(notes) In Pursuit of Wealth: The Moral Case for Finance, by Yaron Brook

Introduction

The special ire directed at finance comes from the recognition that financiers are motivated by the selfish desire for profit — and the belief that the profit motive leads financiers to take short — range , irrational , predatory actions to line their pockets at others ’ expense .

Profit is the economic insignia of production : one profits by creating value — and the motive of those seeking profits is to earn wealth by creating value .

…financiers don’t create the products that enrich our lives — they help create ( and nurture ) all the businesses that create the products that enrich our lives .

A key takeaway from this book is that to counter the vilification of financiers requires moral reframing. Those who recognize the irreplaceable value of finance must change the terms of the debate . The question should not be whether financiers are “ greedy ” or selfish or motivated by money . The question should be : Do they profit through creating values that enhance human well — being — or are they parasites who line their pockets through short — range gambling and predatory exploitation ?

PART 1: HOW FINANCE HELPS US FLOURISH

Unlike the gun industry or the tobacco industry , even the harshest critics of the financial industry view it as a necessary evil. There is simply no denying that progress and prosperity depend on a burgeoning financial industry. It’s something we each experience in our daily lives.

What unites all these different products , activities , and institutions is the assembly and use of savings.

To consume, we need to produce first.

Whatever we produce beyond what we consume immediately is savings. Savings is the master tool because it gives us the time and resources to make and use every other tool . The more savings we have, the more productive we can be, and the better we can live.

Investing is paying a price now for an expected larger reward later. We invest whenever we forego the use of our savings and put it to productive use in the hope of growing our savings.

But investing our own savings has its challenges. Trying to find investment opportunities and assessing those opportunities takes time. It also takes knowledge and judgment that we might not have. Should I lend my money to my brother — in — law who wants to start a restaurant? Or what about a neighbor I barely know who wants to use it to renovate his house and pay me back out of his salary as a doctor? Which is the better deal and how much interest should I charge to compensate for the risk? And what if I want to lend my money for a month, but I only find people who want to borrow the money for a year? On the other side, what if I’m the one looking to borrow money or to find an investor for my plans? How can I find willing lenders and investors? And how do I know I’m getting a good deal?

The financial industry’s purpose is to gather and deploy savings in order to maximize the financial well — being of everyone involved in trade. It solves the problem of how to most efficiently assemble savings and put it to its best use, given the wide variety in interests, time horizons, and risk tolerances of people.

In its simplest form, a commercial bank accepts deposits and makes loans. Its job is to channel people’s savings into profitable investments, and it profits by paying the savers less interest on their deposits ( say, 3 percent ) than it charges borrowers for their loans ( say, 6 percent ). Why would borrowers and lenders tolerate that? Why wouldn’t they deal with each other directly and cut out the middle man? Because by dealing with a bank , they end up better off. As a saver, you no longer have to hunt for people to lend to. You don’t have to learn how to assess various investment opportunities. You don’t have to worry about how long someone wants to borrow for. And you don’t bear the risk of a particular borrower defaulting on his loan. All you have to do is assess the soundness of the bank itself.

The notion that finance is unproductive is profoundly wrong and unjust. It ignores the three enormous and unparalleled value — creation activities of the financial industry that follow from its core function of putting savings to its best uses. The financial industry helps us : Boost production Manage risk Increase consumption.

The basic challenge in an economy is that the people with the best productive ideas seldom have the capital necessary to put those ideas into practice, and the people with the necessary capital do not automatically know who has the best ideas. That’s a big problem : failing to put money in the right hands means that we miss out on revolutionary achievements that can dramatically improve our lives — putting money in the wrong hands means wasting our most valuable tool. Finance is the industry that solves this problem by what economist Luigi Zingales calls “ matching money with talent .”

The financial industry plays a key role in both reducing risk and in transferring risk from those who don’t wish to assume it to those who do.

The ultimate goal of production is consumption, and finance not only helps us maximize what we can produce, but it helps each of us as individuals consume more effectively over the course of our lives.

And this — the creation of value , rather than fraud , theft , recklessness , or exploitation — is how financiers profit.

Profits , then , reflect the gap between the economic value consumed during the productive process and the economic value obtained through voluntary trade. A company profits by using resources in such a way as to produce something more valuable. Profits , in short , are not extracted but created.

Profits , in other words , reflect not the physical effort that went into producing them but how much more value a company creates than it consumes.

…to the extent the market is free , and to the extent all parties abide by the law , they are win / win and any profits are an insignia of value creation. They are not earned at others ’ expense.

Virtually all transactions involve asymmetric information , but one of the major ways that individuals create value in financial markets is by discovering and acting on superior information.

Yes, all fraud counts on asymmetric information but the reverse is not true.

…even if such crises were an intractable result of the financial industry , there would still be no grounds for condemning the industry as immoral , any more than the inherent risks of driving make the auto industry immoral.

Macro-instability is the result of government control of money and credit ( and interference in wages and prices ), while micro-instability is the result of the government restricting financial freedom and subverting market discipline in financial institutions.

Treating financiers and other businessmen as guilty until proven innocent simply because they are driven by the profit motive is not a well thought — out conclusion but a prejudice — and like any prejudice it is based on assumptions. In particular is based on a particular view of morality.

The moral standard we use to evaluate things as good or bad is individual human flourishing. Something is good if it contributes to the long — term intellectual , emotional , and physical well — being of the individual. What does contribute to the long — term well — being of the individual? Fundamentally, two basic virtues : rationality and productiveness.

By contrast, a basic vice is parasitism : seeking the unearned through physical force , fraud , or emotional manipulation. Parasitism not only hampers the ability of others to flourish , but corrodes our own well — being as well .

By taking risks and investing their capital in what they thought would make them the most money, moneylenders and other financiers made possible whole industries —

Moneylending is the lifeblood of industrial — technological society.

The most hated sort [ of moneymaking ] , and with the greatest reason , is usury , which makes a gain out of money itself , and not from the natural use of it. For money was intended to be used in exchange , but not to increase at interest.

Aristotle believed that charging interest was immoral because money is not productive. If you allow someone to use your orchard , he argued , the orchard bears fruit every year — it is productive — and from this product the person can pay you rent. But money , Aristotle thought , is merely a medium of exchange.

Aristotle studied under Plato and accepted some of his teacher’s false ideas . One such idea that Aristotle appears to have accepted is the notion that every good has some intrinsic value — a value independent of and apart from human purposes. On this view , $ 100 will be worth $ 100 a year from now and can be worth only $ 100 to anyone , at any time , for any purpose. Aristotle either rejected or failed to consider the idea that loaned money loses value to the lender over time as his use of it is postponed, or the idea that money can be invested in economic activity and thereby create wealth. In short, Aristotle had no conception of the productive role of money or of the moneylender.

Since usury creates nothing but takes something — since the lender apparently is parasitic on the borrower — the practice is unnatural and immoral. It is important to realize that , on this theory , there is no dichotomy between the economically practical and the morally permissible ; usury is regarded as immoral because it is regarded as impractical.

Тhe church violently opposed even such subsistence — level lending . During this period , the Bible was considered the basic source of knowledge and thus the final word on all matters of importance . For every substantive question and problem , scholars consulted scripture for answers — and the Bible clearly opposed usury . In the Old Testament , God says to the Jews : “ [ He that ] Hath given forth upon usury , and hath taken increase : shall he then live ? he shall not live . . . he shall surely die ; his blood shall be upon him . ”

Although the New Testament does not condemn usury explicitly , it makes clear that one’s moral duty is to help those in need , and thus to give to others one’s own money or goods without the expectation of anything in return — neither interest nor principal. As Luke plainly states , “ lend , hoping for nothing again .”

There was, however, a loophole among all these pronouncements: the Bible’s double standard on usury. As we saw earlier , read one way , the Bible permits Jews to lend to non — Jews. This reading had positive consequences. For lengthy periods during the Dark and Middle Ages , both Church and civil authorities allowed Jews to practice usury .

Although Jews were legally permitted to lend to Christians — and although Christians saw some practical need to borrow from them and chose to do so — Christians resented this relationship. Jews appeared to be making money on the backs of Christians while engaging in an activity biblically prohibited to Christians on punishment of eternal damnation. Christians , accordingly , held these Jewish usurers in contempt. ( Important roots of anti — Semitism lie in this biblically structured relationship . )

Such was the attitude toward usury during the Dark and early Middle Ages. The practice was condemned primarily on biblical / moral grounds. In addition to the fact that the Bible explicitly forbade it, moneylending was recognized as self — serving. Not only did it involve profit; the profit was ( allegedly ) unearned and exploitative. Since the moneylender’s gain was assumed to be the borrower’s loss — and since the borrower was often poor — the moneylender was seen as profiting by exploiting the meek and was therefore regarded as evil.

Calvin claimed that the moral status of usury should be determined by the golden rule. It should be allowed only insofar as it does not run counter to Christian fairness and charity. Interest should never be charged to a man in urgent need , or to a poor man ; the “ welfare of the state ” should always be considered. But it could be charged in cases where the borrower is wealthy and the interest will be used for Christian good. Thus he concluded that interest could neither be universally condemned nor universally permitted — but that , to protect the poor , a maximum rate should be set by law and never exceeded.

The prevailing view that emerged in the late 16th century ( and that , to a large extent , is still with us today ) is that money is not barren and that usury plays a productive role in the economy. Usury , however , is unchristian; it is motivated by a desire for profit and can be used to exploit the poor. It can be practical , but it is not moral ; therefore , it should be controlled by the state and subjected to regulation in order to restrain the rich and protect the poor.

Because of original sin , the Protestants argued , men are incapable of being good , and thus concessions must be made in accordance with their wicked nature. Men must be permitted to some extent to engage in practical matters such as usury , even though such practices are immoral.

In spite of its horrific view of man , life , and reality , Luther and Calvin’s brand of Christianity allowed individuals who were not intimidated by Christian theology to practice moneylending to some extent without legal persecution. Although still limited by government constraints , the chains were loosened , and this enabled economic progress through the periodic establishment of legal rates of interest.

Observe that while pleading for a bill permitting usury — on the grounds that it is necessary ( “ Traffick . . . hardly may be maintained generally without [ it ] ” ) — Molley concedes that it is evil . This is the moral — practical dichotomy stated openly and in black — and — white terms , and it illustrates the general attitude of the era . The practice was now widely accepted as practical but still regarded as immoral , and the thinkers of the day grappled with this new context.

The economic debate had shifted from whether usury should be legal to whether and at what level government should set the interest rate ( a debate that , of course , continues to this day , with the Fed setting certain interest rates ). As one scholar put it : “ The legal toleration of interest marked a revolutionary change in public opinion and gave a clear indication of the divorce of ethics from economics under the pressure of an expanding economic system.”

In the mid — 17th century , northern Europe was home to a new generation of scholars who recognized that usury served an essential economic purpose , and that it should be allowed freely. Three men made significant contributions in this regard. Claudius Salmasius ( 1588–1653 ) , a French scholar teaching in Holland , thoroughly refuted the claims about the “barrenness” of moneylending; he showed the important productive function of usury and even suggested that there should be more usurers, since competition between them would reduce the rate of interest. Other Dutch scholars agreed with him , and , partially as a result of this , Holland became especially tolerant of usury , making it legal at times.

Robert Jacques Turgot ( 1727–1781 ) , a French economist , was the first to identify usury’s connection to property rights. He argued that a creditor has the right to dispose of his money in any way he wishes and at whatever rate the market will bear , because it is his property. Turgot was also the first economist to fully understand that the passing of time changes the value of money.

Correcting another medieval error, Bentham also showed that restrictive usury laws actually harmed the borrowers. Such restrictions cause the credit markets to shrink while demand for credit remains the same or goes up ; thus , potential borrowers have to seek loans in an illegal market where they would have to pay a premium for the additional risk of illegal trading.

Bentham’s most important contribution was his advocacy of contractual freedom : My neighbours , being at liberty , have happened to concur among themselves in dealing at a certain rate of interest. I , who have money to lend , and Titus , who wants to borrow it of me , would be glad , the one of us to accept , the other to give , an interest somewhat higher than theirs : Why is the liberty they exercise to be made a pretence for depriving me and Titus of ours.

Although Salmasius, Turgot, and Bentham made significant progress in understanding the economic and political value of usury , not all their fellow intellectuals followed suit. The father of economics , Adam Smith ( 1723–1790 ) , wrote : “As something can everywhere be made by the use of money , something ought everywhere to be paid for the use of it .” Simple and elegant . Yet , Smith also believed that the government must control the rate of interest . He believed that unfettered markets would create excessively high interest rates , which would hurt the economy — which , in turn , would harm society . 98 Because Smith thought that society’s welfare was the only justification for usury , he held that the government must intervene to correct the errors of the “ invisible hand .”

Following Bentham and Smith , all significant 19th — century economists — such as David Ricardo , Jean Baptiste Say , and John Stuart Mill — considered the economic importance of usury to be obvious and argued that interest rates should be determined by freely contracting individuals . These economists , followed later by the Austrians — especially Carl Menger , Eugen von Böhm — Bawerk , and Ludwig von Mises — developed sound theories of the productivity of interest and gained a significant economic understanding of its practical role . But the moral — practical dichotomy inherent in their altruistic , utilitarian , social justification for usury remained in play , and the practice continued to be morally condemned and thus heavily regulated if not outlawed.

According to Marx, moneylending and other financial activities are not productive, but exploitative; moneylenders exert no effort, do no productive work, and yet reap the rewards of production through usury . 99 As one 20th — century Marxist put it : “ The major argument against usury is that labor constitutes the true source of wealth.” Marx adopted all the medieval clichés , including the notion that Jews are devious , conniving money — grubbers.

Under Marx’s influential ideas , and given the culture — wide contempt for moneylenders , the great era of capitalism — of thriving banks and general financial success — was petering out. Popular sentiment concerning usury was reverting to a dark — ages type of hatred. Marx and company put the moneylenders back into Dante’s Inferno , and to this day they have not been able to escape.

The need for capital , however , would not be suppressed by the label “immoral .” People still sought to start businesses and purchase homes ; thus usury was still seen as practical. Like the Church of the Middle Ages , people found themselves simultaneously condemning the practice and engaging in it.

(The term “ usury ” is now almost universally taken to mean “ excessive ” or illegal premium on loans , while the term “ interest ” designates tolerable or legal premium.)

The earliest known advertisement for a small — loan service in an American newspaper appeared in the Chicago Tribune in November 1869 .

The reason rates were so high is because of the number of defaults . With high rates in play , the losses on loans in default could ordinarily be absorbed as a cost of doing business.

Although Keynes allegedly rejected Marx’s ideas , he shared Marx’s hatred of the profit motive and usury. He also agreed with Adam Smith that government must control interest rates ; otherwise investment and thus society would suffer. And he revived the old Reformation idea that usury is a necessary evil.

From ancient Greece and Rome , to the Dark and Middle Ages , to the Renaissance and Reformation , to the 19th and 20th centuries , moneylending has been morally condemned and legally restrained. Today , at the dawn of the 21st century , moneylending remains a pariah.

Moneylending cannot be defended by reference to its economic practicality alone. If moneylending is to be recognized as a fully legitimate practice and defended accordingly , then its defenders must discover and embrace a new code of ethics , one that upholds self — interest — and thus personal profit — as moral.

Although serious economists today uniformly recognize the economic benefits of charging interest or usury on loans , they rarely , if ever , attempt a philosophical or moral defense of this position . Today’s economists either reject philosophy completely or adopt the moral — practical split , accepting the notion that although usury is practical , it is either immoral or , at best , amoral .

Lenders charge interest because their money has alternative uses — uses they temporarily forego by lending the money to borrowers . When a lender lends money , he is thereby unable to use that money toward some benefit or profit for himself . Had he not lent it , he could have spent it on consumer goods that he would have enjoyed , or he could have invested it in alternative moneymaking ventures . And the longer the term of the loan , the longer the lender must postpone his alternative use of the money . Thus interest is charged because the lender views the loan as a better , more profitable use of his money over the period of the loan than any of his alternative uses of the same funds over the same time ; he estimates that , given the interest charged , the benefit to him is greater from making the loan than from any other use of his capital.

The practice of charging interest is therefore an expression of the human ability to project the future , to plan , to analyze , to calculate risk , and to act in the face of uncertainty.

Another economic principle that is essential to a proper defense of usury is recognition of the fact that moneylending is productive.

By choosing to whom he will lend money , the moneylender determines which projects he will help bring into existence and which individuals he will provide with opportunities to improve the quality of their lives and his .

And , of course , lent money is not “ barren ” ; it is fruitful : It enables borrowers to improve their lives or produce new goods or services. Nor is moneylending a zero — sum game : Both the borrower and the lender benefit from the exchange ( as ultimately does everyone involved in the economy ). The lender makes a profit , and the borrower gets to use capital — whether for consumption or investment purposes — that he otherwise would not be able to use.

PART 2: THE “INEQUALITY” ATTACK ON FINANCE

As Frank complains , “ overlooking luck’s role makes those who’ve succeeded at the highest levels feel much more entitled to keep the lion’s share of the income they’ve earned.” But if Americans become convinced that they are not the authors of their own success but the beneficiaries of luck , then they will be much less opposed to the various wealth redistribution and other “ social justice ” schemes critics of economic inequality favor. When people don’t believe they built that , it’s much easier to take that.

Was Gates the only person of his era who grew up in an upper middle — class American family? Was Gates the only person born in the mid — 1950s who attended a secondary school with access to computing? Was Gates the only person who went to a college with computer resources in the mid — 1970s? Was Gates the only person who read [ a seminal ] Popular Electronics article? Was Gates the only person who knew how to program in Basic? No , no , no , no and no.

Collins and Hansen observe that the question isn’t whether luck plays some role in success — but whether it plays a differentiating role. Life is filled with events and circumstances we can neither control nor predict. But to say that luck explains success ( or failure ) is to say that successful individuals ( and companies ) enjoy more good luck and less bad luck than the rest of us. But when Collins and Hansen tried to investigate the matter , that is not what they found. What distinguished the most successful companies “ wasn’t luck per se but what they did with the luck they got.” This led the authors to formulate the concept of “ return on luck.” The difference between Bill Gates and similarly advantaged people is not luck. Gates was lucky to be born at the right time , but many others had this luck. And yes , Gates was lucky to have the chance to learn programming by 1975, but many others had this same luck. Gates did more with his luck , taking a confluence of lucky circumstances and creating a huge return on his luck. And this is the important difference.

What they are drawing attention to is something the “ luck ” advocates minimize : the decisive role of human agency.

It is striking how seldom the luck advocates discuss the role of knowledge in success. For them , success is either about luck or “ talent and hard work .” They ignore that most of what successful individuals do to succeed is restlessly seek out knowledge.

What is true is that success is difficult. Namely , it is a long — range endeavor requiring dedicated effort.

It’s understandable that taxpayers think they should have some say in how bailed — out businesses are run , which is one reason why Washington should never have bailed out those companies in the first place. But why have the critics been so intent on dictating to shareholders of private companies how much they can pay their CEOs?

It’s not because the supposed victims , shareholders , have been demanding it.

They allege that , despite appearances , executives were not really being paid for performance. Pointing to CEOs who raked in huge bonuses while their companies tanked, the critics say that executive pay was driven not by supply and demand, but by an old boys ’ network that placed mutual back — scratching above shareholder welfare.

It was a compelling tale, but this account of rising pay just doesn’t square with the facts. To name a few : ( 1 ) the rise in CEO pay was in line with that of other elite positions , such as professional athletes ; ( 2 ) the rise in pay continued even as fewer CEOs chaired their board of directors ; ( 3 ) the companies that paid CEOs the most generally had stock returns much greater than other companies in their industries, while companies that paid their CEOs the least underperformed in their industries … what kind of compensation package will attract , retain , and motivate the best CEO is a complicated question.

Of course , a free market doesn’t eliminate mistakes. A company can hire an incompetent CEO or structure a pay package that rewards executives for short — term profits at the expense of the company’s long — term welfare. But a company suffers from its mistakes : shareholders earn less , managers need to be fired , and competitors gain market share.

If the critics ’ goal were really to promote pay for performance , they would advocate an end to all such regulations and let the free market work. But that’s not what they advocate. Instead , they call for more regulatory schemes , such as government — mandated “ say on pay , ” massive tax hikes on the rich , and even outright caps on executive compensation. They do not want pay to be determined by the market , reflect performance , or reward achievement — they just want it to be lower. Frank stated the point clearly when he threatened that if “ say on pay ” legislation doesn’t sufficiently reduce CEO compensation , “ then we will do something more.”

The critics want to bring down CEO pay , not because it is economically unjustifiable , but because they view it as morally unjustifiable.

In smearing America’s great wealth creators as villains and attributing their high pay to greed and corruption rather than productive achievement, the critics want us to overlook the virtues that make CEOs successful. In demanding lower executive pay , despite the wishes of shareholders , the critics aim to deprive CEOs of their just desserts. In denouncing CEO pay for the sole reason that it’s higher than the pay of those who haven’t achieved so much , the critics seek to punish CEOs because they are successful.

Ultimately, how to pay CEOs is a question that only shareholders have a right to decide. But in today’s antibusiness climate , it’s vital that we recognize the moral right of successful CEOs to huge rewards. They earn them.

…a totally meaningless ratio that has no purpose other than to shame highly paid CEOs .

…what a company pays its executives is nobody’s business but the shareholders. They’re the ones that foot the bill , and if they think a CEO is overpaid , they can either fight for lower compensation or sell their shares .

But I do think it’s important for the public to have some sense of why successful CEOs are paid so much. ( It’s precisely because they don’t have that sense that the attacks on CEO pay have been successful.) Comparing a CEO’s pay to his employees ’ pay doesn’t shed light on that issue. Comparing his pay to the value the company creates , does.

EPILOGUE: AN INTERVIEW WITH YARON BROOK

Americans do not understand the productive role of finance , and so they wonder , why are all these paper shufflers making millions or billions of dollars? Add that to the fact that finance takes the blame for legitimate problems caused by government intervention , and to the fact that government intervention has encouraged genuine evils on the part of some financiers , such as cronyism , and of course the opponents of capitalism are going to target finance.

In a free market, Madoff would’ve been caught quickly. The market first of all would have been suspicious of him. One of the reasons frauds can get away with this is because people are far less skeptical of crooks when they believe the government is looking after them.

First , you need to be explicit about the moral standards we should use .

Second , you have to make the broader case for business and the profit motive. You need to help people grasp that wealth creators are doing something noble : they are creating the wealth that has lifted us from the Stone Age to the digital age , with each individual profiting , according to the value that he creates.

Third , you have to explain the productive role of finance in terms that people can understand.

Whatever your role is in finance , that’s what you have to strive to do : to connect your function or your industry’s function to people’s existing values .

Finally , you need to be able to properly frame the real challenges that exist in your industry , above all , the way you need to be able to explain how government intervention causes genuine problems .