We Need To Rethink The Ethics of Debt
A few months ago, I heard an economist argue that we need to change the way we think of
debt. I didn’t think much of it right then, but later this idea intrigued me and I have been searching for articles or books on the subject. I haven’t quite found what I have been looking for, and hence this article is my own rumination on the idea. Maybe this blog post will reach someone who will direct me to more expert views on this subject.
What is the difference between an investor and a lender? What is the difference between a borrower and an investee? How have these groups evolved? And how should we think of the relationships between these entities?
Let’s start by thinking about the similarities between lending and investing. In both cases, one person (or firm) needs money and another person provides the money. In return, the person who receives the money ends up returning more money than was taken, thus providing a profit to the person who gave the money. So far, the two transactions are the same.
Now imagine that the person who has taken the money is not able to return it. If the money has been taken as a ’loan’ then the borrower has to return it with interest or face severe penalties including prison sentences. However, if the money was taken as ‘equity’, then it doesn’t have to be returned and the investor takes a loss.
We can think of an investor as a rich and sophisticated person, who understands the intricacies of business and the stock markets. We think such a person has a large amount of money and can afford to take losses in the short run, which they can redeem in the longer run.
In reality, this investor may be a working class person who is investing their life savings. Or it is an institution such as a mutual fund or an insurance company which is investing on behalf of this working class person. Investors buy shares in companies, that are supposed to be run fairly for the benefit of all investors. In reality, companies are run by promoters and their families and often work towards their benefit, rather than to the benefit of the small investor.
So in an investment, a working class family is often giving money to a rich promoters family. Aam Aadmi gives to Khaas Aadmi. We now need to ask in what proportion the losses, when incurred, should be shared by the promoters and the retail investors.
Let’s look at the borrower-lender relationship. We keep hearing about large companies and rich businessmen who take huge loans and don’t repay them. They seem to get away without much trouble. Meanwhile the Aam Aadmi who has borrowed money to buy a house, or to study or for a small business or just for day to day expenses is often hounded by loan collectors.
The Aam Aadmi is charged huge interest rates. Credit card debt, personal loans, student loans, two wheeler loans, car loans all pay much higher interest rates than companies that borrow for investment or working capital. And despite the high interest rates, individuals and poorer families may not be able to get these loans and end up with money lenders who charge even higher interest rates.
The loans are issued to people by banks who are supposed to evaluate the credit worthiness of borrowers and their projects. These banks get a nice cut for this work. But when a loan goes bad, the bank don’t take much of the responsibility and the pressure to pay is on the borrower.
In any case, the bank is not lending its own money, but the money of its depositors. Who are these people? Of course, the Aam Aadmi puts their savings in a bank, but given that in an economy the rich have much larger savings than the poor, the banks are really channelling money from the rich depositor to the poor borrower. Banks are just middlemen who make a commission but take on very little responsibility.
So there you have it. In an investment, the Aam Aadmi is giving money to a Khaas Aadmi. In a loan, the Khaas Aadmi is giving money to the Aam Aadmi. In both cases, the Aam Aadmi has to bear the brunt of the losses.
Makes you think, doesn’t it?
Can we imagine an economic system where we do away with the artificial distinction between debt and equity? Where losses incurred are fairly shared between the giver and the receiver of money? That would hinge heavily on what ‘fairly shared’ means.
If I invest in a company, then I expect the promoter to take the responsibility of making sure the money gets a good return. If not, can the promoter family or the management team take on the larger share of the losses? If they did, then what would be the impact on how companies behave?
When the Aam Aadmi takes a loan, they have every intention to pay it back. If they can’t it is often due to macroeconomic reasons. If my company lays off a lot of people, then many of us may be unable to pay off our loans. If the housing market crashes then the value of the apartment that I live in might fall below the value of the mortgage on it. If a student doesn’t get a good job after their degree, then how can they return their loan?
At times like this, the common man needs the help of friends and family. Of society at large. Is it too much to expect that the losses in such a situation be shared in a more equitable manner?
The economist, Thomas Piketty, has shown that a major reason for inequality in the world is that capital gets a higher share of the profits than labour. The argument above shows why. Perhaps if we removed capital from this privileged position, then there would be much less inequality in society. Wouldn’t that be a great thing?
Around the world, experts are thinking about how capitalism can be modified to remove some of its ills. One major problem is that it creates inequality. Perhaps erasing the distinction between debt and equity can help remove one of the ills of capitalism.