The following was excerpted from Third Eye Capital
Management Inc.'s 2011 Annual Investor Letter.
The roots of lending can be traced back to the roots of
civilization itself. Written loan contracts from Mesopotamia that
are more than 3,000 years old showed the development of a credit
system that included the concept of interest. Loans are very simple
contracts with remarkable properties. One person lends something to
another with the promise that it will be repaid in the future. The
borrower suddenly has wealth, while the lender takes current wealth
and places it in the contractual equivalent of a time machine in
order to transfer it to a future date when he might better use it.
For doing so, the lender is compensated with interest that makes
him better off than in the present.
But, as Dr. Niall Ferguson, Professor of International History
at Harvard University, points out, "civilization has long had an
ambiguous attitude toward lending and interest."
The Roman Catholic Church frowned upon the
taking of interest during the 13th through
18th centuries in Europe, when finance underwent its
greatest dynamism. Islamic Sha'riah still proscribes against
lending despite the fact that the mathematics of compound interest
originated in the Middle East. The uncomfortable coexistence of
finance and religion may be due to the parallels between the term
of a loan and the term of a life. The word "finance" comes from Old
French and shares a common root with the word "finish". It was used
in the 14th century, according to scholars, to imply a
final settlement, and referred to metaphorically in medieval poems
which described life itself as a loan from God, and death as its
final repayment. French theologians considered lenders as "sellers
of time" that acted contrary to natural law. For almost a
millennium, loans were considered unholy leaps into the fourth
dimension that were contrary to divine plan.
Many people today would blame lending for
causing the financial crisis and consider credit as the evil
plaguing Europe. Yet, throughout history loans have enabled
profound life-serving commerce and industry. They supported Spain's
exploration of the New World, made possible the successful
colonization of America, and fueled the Industrial Revolution. The
immense progress of human well-being would not have been possible
The lender's time machine is interest. A lender
tries to calculate in advance the likelihood or unlikelihood that
he will be repaid all his capital plus the interest. The less
convinced he is that a loan will be repaid, the higher the interest
rate he will charge. Higher rates enable lenders to profit for
their willingness to take greater risks. The practice of charging
interest is therefore an expression of a lender's ability to
project the future, to plan, to analyze, to calculate risk, and to
act in the face of uncertainty.
Lending is productive to society, and this fact
has been made increasingly clear over the centuries. By choosing to
whom he will lend money, a lender 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.
Thus, lenders make themselves money by rewarding people for the
virtues of innovation, productiveness, personal responsibility, and
entrepreneurial talent; and they withhold their sanction, thus
minimizing their losses, from people who exhibit signs of
stagnation, laziness, irresponsibility, and inefficiency. Loans are
fruitful and enable borrowers to improve their lives or produce new
goods or services. And contrary to some theological systems that
exist today, lending is not a zero-sum activity: 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.
We witness the direct impact that our lending
activities have on companies every day. Currently, our loans help
companies generate a quarter billion dollars in sales every year,
keep nearly 1,000 people employed, and foster growth and innovation
that would otherwise be lost. We cannot travel ahead in time, but
we are confident that our investments create a better future for
investors, our borrowers, and our society.
Third Eye Capital Management Inc.