The History of Consumer Credit

First draft, 2020. Concluded 2022.
Not a well-written book.

My Quick Take

Gelpi and Julien-labruyére offer a rich survey of the history of credit institutions in Europe but, throughout this work, they are frank in their bias against the so-called moralists who in their view have held back economic growth. They also use more exclamation points than one would expect and it seems the exclamations are more frequent towards the end of the book when the content moves away from historical exposition and into the space of interpretation. As an economist-in-training, I'd like to see empirical studies addressing some of the causal claims the authors make on the link between thriftiness or an aversion to indebtedness and economic growth. Financial development is certainly important and I've seen studies on that, but the behavioral aspect is where I can read more.

Part 1: Credit from ancient to modern times: dogma vs practice

1 Usury in the ancient world

Borrowing and lending are activities as old as historical records reveal. The Babylonian Code of Hammurabi of the 1700s BC, the legal reforms of the Athenian Solon in 591 BC to the Draconian laws, the regulations of Ptolemy of Philadelphia in the Alexandrian world, the XII Tables, the foenus uniciarum of Roman law in 450 BC, the Licinian Laws of 376 BC, the Poetelia Papiria of 326 BC, and much later in 533 AD the Code of Justinian all sought to regulate interest. They addressed the general question of whether money can reproduce. Plato banned lending at interest and Aristotle condemned it expressing his bias for landowners and warriors.

2 Almsgiving versus usury

The Hebrew bible explicitly banned interest and so the 9th century BC Civil Laws of the Book of the Covenant were adopted in the Code of Josiah of 622 BC. These rules arose in a unique historical context but that didn’t stop Christians from rigidly adopting them later. Just as Josiah did with the Mosaic tradition, several church fathers in 600 AD took a moral stance against usury and credit in general claiming that it is better for people in need to beg than to borrow. While almsgiving would be denigrated during the Enlightenment, at the time it stood in contrast to lending. Church fathers including Saint Basil of Caesarea, Saint Gregory of Nysse, Saint Clement of Alexandria, Saint Ambrose of Milan wrote much in this regard. Later in the ninth century, the Carolingians who came to power through a coup d'etat fought vigorously against usury in Frankish Europe. The Catalonians of Visigoth Europe only regulated interest rates and so they were more prosperous and their economies more vibrant than the Carolingians.

3 The two-sided attitude of the church

In 12th-century Europe where usury was condemned as a sin akin to greed, individuals and institutions dealt increasingly in interest-bearing loans if not directly then indirectly using intermediary commodities or pledges. Some studies show a relationship between the increased sales of annuities and economic revival. But feudal and religious sentiments resisted the shift towards urbanization and away from the trio of peasant, knight, and cleric. The adoption of purgatory and the abolition of public confession by clerics in northern Italy gave birth to modern Europe.

Enter Saint Thomas Aquinas. He condemned usury, stating that money could not be lent because it was not fungible. His condemnation of interest-bearing loans on theoretical grounds set the stage for four classic exceptions to the ban on usury some of which are adopted today by religious institutions: (1) late payment or damnum emergens, (2) opportunity cost or lucrum cessans, (3) payment for work or service or stipendium laboris, and (4) high uncertainty or ratio incertitudinis. In medieval Europe and primarily in Italy, credit transactions grew in number while the church continued to condemn it. The church even promoted Dante’s Inferno known for illustrating the usurer's divine punishment. Still, the church was stricter in its inquisition against peasants than institutions and governing bodies. With this double standard, therefore, by 1462 Saint Antonin of Florence and Saint Bernardin of Sienna would build on Aquinas’s work and the Franciscans would establish state-owned pawnshops.

4 The cleavage of the reformation

The Reformation led by Martin Luther (1583-1546) and John Calvin (1509-1564) challenged the Catholic perception of man’s spiritual life. Luther wrote two Sermons on Usury in 1519 and 1520. A few years later, debates over the Eisenach annuities led to the first break away from the strict Biblical ideal that Luther promoted. Luther declared war on usurers but only those who charged excessive rates thereby marking a distinction between usury and interest. Calvin who came later was more cosmopolitan and associated piety with work and commerce so that worldly success was the only good deed. He perceived the scriptural ban on interest as a dated political measure. Analyzing the nature of investments, he argued that money can and does indeed generate more money. The cost of money can be usurious but only when excessive, he argued, theologically legitimizing interest-bearing loans. Across the Channel in England, the abolition movement of the 16th century featured first a surge in negative sentiment towards usury, various changes in usury laws, and then an abolition in 1571 of the ban on rates exceeding 10%. Anything beyond 10% was excessive and hence illegitimate. This, despite Dr. Thomas Wilson’s famous parliamentary Discourse Upon Usury.

5 The hypocritical masks of the ancien regime

The Catholic Church’s counter-reformation of the 17th and 18th centuries focused heavily on the question of interest. The Council of Trent, the Jansens, the Dutch bishop of Utrecht, and the French bishop Bossuet condemned and mercilessly campaigned against the practice. Their doctrinal demagogy held back the southern and Iberian peninsulas in particular. The Ancien Regime of France featured aristocratic families that sought nobility via hereditary title-holding and Jeffersonian ambitions. Banking was nonexistent and trade, manufacturing, and mercantile professions were looked down upon as inferior to the administrative power that came with seigneurial positions and landed property. The 16th and 17th centuries were economically and politically difficult in France. Over-rigid structures banning interest-bearing business loans only made things worse. In Spain as well, the hypocritical yet unproductive practice of allowing only small-time usury hindered the mechanisms of modernization. All the while, Northern Europe surged ahead developing maritime insurance and modern specialized banking.

6 The contrasts of the enlightenment

After the reformation, a range of views and practices continued to hold across Europe. In 1745, the Pope took a sudden conservative stance whereas Catholic Italian economists distinguished between interest and usury. In Northern Europe where commerce was more active, charging interest on loans was more acceptable but questions on the level of interest rate caps persisted. The utilitarian Jeremy Bentham provided five arguments against interest rate caps. First, usury was loosely defined only by custom and haphazard laws. Second, extravagance (prodigality) was not prevented by rate caps because people could always seek other costlier funding if they so badly needed it. Third, the poor person (the indigent) is not protected by restricting their borrowing if they want to borrow to protect themselves from a loss, mischief, or inconvenience. Fourth, the temerity of the enterprising (projector) is repressed. Fifth, the naive or simple person can always refinance a loan with a cheaper one if he realizes he was taken advantage of. Bentham also defends the lenders’ thriftiness and service against their popular disrepute.

Before Bentham wrote his Defense in England, Anne Robert Jacques Turgot published his Memoir in France in 1770 following the Angouleme banking affair. Turgot’s premise is that loans are necessary hence interest rates should be floated, determined by supply, demand, and the risk of default. Since “no civil or religious law obliges anyone to give [the deprived man] free assistance,“ why, he argues, should any law forbid a borrower from willingly paying for funds? He argues that money is not sterile and that the lender can sell without injustice something real that he would otherwise give out of generosity for the benefit of the borrower. He reasons that “human sentiment and pity always side with the debtor” whereas the lender is held in contempt because, while the borrower is merely satisfying his needs, the lender’s needs are more than satisfied. In 1789 the French assembly proclaimed freedom of credit and in 1804 interest-bearing loans were legalized. The church thereafter only condemned “excessive” interest rates.

7 Toward an economic concept

Classical thinkers who argued that consumption was dangerous included Benjamin Franklin in Poor Richard's Almanac (1732), Adam Smith in An Inquiry into the Nature and Causes of the Wealth of Nations (1776), Jean-Baptiste Say in his Treatise on Political Economy (1803), David Ricardo in his Principals of Political Economy and Taxation (1817), and John Stuart Mill in his Principals of Political Economy (1848). Though some of them distinguished between normal goods and durables, in their eyes consumer credit (a mere transfer of capital) bred extravagance and social waste while not contributing to economic growth. To achieve growth under their assumptions of perfect competition and price flexibility, populations were encouraged to save and invest rather than spend because national revenue was supposedly constrained not by the demand for goods but by their supply.

Several economists criticized Say's famous law as they tried to explain what caused economic crises [none mentioned explicitly] in the 19th century. Thomas Robert Malthus in his Principles of Political Economy (1820) argues that stagnation occurs when people save and invest instead of consuming. Jean-Charles Leonard Simonde De Sismondi in his New Principles of Political Economy (1819) describes the role that inequalities in purchasing power play in determining who consumes what. He also argues that lowering or fixing interest rates is foolish and preposterous. Karl Marx in his Capital: A Critique of Political Economy (published in three volumes between 1867 and 1909) is ambiguous but he draws no distinction between selling (consumption) and loaning (credit). Thus consumer credit "remained in the limbo of social and economic thought."

Part 2: Consumer credit in contemporary societies

8 The American way

The system of credit in the United States around the beginning of the 19th century resembled that of France. Although the American farmer was more independent than the European peasant at the time, repaying debts on consumer goods and agricultural assets was still considered a virtue. Not repaying was a mortal sin. In their westward expansion, Americans abolished the practice of imprisonment for defaulting on debts, and credit trading grew as did Chicago as a major trading hub. Crucially, American manufacturers also began selling durable goods on "hire purchase" agreements (like a lease) circumventing the old usury laws that were imported from England. The increasingly urbanizing and industrializing American population resorted to credit in the favorable economic conditions of the late 19th century. Borrowing (spending) was normalized as increased access to durable goods improved the well-being of households across the income spectrum. Such a large market worked in tandem with large reductions in unit costs thanks to mass production. American Economists studied such trends more closely than their European counterparts.

During the 20th century, American usury laws were so strict that the illegal credit market flourished. As happened later during the Prohibition years, local mafias took over the vacuum created by the law. Loan sharks offered high-interest loans that were unprofitable for personal banks. The RussellSage Foundation was founded in 1908 to explore the problems faced by borrowers. By 1916, the Uniform Small Loan Law was drafted and later adapted by states to raise interest rate ceilings and make lending more profitable to legitimate banks that would avoid recovering unpaid loans illegally. By 1932, however, interest rate ceilings were lowered again, bringing loan sharks back into business. Later in 1968, the Consumer Credit Protection Act (CCPA) unfolded a series of regulations that addressed credit transactions while Europe lagged behind.

In the post-war years, American credit (loans outstanding) grew rapidly. Consumer credit paved the way for an optimistic American middle class whose aspirations rose with improvements in technology and social welfare. Inflation accelerated, however, in the late 1960s when the government increased spending to finance social programs and the Vietnam War. Restrictive monetary policy at the time caused money market interest rates to rise while remunerations on savings deposits remained low by law. Savers withdrew their funds seeking higher rates of return elsewhere thus leaving depository institutions in a "credit crunch." The Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-Saint Germain Depository Institutions Act of 1982 addressed this issue by legalizing "new financial products allowing for remuneration of deposits at rates close to those of the money market." Competition in the credit market grew as a result of these laws that also liberalized interest rates.

In both its economic and social success, the American story points to the importance of consumer credit. [This book was published well before the housing bubble of 2008 that some economists, whose work I summarize here, blame on a build-up in household credit.] In stark contrast to Europe stands not just the United States but Japan as well where lending at interest has traditionally been considered more favorably. Throughout the 20th century, the Japanese Ministries for Trade and Industry and for Finance adopted American laws pertaining to hire purchase agreements (shinpan) and interest rate ceilings on the moneylending (sarakin) industry that in 1953 replaced the traditional Meiji Era Kori-Kashi system. As did its American equivalent, the sarakin system in Japan went through a disreputable phase before interest rate caps were raised to quell underground lending. Despite high levels of household debt (20% of national income in 1990), Japanese households are also among the world's most frugal savers (16% in 1992).

9 European ways

[The text is verbose in this latter half so I suffice by listing a few highlights]

The authors contrast consumer credit institutions in France and England and then offer a brief survey of the rest of Europe. In France, pawnbrokers known as Mont-de-pietes operated as charities, subsidizing smaller loans with profits from larger ones. They were popular and profitable operations but they were run inefficiently and hence exploited. Thus they had a bad reputation and the industry as a whole continued to suffer the age-old bias. In France, the novelist Honore de Balzac captured the social scene in his works.

In England, there was a more pragmatic distinction between pawnbrokers who served the poor and financial services that targeted wealthier clients. Only the former was regulated. In England, the novelist Charles Dickens captured the social scene in his works.

The arrival of consumer credit (where credit is extended directly from buyer to seller) marked another turning point in the European story. In the UK, the 1959 Radcliffe Report and the 1971 Crowther Report set the stage for sweeping changes in credit market regulation that culminated in the Consumer Credit Act of 1974 and took ten years to be fully implemented.

In France after the First World War, sellers of durable goods joined the American trend of selling on credit. This period saw the rise of financial firms such as Cofico and Cetelem (the authors' employer) that facilitated credit transactions. Public bias against taking out loans persisted in France even as credit sales became more common. In 1941, 1966, 1978 (Neiertz law), and 1989 (Scrivner law), different French laws were passed to regulate entry into the market and adjust the maximum allowable interest rate. Eventually France "shook off the guilt so long associated with credit."

Credit markets would eventually be internationalized with the establishment of the European Union and a push by American banks and manufacturers to access the European market. The 1958 Treaty of Rome (the first of two treaties that laid out the constitutional organization of the European Union) marked this internationalization of credit markets across the continent as the automobile industry matured and both American and European manufacturers pushed for room to offer their consumers sales on credit.

10-11 Conclusion

Before summarizing, the authors close with a now-outdated discussion on the level of household debt. For more recent discussions on this topic in the aftermath of the 2008 financial crisis, see Mian and Sufi's House of Debt (2014) or Turner's Between Debt and the Devil (2016), which I've also summarized here and here.