In his 2009 Encyclical, Caritas en Veritate, Pope Benedict XVI pointed out the need to protect “the more vulnerable sectors of the population…should be protected from the risk of usury and from despair. The weakest members of society should be helped to defend themselves against usury, just as poor peoples should be helped to derive real benefit from micro-credit, in order to discourage the exploitation that is possible in these two areas.”   What is particularly compelling about this statement is his mention of usury.  Unfortunately, his call fell mostly upon deaf ears because of the ambiguities surrounding usury itself.  Put simply, most do not understand what usury is and because of that assume that it simply means “charging a high rate of interest.”  What is clear is that, if the weakest members of society should be helped to defend themselves against usury, then usury itself is something that all need to be defend themselves against because it is a social evil.

One of the sources of confusion associated with usury is the fact that it requires that some important distinctions be made.  It is not simply charging interest, nor is it charging a high rate of interest. The distinction requires more nuance than that.  But without making these distinctions the prohibition becomes nonsensical.

As usual when a nuanced understanding of an issue is required, we can turn to St. Thomas.  He addresses the sin of usury in the Summa Theologiae (II-II, q.78, a.1) by making a very important distinction.  It is a distinction we make all the time, but without thinking about it.  When we need a tissue, we may ask “can I borrow a tissue?” But the lender does not expect us to give the same tissue back to them.  Why?  Because the tissue is consumed once we use it.  But if we ask to “borrow a pen” then the lender expects the pen back because it is not consumed when we use it.  With this distinction in mind, St. Thomas says that in general goods that are borrowed/lent can fall into the two categories above:  those that are consumed with their use and those that are not (which we call productive goods).

Now assuming that we really meant that we were merely looking to borrow the tissue (i.e. we were going to compensate the lender for it) then understanding this distinction between the two types of goods is important.  This is because in the first case to charge for the tissue and to charge for its use is to charge for what is essentially the same thing.  This price for a consumable product’s use is called usury.  On the other hand, because the pen is not consumed by its use and one may both borrow and return it, then it is just to charge for its use because of the “cost” to the lender (e.g. wear and tear on the pen, personal loss of not having the pen, transportation costs, etc.).  So then usury is not merely interest, but to charge for the use of product that is consumed in its use.

To understand this more fully, there is another important point that St. Thomas makes.  He says that every transaction (including borrowing and lending) must be to the mutual advantage of both parties. In other words, neither party should shoulder an unfair portion of the burden.  When the transactional burden is greater for one of the parties then this constitutes an offense against commutative justice.  This is the basis of the Church’s just price theory.  It applies here because if paying more for something than it is worth or selling a thing for less than it is worth is unjust, then there can be fees associated with borrowing.  The lender should never end up in an inferior position than he would have been had he not made the loan.  He should be compensated to make up for damage or loss of profit.  This compensation is considered to be the interest.

To summarize then, Usury consists in the “intention of gain” while interest is a compensation for loss.  This of course leads us to probe interest a little deeper to help understand the line between just interest and usury.  Borrowing from the laws of Ancient Rome, legitimate interest has been thought to come from two sources.  There are the immediate costs (dammum emergens) as well as the loss of forgone profits (lucrens cessans).   It seems to be common sense that if the lender can demonstrate the ability to use the funds in a productive way then there is nothing inherently unjust about including both under “costs” for the lender.  Of course coming up with a precise number is not always clear, but it is certainly legitimate to include some compensation for lost profits.

What would this look like?  While it could get complicated, a simple example from which we could apply the principles would look like this:  Suppose Joe goes to Ed and asks to borrow $10000.  Ed says he was planning on investing the $10000 in Microsoft but that he would loan him the money if when Joe repays the loan to Ed he would pay him the principal plus any costs in making the loan (like hiring a lawyer to write the terms of the contract) and the return on $10000 for Microsoft over the period of the loan (even if it is a loss).  Those additional fees are both legitimate.  Notice however that the terms must be explicit so as to best capture the actual losses that the lender would incur in lending the money.  He must not make a profit in the strict sense from Joe.

While what I said makes sense with tissues and pens, it is not clear that money is a consumable good.  After all the whole argument against usury hinges on the assumption that money is not a productive asset.  People invest money all the time and increase their wealth.  Doesn’t this make it a productive good?

Properly understood, money is a fixed medium of exchange and can only be sold (lent) for its fixed price.  Owning money means simply that one has the right to use the money to buy something.  In other words, ownership and use cannot be separated.  Once money is lent, the borrower is now the owner.  So it is not the money itself that produces new wealth but instead it what it is exchanged for that produces new wealth.  As a medium of exchange in and of itself money bears no fruit.  Now we see that it is important that we make the distinction between lending and investing.  Investment of capital in a business differs from a loan of money in that you are not loaning the money but instead the commodities the money can buy.  This, in turn entitles the lender to a share in the productive fruits of the venture or charge a “fee” for their use (since they are part owner of them).  Obviously an investor shares in the trade risks and thus can share in the profits or the losses.  This mutual sharing in the risk is what separates an investment from a usurious loan.

Given all that has been said, let’s look at an example of a usurious loan.  Suppose Joe now approaches Bank A for a Home Mortgage for his $100000 home. Bank A charges him an “Origination Fee” to cover their cost in lending.  So far, so good.  But that is not all they also charge him an interest rate of 5.25% over 15 years.  All of this is usury.

Properly understood, a typical home mortgage is really the bank purchasing the property and reselling it to the buyer at a higher price paid at a future date.  But the total price that the homeowner pays ($199,000) has nothing to do with the actual price of the home in 15 years.  The borrower almost always pays significantly more than the just price—meaning the price of the home at the time of payoff, even if one added in costs associated with lending.

Now the bank could claim lucrens cessans for money that could have been invested in something else.  This may be a legitimate cost (again if explicitly detailed out) but not in the United States.  With the fractional reserve lending practiced by the banks, the money that they lend does not actually exist.  They artificially create the money to supply the loan and then once it is paid off it ceases to exist.  Therefore banks can neither claim lucrens cessans for money that otherwise would not have existed nor a loss due to due to inflation because but for the loan the money would not have existed and upon repayment it ceases to exist.  It literally is as if money grew on trees and the banks operate on pure profit.  They can never lose, even when someone defaults (assuming that the number of defaults does not threaten their fractional reserve).

The Father of Modern Economics, John Maynard Keynes, saw the wisdom of the Church’s teaching on usury and interest.  He is quoted as saying,

“I was brought up to believe that the attitude of the Medieval Church to the rate of interest was inherently absurd, and that the subtle discussions aimed at distinguishing the return on money-loans from the return to active investment were merely Jesuitical attempts to find a practical escape from a foolish theory. But I now read these discussions as an honest intellectual effort to keep separate what the classical theory has inextricably confused together, namely, the rate of interest and the marginal efficiency of capital. For it now seems clear that the disquisitions of the schoolmen were directed towards the elucidation of a formula which should allow the schedule of the marginal efficiency of capital to be high, whilst using rule and custom and the moral law to keep down the rate of interest.”( JM Keynes, General Theory).

If he, who is no friend of the Church can see its wisdom, then perhaps we too might benefit from examining this teaching once again.