loan contract has got to be a legally binding one - or in other words, it has to be able to stand up in court.)


In fact, the People's Bank ought to be able to operate at a decided profit. That's because, as I said above, it could enter into profit-sharing contracts with its borrowers, and share in the profits they make. Yes, some of these borrowers will clearly lose money, but if the Bank chooses its customers carefully, and is prudent, it could lend far more money to people and companies which are likely to be successful in their new ventures, than to people and companies which are likely to lose their shirts ... and as a result, the Bank could end up a very profitable institution. All its profits would, of course, belong to the People, because it would, after all, be the People's Bank. The profits would end up in the treasury, and thus go towards financing all the things any good government ought to do: like building roads, streets and bridges, paying all the firemen and polices, paying all the doctors and nurses, etc., etc.


OVERCOMING OPPOSITION 


There will, of course, be strong opposition to this proposal from private banks operating today, because it will effectively be forcing them to give up their cash cows. And they have all the money and the financial clout, so they will try to do their darndest to prevent the proposal from seeing the light of day - like paying "eminent" economists to pooh-pooh the proposal (heck, they probably paid Mises and Keynes to publish all that bullshit I quoted earlier.) 


But there are at least two ways to overcome this resistance.


The first - and, in the long run, the best - way is, of course, to convince most citizens that they would stand to benefit enormously from the proposal ... and to convince them, as a result, to vote only for politicians and/or laws which will put the proposal to abolish interest into practice. If the vast majority of a country's citizens come to understand how they are being scammed by the banks, they will, if they have any brains, clearly do something about it. They will refuse to vote for any politician, regardless of political party, who will allow the banks to get away with the fraudulent practice of charging interest on loans which they have created out of thin air.


But there's an easier way to accomplish what we want: a short-cut, we might call it, which has a good chance of working too: and that way is to get together enough people with enough capital to start a bank which will offer interest-free loans. 


It doesn't take a lot to start a bank, though it's more than you and I can afford, for sure. But a group of people who get together and pool their resources could do it. Check this out, from Ellen Brown's excellent web site,


<http://webofdebt.wordpress.com/2008/02/23/how-to-start-your-own-bank/>:


How to start your own bank:

 

<http://www.financialsense.com/fsu/editorials/schoon/2007/0514.html>

 

<http://money.howstuffworks.com/bank5.htm>

 

Idea: we get 6 investors with $100,000 each to become the directors. Their $600,000 is the 10% needed to get started; we raise the other 90% by issuing stock. That gives us capital of $6 million, enough to charter a bank. Then we’re allowed to create and lend ... $200 million! (See first article above.) Today you only need 3% reserves if you're a small bank. The BIS (Bank for International Settlements) capital requirements are a bit higher - 8% - but even at 8%, our $6 million lets us lend $50 million. We lend interest-free to various worthy causes that will generate a profit if they don't have the burden of interest, such as alternative energy projects, low-cost housing, Permaculture farming projects and the like. Rather than charging interest, we take a modest share of the profits, on the model of Islamic banking or investment banking; but our real purpose is to set up a working model of what community-oriented banking could be. We use the principles developed over 300 years by the private banking system and turn them to public ends.


Why not? And although most of us can't easily find 6 investors with $100,000 each to become the directors, we could, conceivably, find 60 investors with $10,000 each, or even 600 investors with $1,000 each.


So it isn't necessary to convince more than half the population of a country to start a bank that offers interest-free loans. And once it's started, there no way, short of assassination of all its directors, that it won't keep growing. For who in his right mind wouldn't switch his loan or mortgage from financial institutions that charge interest, to one which doesn't? All the other banks would have to follow suit, or else risk losing all their customers.


THE BENEFITS TO ALL OF US


To re-cap, here's what we would see as a result of the abolition of interest:


1. The prices of most things will go way, way down, because none of the manufacturers and retailers will be paying interest to the banks, and so would have to sell their stuff cheaper to avoid being wiped out by their competition;


2. Consequently, the demand for these items will go way, way up, because more people could afford to buy them;


3. Consequently many more jobs will be created to make and sell all these things;


4. Which means increased prosperity all around.


5. In addition, the profits the People's Bank (I know, I know, it's a corny name, but please bear with me) will be going to the national treasury, and as a result, the government would be able to provide many more services than it is doing - it could repair all the roads and bridges, provide free health care for everyone regardless of income, pay for more firemen and police, and so on and so forth.


SO WHAT'S NOT TO LIKE?


I encourage criticism of my proposal. You may e-mail me, telephone me or write to me at the following address:
 
Ardeshir Mehta
414 Kintyre Private
Ottawa, ON

K2C3M7 Canada
Tel: 613 225 6208
Email: ardeshir [at] mac.com