Direct Lending at Lower Rate and Debt Relief

October 2, 2008

Sankarshan Acharya
Pro-Prosperity.Com and Citizens for Development

October 2, 2008

Written to U.S. Senators

Sub:  Urgently needed: Direct lending at lower rate and debt relief

The current financial crisis may have reached an epochal point: unsustainably high (usurious) lending rate of interest and usurious creation of credit over many years.  The optimal solution to the epochal crisis is two-pronged:[1]


·         Cut the price of credit by lending at lower rate directly to grass-root borrowers.

·         Offer debt relief to the grass-root borrowers. 

Grass-root borrowers are the businesses and homes which are centers of real activities.  Cutting the Federal Reserve benchmark rate has not lowered the lending rate.  Direct lending is the only tool available to the government to cut the lending rate.  Direct debt relief by fiat for all indebted households is perhaps the fairest, quickest and cheapest approach to have an immediate positive impact on reviving the economy. 

The buyout program being debated now will unlikely result in a resurrection of economic activity because the bankrupt financial companies will simply use the cash received from the government, by swapping their toxic debt, to lend it back to the Treasury, as happened in Japan and argued in my memo of September 28, 2008.   

Epochal nature of the financial crisis

The price of labor (mental and physical) is set by monetary units.  Everything including material is ultimately delivered through labor.  The price of labor is the source of creation of debt and credit in an economy, and it is crucial to solve the current credit crisis optimally.  Succumbing to greed and fear will likely result in suboptimal policies leading to an escalation of the crisis.   

It is obvious that the net creditors in an economy are able to accumulate more monetary units than they need and the net debtors are unable to receive as many monetary units as they need.  The surplus credit is loaned as debt at a price of credit or an interest rate which is set by creditors through the banking and monetary system.   The debtors are prone to think that the price of credit is too high while the creditors may not lend even when the price is high.    

The tussle between the debtors and creditors is not new.  The first documented tussle occurred sometime in 500 B.C. when a Hindu Lawmaker Vashistha proposed to set a low rate of interest on credits.  Monetary economics was perhaps born then.  Philosophers like Aristotle and Plato have also advocated for zero rate of interest.  Then Prophet Mohammed enunciated a new religion based on zero interest rate and equality of all humans.  The Church later adopted a philosophy of zero interest rate being good for humanity.

The humans have become wiser over time to adopt the first ever written democratic constitution founded on the principle of “we the people are created equal” with nonpareil monetary rules for the price of credit based on demand and supply in America.  As someone who pledges allegiance to such democratic constitutional rules of law everywhere, I see the ancient religious tomes starting from the Gita to the Bible and then to the Quoran as scripts on governance of humanity akin to the modern constitution. [2] 

The ancient religious scripts offer no room for amendment.  They were propagated as sacrosanct religious documents for governance of human behavior.  The humans over time have questioned such sacrosanct rigidity, although they are indoctrinated as children, when they cannot think or judge. 

The modern constitutional rule of governance allows amendment based on the latest human wisdom and democratic discourse.  Most countries have adopted this system.  But the current financial crisis has raised doubts about whether this system is capable of begetting prosperity for the vast majority.  Such doubts have unfortunately emboldened the obscurants steeped in their ancient religious dogma to wage a terrorist war against the constitutional rules of governance. 

Usurious price of credit

Resolving the financial crisis is necessary to clear doubts about the efficacy of the constitutional system of democratic governance.  A resolution is needed urgently to contain terrorism and obscurantism.  This is daunting, though, because the root cause of financial meltdown stems from an unsustainably high (usurious) price of credit, but what is usurious may be unclear. 

Economists may argue endlessly for or against a rate of interest using economic indicators like inflation, manufacturing activity, unemployment and even stock markets.  They may even come to a unanimous conclusion on the rate of interest.  But their conclusion is invariably predicated on retaining the real value of the accumulated credit, not on whether the rate is usurious. 

Usurious interest rates over a prolonged period eventually leads to financial meltdown, economic agony, riots, social chaos and maybe Great Depression.  Such catastrophic events ultimately force the creditors to face default or grant debt relief and accept a much lower rate of interest.  In such circumstances, the economic indicators are not very useful. 

My argument about whether the current rate of interest is usurious is based on distribution of surplus credit in a democratic society.  The current distribution of credit in America should show, if factually documented, that the vast majority that wields power in a democracy has negative net credits or positive net debts, while a small fringe of households have accumulated vastly positive credits.  This means that the price of labor of the vast majority has been substantially less than that sustainable in a democracy. 

I have argued earlier about how the few top creditors could rig up the price of credit by fooling the Federal Reserve’s model based on economic indicators: 

(i)                 The federally insured banks lend easy credit to hedge funds owned by the top creditors including the CEOs of the same banks.  Using the power of leverage, the hedge funds could rig the markets to wangle wealth from passive pension plans and mutual funds.  If the credits available at the federally insured banks were instead channeled to real activities, the lending rates of interest would be much lower than they have been. 

(ii)               The hedge funds could also rig up the prices of commodities to create an illusion of inflation to pressure the Federal Reserve to keep the rate of interest high.  This means the true equilibrium rate of interest has been less than the rate decreed by the Federal Reserve. 

(iii)             The Federal Reserve has always acted to preserve and enhance the real value of credit, which invariably leads to higher rate of interest than warranted in a democratic government.   

The above reasons imply that the price of credit has been unsustainably usurious.  That they are true is indicated by the fact that the government seems to have actively counseled the federally insured banks to not lend to hedge funds.  I had sent earlier a pertinent memo entitled, “Lending Taxpayer Funds to Investment Banks and Hedge Funds is Suicidal for Taxpayers.”  The current market meltdown is mainly due to a restriction of federally insured credit to hedge funds and investment banks.  Hedge funds and investment banks had to unwind their long positions on commodities that have resulted in precipitous falls in prices of oil and metals.   Now top creditors are craving to buy the Treasuries yielding as low as 0%.  Before the restriction of federally insured credits to hedge funds, I had suggested lowering the Fed benchmark rate to about 2% or lower when indeed the Fed’s model was indicating 5.5%, with vociferous support for keeping the rate that high or even raising it further. 

The Federal Reserve is now coming under pressure to lower the benchmark rate of interest even below 2%.  Maybe it should.  But lowering the benchmark rate does not make credit available at lower rates to the grass-root borrowers, the businesses and homes where real economic activity flourishes. 

Policy Solution

The current financial meltdown shows that the effective lending rate is still usuriously high for the grass-root borrowers.  To cut the lending rate to the grass-root borrowers the government has no option but to decree by Congressional fiat:

(i)                 Direct lending to grass-root borrowers at lower rates.

(ii)               Grant debt relief to grass-root borrowers. 

These seem to be the only two urgent policy tools needed to maintain a non-usurious lending rate.  Competing private banks will automatically lower their lending rates once the government steps in.  This will likely boost confidence and revive economic activity. We should also adopt a long-term policy of safe banking to avoid moral hazard, as detailed in my previous memos.[3] 

To conclude, the current financial crisis seems epochal, rooted in usurious creation of credit and high price of such credit, controlled directly by policymakers who generally have large positive net credits and indirectly by the top creditors.  The current crisis can be resolved only by the constitutional principle of liberty for the vast majority via an optimal sustainable (non-usurious) price of credit. The issue here is neither fairness nor the mighty being right.  It is a matter of optimal democratic governance to maintain social stability and to obviate chaos and incivility.

With profound regards,

Sankarshan Acharya

[1]Acharya, Sankarshan (2005), “Prosperity: Optimal Governance, Banking, Capital Markets, Global Trade, and Exchange Rate,” Citizens Publishing.