From Wikipedia:
Usury (pronounced /ˈjuːʒəri/, comes from the Medieval Latin usuria, “interest” or “excessive interest”, from the Latin usura “interest”) originally meant the charging of interest on loans. This would have included charging a fee for the use of money, such as at a bureau de change. After countries legislated to limit the rate of interest on loans, usury came to mean the interest above the lawful rate. In common usage today, the word means the charging of unreasonable or relatively high rates of interest. As such, the term is largely derived from Abrahamic religious principles; Riba is the corresponding Islamic term. The primary focus in this article is on the Christian tradition.
If you saw the BBC’s Newsnight programme on Wednesday July 22 you might have watched (go to 24.50) a somewhat intimidating Paul Mason standing outside the headquarters of RBS in London inviting employees to come and discuss the ethics of usury with him.
Motivation for the report: growing religious campaigns in the UK urging the government to enforce usury laws on banks and high-street lenders. Mason was joined by vicars, priests, rabbis and muslim clerics — all seemingly united on the issue.
We mention this because it seems to be a concept ruminating around Willem Buiter’s Maverecon blog on Thursday morning. For example, he pitches the following solution to the world’s current economic malaise (his emphasis):
A possible solution: the application of Islamic finance principles through the equitization of private and public debt. If too much debt and too little capital are (part of) the problem, then the conversion of debt into equity is (part of) the solution.
He goes on to explain how a debt-for-equity swap concept might be applied to mortgage debt in particular:
Household mortgage debt could be turned into an equity claim. Many proposals of this kind have been floated in the US for quite a while now. For a new equity mortgage, the bank would start off as the owner of the property that secures the mortgage. The contract could take the following form. With a 20-year mortgage, say, the ‘borrower/tenant’ would pay the bank a rental to live in the property, plus a periodic payment transferring part of the equity in the property to the tenant, say 5 percent of the purchase price each year.
The initial value of the equity (the purchase price) is the present discounted value of the rentals expected not just over the 20 years of the mortgage contract, but over the entire economic life of the property. The actual rental payments would be determined by some index of local market conditions. Each period the bank would only receive a share of the total rental income from the property equal to its remaining equity share. As long as the tenant meets the terms of the contract, she cannot be forced to vacate the property. The bank could sell its share of the property (and the right to collect the rents for the remainder of the mortgage). It would have a stake in the upside (and the downside) of the property market.
As he concludes:
A mortgage contract of this nature (suitably modified to allow for past interest and amortisation) could be offered to existing mortgage holders who are in default on their mortgages as an alternative to repossession. It could significantly reduce the socially wasteful repossession costs, which have been estimated for the US at between $50,000 and $80,000 per property repossessed. It could also be offered as an alternative to regular mortgages for new home borrowers.
So in effect, the “tenant” would not be paying off a debt anymore but paying a rental income that goes towards upping their equity stake in the property. Where’s the return for the bank? Well instead of getting returns determined at interest rates on origination, the bank would be receiving rents based on local market price conditions. The bank is essentially taking a view on the economy — that property prices and rents should go up in the lifespan of the agreement, or at the very least match inflation. There is no interest, or usury. The model works because of the distribution of risk between borrower and investor.
Buiter also explains how the model can be applied to public debt. For example:
How can we turn public debt into something more akin to equity? One way would be to replace regular fixed or variable interest rate bonds by a security that would have the growth rate of nominal GDP (plus or minus some fixed number) as its interest rate.
Which would have the following effect:
This way, with government revenues and deficits so closely coupled to GDP (as a measure of the effective tax base), weak growth would reduce the expansion of the public debt through the intrinsic debt dynamics that comes out of the product of the interest rate and the outstanding stock of debt.
All of the above is, of course, not new. It’s the sort of thinking that underpins the Islamic finance principle already.
As Buiter concludes:
What we need is the application of Islamic finance principles, in particular a strong preference for profit-, loss- and risk-sharing arrangements and a rejection of ‘riba’ or interest-bearing debt instruments. I am not talking here about the sham sharia-compliant instruments that flooded the market in the decade before the crisis; these were window-dressing pseudo-Islamic financial instruments that were mathematically equivalent to conventional debt and mortgage contracts, but met the letter if not the spirit of sharia law, in the view of some tame, pliable and quite possibly corrupt sharia scholar. I am talking about financial innovations that replace debt-type instruments with true profit-, loss- and risk-sharing arrangements.
Related links:
Islamic finance principles to restore policy effectiveness – Maverecon
Islamic finance escapes worst of crisis - FT