Why should we pay our debts? It is easy to evade the question by mistaking etymology for morality. Most Indo-European languages have a single word for “debt”, “sin”, and “guilt”. Our language tempts us to equate being in debt with ongoing culpability.
But, despite etymology, nobody really believes that debts should always be repaid. Plato, in the Republic, builds an intuition pump to draw this out. Suppose I borrow a weapon from a neighbour, who, in the meantime, becomes violently mad and wants the weapon back for the wrong reasons. Nobody is so morally obtuse as to deny that there is at least a dilemma here. Paying our debts isn’t always obviously the right thing to do.
This contrived example should not nevertheless overthrow the common notion that debts should ordinarily be repaid. What we want is a justification for this common notion, to guide us on when to apply it. The clearest justification was given by Hume. The institution of debt is a social good. If we could not borrow from each other, we would be poorer as a society. Yet if people did not routinely repay debts, nobody would lend. The routine of repayment arises from the general belief that debts ought to be repaid.
This justification is, however, contingent on the net social benefit arising from the institution of debt. In my book, The Philosophy of Debt, I argue that there is no natural mechanism ensuring that the institution of debt will operate for the public good. I discuss two types of lending at interest: usury – lending to finance profitable and productive enterprises – and abusury – lending that targets non-creditworthy borrowers, at rates they cannot sustain, in the hope of extracting collateral or selling bad debt on to unsuspecting secondary buyers. Usury is of net social benefit, at least in material terms. It fosters the production of new real goods and services. Abusury is of no net social benefit. It serves only to extract already-existing wealth from some and transfer it to others. Is the institution of debt a social good? Yes, if the debt environment is sufficiently usurious. No, if it is sufficiently abusurious.
In the ancient world, lending was primarily abusurious – so much so that debts had to be routinely cancelled simply to stop the social order from collapsing from extreme wealth concentration. Many of the condemnations of usury found in the great religious traditions are really aimed at abusury. Modern defences of usury, like those of Turgot and Bentham, were made in a different debt environment. There the legal and social framework was less favourable to abusury.
What about today? I believe that the global financial system took a profound turn towards abusury in the 1980s. Mortgage lenders in the 1960s used to be known as the “5-4-3 boys” (they were almost all boys). They would lend mortgages at 5%, fund their lending at 4%, and be on the golf course by 3pm. Their profit margins were small. Their lending was neither usurious nor abusurious; it simply allowed borrowers to spend tomorrow’s income today. Bankers who wanted to make real money had to go into usury: to seek out and lend to profitable productive ventures.
Things changed dramatically in the 1980s, due to the growth of two markets: the secondary market for mortgage loans and the market for default insurance. The first allows banks to lend to non-creditworthy borrowers and then sell the risk on to third parties. The second allows them to make arbitrage trades – effectively bets – on the risk of default. This is abusury. It finances no production and merely transfers wealth from those who guess risks incorrectly (often the borrowers themselves) to those who guess them correctly.
Now mortgage lending is for abusurers, not the 5-4-3 boys. Bankers increasingly prefer it to the old usurious path. Businesses struggle to get loans while the securities markets are awash in credit. The flow of credit inflates property prices, raising the cost of accommodation. Thus businesses also struggle to make sales: their potential customers are spending all their income paying mortgages and other debt. Financial crises are frequent. Real production becomes unprofitable and is thus neglected. None of this is of net social benefit; much is socially harmful.
Governments could ban the sale of mortgage loans to third parties, prohibit lending institutions from selling default insurance, and disallow volatile financial assets as permitted collateral. Some lenders might try their luck overseas; most would just return to the old path of productive usury. In failing to bring about this change, governments are complicit in sustaining an abusurious banking environment. Yet the obligation to repay debts is contingent on the debt environment being primarily usurious. To be morally consistent, governments must either change the nature of finance or stop enforcing debt obligations.