Monday, April 6, 2009

Adam Smith Warned Against Subprime Lending

Posted on Naked Capitalism by Yves Smith:

Adam Smith, in The Wealth of Nations, advocated usury laws (limits on interest rates) because they would promote lending to prudent borrowers and productive projects, which was better for society as a whole:
The legal rate...ought not 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 [promoters of fraudulent schemes], who alone would be willing to give this high interest....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.

When 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 in the hands in which it is most likely to be employed with advantage.
Now before you say this approach discriminates against the poor, banks like ShoreBank of Chicago, and not for profit mortgage lenders extend credit to lower income individuals with loss rates in line with prime borrowers, It takes (gasp) borrower education and in person screening, something most banks eschew.

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