Adam Smith on Usury Laws
- From: "ruetheday@xxxxxxxxxx" <ruetheday@xxxxxxxxxx>
- Date: Sun, 10 Jun 2007 09:17:04 -0700
It's truly amazing how something written well over 200 years ago could
be so timely and relevant to what we are seeing today with the
collapse of the subprime mortgage market and its potential negative
impact on the entire housing market and the entire economy.
This is from Book II Chapter IV of The Wealth of Nations:
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In countries where interest is permitted, the law, in order to prevent
the extortion of usury, generally fixes the highest rate which can be
taken without incurring a penalty. This rate ought always to be
somewhat above the lowest market price, or the price which is commonly
paid for the use of money by those who can give the most undoubted
security. If this legal rate should be fixed below the lowest market
rate, the effects of this fixation must be nearly the same as those of
a total prohibition of interest. The creditor will not lend his money
for less than the use of it is worth, and the debtor must pay him for
the risk which he runs by accepting the full value of that use. If it
is fixed precisely at the lowest market price, it ruins with honest
people, who respect the laws of their country, the credit of all those
who cannot give the very best security, and obliges them to have
recourse to exorbitant usurers. In a country, such as Great Britain,
where money is lent to government at three per cent. and to private
people upon a good security at four and four and a half, the present
legal rate, five per cent, is perhaps as proper as any.
The legal rate, it is to be observed, though it ought to be somewhat
above, ought not to be much above the lowest market rate. If the legal
rate of interest in Great Britain, for example, was fixed so high as
eight or ten per cent, the greater part of the money which was to be
lent would be lent to prodigals and projectors, who alone would be
willing to give this high interest. Sober people, who will give for
the use of money no more than a part of what they are likely to make
by the use of it, would not venture into the competition. A great part
of the capital of the country would thus be kept out of the hands
which were most likely to make a profitable and advantageous use of
it, and thrown into those which were most likely to waste and destroy
it. Where the legal rate of interest, on the contrary, is fixed but a
very little above the lowest market rate, sober people are universally
preferred, as borrowers, to prodigals and projectors. The person who
lends money gets nearly as much interest from the former as he dares
to take from the latter, and his money is much safer in the hands of
the one set of people than in those of the other. A great part of the
capital of the country is thus thrown into the hands in which it is
most likely to be employed with advantage.
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In short, Smith supported usury laws that capped the maximum rate of
interest that could be charged on a loan. His rationale was simple,
straightforward, and impeccable - if you allow lenders to charge any
interest rate they want, loans will be steered to those most likely to
waste and squander the money and the effects are likely to be
disastrous for the lender, the borrower, and the economy; if you cap
it at a rate a little above the lowest market rate, loans will be
steered to those most likely to invest the money productively.
.
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