The Lending-for-Profit Factor

By PROF Dr MOHD NAZARI ISMAIL

As long as there is such an industry, there will always be financial crises. THE present financial crisis which started in the US is now fast spreading to the rest of the world. Some people are puzzled as to why experts in academia and experienced policy makers are unable to prevent it from happening in the first place.Their puzzlement actually stems from a failure to realise that financial crises at their core are problems of over-leveraging, over-lending and over-borrowing.

Unfortunately history has shown that regardless of efforts to prevent the occurrence of financial crises, as long as the lending-for-profit industry exists, problems of over-leveraging, over-lending and over-borrowing will always be with us.

Take the Asian currency crisis of the late 1990s. The cause of that crisis was over-investment in the Thai real estate sector which was financed by massive foreign borrowings.The resulting current account deficits put pressure on the baht. The Thai authorities were unable to support the baht which later depreciated.This led to a ballooning of the country’s foreign-denominated debts. The crisis spread to other South-East Asian countries with some having to resort to International Monetary Fund’s assistance.

Another example is the Argentinean financial crisis of 2001. It was caused mainly by fiscal indiscipline by successive governments using foreign debt. In 1983, Argentina’s foreign debt was US$46bil. By 1999, it was US$130bil. This dependence on foreign borrowings, combined with severe unemployment, rampant corruption and political instability led to massive capital flight by companies and individuals. By 2001, the government of the day was forced to take drastic measures including freezing all bank accounts, leading to violent riots.

The Japanese market crash of the late 1980s stemmed from a speculative stock and property markets bubble. These were financed by loans from Japanese banks. When the bubble burst, trillions of yen were wiped out in those markets. Ever-cautious Japanese consumers withheld spending because of the poor economic conditions and this slowed down the economy even more. The Japanese economy has never recovered fully from this crisis till today.

It is widely agreed that the current global financial crisis is a case of a market crash followed by a banking crisis followed by economic slowdown, which is spreading worldwide from the US. The problem originated from the low interest rates in the late 1990s.This encouraged over-borrowing, especially in the housing market. When interest rates rose from 1% to more than 5% between 2004 and 2006, the less-than-sound borrowers, i.e. the subprime sector, defaulted.Many lending institutions which specialised in subprime mortgage went belly-up. This has a knock-on effect, which is ongoing, throughout the financial markets of the US and beyond.

In all the above cases, the fundamental common features are problems of over-lending, over-borrowing and over-leveraging. It may surprise some people but these problems never existed before lending-for-profit became an industry.This was because “usury”, as lending-for-profit is also called, was condemned by all major religions and philosophers such as Aristotle and Cato.The practice of usury was looked down upon in ancient Greece and Rome and by Hindu and Buddhist teachings.Judaism prohibited usury against fellow Jews while the medieval Christian Church forbade it completely. Islam forbids it to this day.

What changed in 16th century Europe was the emergence of Christian scholars such as John Eck and John Calvin who argued that Christianity permits the charging of interest on loans and that the term “usury” refers only to “excessive interest”.With the advent of the Industrial Revolution, interest-charging gained further respectability with the arguments put forward by the champions of capitalism such as Jeremy Bentham and Adam Smith.

It is to be noted from that period onwards the phenomena of financial crises came into existence.It is my contention that the active existence of the lending-for-profit industry will inevitably and unavoidably lead to excessive lending, excessive borrowing and leveraging.As long as there is a lending-for-profit industry, there will always be financial crises of varying magnitudes.

What is particularly worrisome is that some of the solutions offered, especially the fiscal stimulus policy, in my opinion may worsen the situation in the long run.It is true that fiscal stimulus may boost the economy in the short run. However, this will inevitably result in the government taking up ever greater debt burden.It is strange to note that people seem to suddenly and completely forget that excessive debt is the very thing that brought forth the crisis in the first place.Stimulus packages are simply a postponement of the greater debt burden to a future date, to be paid by future generations. It is, in a sense, an ultimate act of irresponsibility and selfishness.

What is needed in these trying times is to challenge our fundamental assumptions about how the economy, industry and commerce are and should be run.A paradigmatic shift of our mindset is perhaps required if we were to get out of this endless cycle of booms and crises with its ever increasing toll of economic and human pain and suffering.Could the wisdom of the ancients, repeated by the world’s great religions, about the evil of usury not be a sound ingredient for the foundation of human happiness?