"Lending is Meritorious and Should be Praised": How The Fifth Lateran Council Unlocked Financial Theory | Sebastian Garren

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Advances in medieval economic theory had greater real-world consequences than many know. Among economists, Joseph Schumpeter’s economic history mostly starts economic theory with the Salamancans. Tyler Cowen in The Marginal Revolution states that the advances of the Salamanca school remained largely ignored, and the connection between economic theory and practice was non-existent until 1776, when Adam Smith made a treatment of economics so systematic that economics became a field in its own right. And even still, the key insights of demand, supply, and marginal slopes took a century more, until Walras and Jevons.

Yet within finance, academic theory had real-world consequences, starting of course with the theory of usury.

The moral theory of usury grew in import throughout the first seven centuries of Christianity, but it was a single moral theory, not an economic one. The idea was that interest on loans was a way to get money without work; it was not only a form of sloth, but also a pure transfer from the borrower to the lender. The practice was much maligned and often condemned by the Catholic Church. Perhaps in a Malthusian world this makes sense, but nonetheless loans were frequently necessary to overcome difficulties, and future flows of cash and crop are always tempting to mortgage. The Jewish ghettoed underclass met the demand of kings for cash now and charged interest. They were resented and abused, but useful.

Joel Kaye has shown that the thirteenth-century expansion of trade helped spur refinement of scholastic economic theory, especially for Franciscans, whose views and practices of poverty were contentious. Two very important theories of finance had been developed by the great Franciscan Peter John Olivi in the late thirteenth century: opportunity cost and risk. According to Olivi, it was because of opportunity cost and risk that merchants justly can make profits on arbitrage, seek modest returns on a loan, and charge a range of prices based on market conditions. It took the radical poverty of the Franciscans to see with fresh eyes the value to society provided by merchants and trade!

These theories provided groundwork for the idea that interest-bearing loans could be socially valuable rather than merely extractive. Another Franciscan, Bernardino da Feltre, took up the argument, extended it, and openly supported low-interest lending to the poor. He helped Pavia set up a Monte in the fifteenth century. The Monte was a collateralized loan service initially funded by donations. Poor and middle-class people could pawn an item in exchange for a loan. What made this controversial was that the one-year loan would bear interest between 2 and 15% per year to pay for the stewards of the fund. Were profits on a loan morally legitimate if they only paid for the management of the loan? In Leo X’s formulation the interest gained was given a list of legal uses, all of which were meant to indicate that loan services should have zero producer surplus. At first, only the expense of running the fund was an approved use of the interest, and any additional profits were to help the poor. However, the notion of just remuneration to the Monte expanded to include both opportunity cost and risk. And at the same time, in practice, the notion of "help the poor" expanded — as did who could deposit funds in the Monte.

While the Franciscans supported a limited form of lending at interest in charitable circumstances, the Dominicans took the other side of the debate. The Dominicans thought the loosening of the purse was also a loosening of morals. For how could a person charge interest in any circumstance without opening the door to justifying interest in many circumstances? It is not how the interest is used that makes it just or unjust. It is the act itself: as soon as you’ve charged interest, no matter how noble the cause the interest is put to, you’ve stolen from the laborer as an idle lender. The ongoing dispute was on the docket to be resolved at the Fifth Lateran Council.

Painting of St. Dominic (on left) and St. Francis by Angelo Lion (1597-1621)

At that council in 1515 Franciscan financial reasoning won. The Monti di Pietà were sanctioned by Pope Leo X. The 1515 document Inter multiplices gave full license to the practice. He understood that the Monti, properly restricted, helped and did not harm, and the payment in interest was a just fee for the administration of the program.

"We commend the zeal for justice displayed by the former group, which desires to prevent the opening up of the chasm of usury, as well as the love of piety and truth shown by the latter group, which wishes to aid the poor, and indeed the earnestness of both sides. Since, therefore, this whole question appears to concern the peace and tranquility of the whole christian state, we declare and...