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Usufructuary mortgages in rural South Asian economies: collateral valuation and internal rates
M. Abdullah ShibliI
Introduction
MONEYLENDING in the rural areas of South Asia takes various forms. One type of informal loan agreement commonly found in many areas is the usufructuary land mortgage, hereinafter abbreviated to ULM. Under this type of contract, the borrower transfers to the lender a parcel of his land, to be held by the latter as collateral until the exact monetary amount of the loan is repaid in full. In all cases, after the loan is made, the lender is in possession of the collateral with the authority to cultivate or lease out the land.
In this type of loan, the lender, the mortgagee, charges no explicit interest on the loan. However, because the mortgagee is free to utilize the land for his own cultivation, income from the land is, in effect, an implicit form of interest.(1) The repayment period for the principal is not specified when the loan is contracted--the landowner is free to reclaim his land as soon as he has the means to pay back the loan. In practice, the land is held for a few years. Field research shows that at least four to five years usually elapse before a loan is repaid, and the average repayment period is much longer than that (Bertocci, 1972; Rashid, 1983).
Under some arrangements, the title of the mortgaged land is also transferred to the lender with a verbal stipulation that when the loan is repaid, the land title would revert to the borrower. In such cases, the lender becomes the owner of the land in legal terms and acquires all usufruct rights, including the right to sell. However, social sanctions deter sale of collateral unless the borrower is in default.
While there is no stated term for the loan, default and foreclosure are relevant and meaningful concepts in the context of ULM. However, these concepts cannot be interpreted in purely legalistic terms. Foreclosure can occur for a variety of reasons. For example, if a borrower expresses his inability or unwillingness to repay the loan, he forfeits the collateral. On the other hand, a lender can foreclose if a borrower is deemed to be in default. A not too uncommon foreclosure scenario involves a majlish (gathering) or shalish (arbitration) of village elders. If the elders make a determination that the borrower has no chance of redemption owing to his worsening financial conditions, or other reasons, the land belongs to the lender, de jure as well as de facto. One interesting thing to note is that if, as in some cases, the borrower is given the title to the land when the loan is made, foreclosure proceedings take place only for social validation of the transfer of ownership.
The literature on rural credit has largely focused on the determinants of the high rate of interest on loans (Bhaduri, 1973; Long, 1968; Wai, 1958). Many have noted, in passing, that collaterals, including land, are often undervalued by the lender in loan contracts (Wai, 1958; Bottomley, 1963b; Bhaduri, 1977). Since providing an explanation for the high rate of interest has been the prime concern, the collaterals and their valuation have not always been integrated in the analyses.
In this paper, the informal credit market and usufructuary land mortgage is examined from two points of view: to seek the rationale for the undervaluation of collateral, and to explore the implications of the undervaluation for the determination of interest rates for secured loans. Contrary to the literature which sees undervaluation of collaterals, and thus the high interest rates, as attributable to risk and monopoly power (see Section II below), this paper provides a model that shows the proper relationship between undervaluation of collaterals and the high implicit rates of interest on ULMs. This relationship only can be understood by comparing the opportunity cost of funds and return from money-lending: The opportunity cost of funds tied up in loans is equal to the net income foregone, including capital gains, from comparable pieces of land, whereas return from moneylending is given by net income from the land collateral, after factoring in default. It is shown that, for any rate of default less than 100%, return from such moneylending is lower than the return from land purchase if the price of land appreciates faster than the general price level and land is collateralized at face value, i.e., there is no undervaluation of the collateral. It is argued that undervaluation of collateral may be a mechanism to compensate the lender for the opportunity cost of his funds.
The paper is organized as follows. In section II, the literature on rural credit is reviewed with an emphasis on issues discussed in the paper. This is followed in section III by a discussion on the opportunity cost of moneylenders' funds. In section IV, an alternative model on undervaluation of collaterals and internal rates of return is presented. Implications of the model using numerical values are discussed in section V. The final section contains a summary and the conclusions.
II
A Critical Review of the Literature
THE USUFRUCTUARY LAND MORTGAGE, in spite of its ubiquitous presence in the rural landscape of South Asian countries, has not received much attention.(2) The literature has, by and large, sought to explain the more egregious high interest rates. Most references have been parenthetical--the implicit assumption being that the processes and forces underlying ULM lead themselves to the same analytical framework as the general theory of rural credit market and usurious interest rates. (See, for example, Bottomley, 1963a, 1963b and Bhaduri, 1977). Since, interest rate determination for ULM has not been treated separately, their rate of interest is thought to be influenced by the same forces that determine interest rates for short-term (mostly unsecured) loans (Bottomley, 1963b; Long, 1968; Rashid, 1983).
Bottomley first drew attention to the lender's risk as an explanation for undervaluation of collaterals and high interest rates. This risk of default, he said, is present not only in unsecured loans but also in those that are secured by collaterals (Bottomley, 1963a, 1963b). According to Bottomley, risk in secured loans arises from: (a) estimated value of collateral in relation to the size of the loan; (b) marketability of collateral, and (c) movements in the market value of the collateral.
How plausible are these as explanations for undervaluation? For ULM where loans are, if anything, over-collateralized, factor a) can be discounted. Non-marketability of land, due to difficulties in establishing title to land in some developing countries, has often been cited as a risk-causing factor. Bhaduri has explicitly identified non-marketability of the assets as an important factor contributing to the undervaluation of collateral (Bhaduri, 1977). It appears that this argument is irrelevant in the majority of ULMs where the lender actually is given a valid and marketable legal title to the land.
Movements in the market value of collateral may also influence the element of risk. To quote Bottomley, ". . . the premium for risk charged on a secured loan will be inverse of the value of the collateral against which it is made" (Bottomley, 1963b, 646). To protect against any decline in the value of the collateral, a lender would be expected to charge a risk premium. However, in the context of South Asian rural economies with acute land scarcity, the relative price of land has been going up every year (see data in Table 1 in the following section). The impact of the increase in land price on ULM has not been brought out in the literature.
Bhaduri (1977) directly addresses the twin issues of interest rate determination and the undervaluation of collaterals. He offers his model that explains the high rate of interest as an alternative to that of Bottomley. The model's key assumptions are that the lender's objective is to appropriate the collateral at the least cost, and that he has monopoly power, which he exercises, both to undervalue the collateral and to impose a very high rate of interest. According to Bhaduri, undervaluation in conjunction with interest rate allows the lender to appropriate the collateral. As we shall see presently, undervaluation and interest rates are not two separate instruments, but two faces of the same coin. This result diminishes the strength of his "appropriation motive" thesis.
There are three stages in the lender's Machiavellian game plan, as enunciated by Bhaduri. First, the lender undervalues the collateral to attach a sizable part of the borrower's property which limits his (the borrower's) income and chances of repayment. Second, Bhaduri assumes (incorrectly as shall be pointed out) that the lender charges a high rate of interest forcing the borrower to fall behind in interest payments. Finally, Bhaduri argues inappropriately that the twin burden of undervaluation and usurious interest rates causes the borrower to default when the outstanding debt exceeds the "cost of defaulting in terms of the lender's valuation of the assets transferred" (352). To quote Bhaduri,
Such forced default is the very essence of the economic phenomenon of usury. . . . The rate of interest is then seen to operate as a convenient device in the hand of the rural money-lender for accumulating assets, through the transfer of undervalued collateral deliberately brought about by large-scale default.(352)
One key feature of Bhaduri's analysis is the failure to recognize the inappropriateness of his model for ULM. Although he appears to assume its validity for this type of loan contracts, he really appears only to be talking of secured loans which are not of the type we called ULM. In ULM, no interest payment, usurious or not, is required from the borrower. On the other hand, net output from the mortgaged land accrues to the lender in lieu of formal interest payments, and the implicit rate of interest is determined by the net productivity of the land that is held as a collateral.(3) The greater the extent of undervaluation, the larger the size of the land parcel held as collateral; and assuming that land is homogeneous, the higher the net income and implicit interest rate. Therefore, undervaluation affects the implicit rate of interest directly--the interest rate is not independent of the extent of undervaluation.
To show this formally, we assume that loans are fully collateralized. Let A = amount of loan, R = implicit rate of interest and y = net value of annual production per acre of land. Following Bhaduri, let the extent of undervaluation of assets be represented by u, and
!Mathematical Expression Omitted^
where p = the market price of land per unit, and, !Mathematical Expression Omitted^ = the price of the same land accepted by the lender as a collateral for advancing loans.(4)
Therefore, the value of the collateral per unit of loan is !Mathematical Expression Omitted^ and the implicit rate of interest, i.e.,
R = y (A/p) u / A = (y/p) u !1^
We notice that, as the extent of undervaluation, i.e., u, goes up, so does R.
A numerical example will illustrate this point. In the first case let us assume no undervaluation of land, i.e., u = 1. For a loan of Tk. 10,000, the land offered as collateral would have a market value of Tk. 10,000.(5) If the net product of this land is Tk. 1,000, then the rate of return is 10%. If, on the other hand, the value of land is discounted 50% (or !Mathematical Expression Omitted^ = 2), then the value of the collateral needed to support a loan of Tk. 10,000 is Tk. 20,000. If we assume constant returns to scale, net productivity of this collateral is Tk. 2,000 and the implicit rate of interest is twice as high, since R = 2,000/10,000 = .2 or 20%. Therefore, rate of interest and degree of undervaluation are not two independent instruments in case of ULM--the value of one varies proportionately and directly with the other.(6)
Bhaduri's conclusion that the rate of default goes up with the extent of undervaluation is also doubtful in the case of ULMs. His argument rests on the belief that it pays the borrower to default when the amount owed (1 + r*) exceeds the value of transferred collateral (z), per unit of loan, i.e., when 1 + r* !is greater than^ z.(7) However, the mechanism for attaining the critical level of principal and interest rests on the ability of the lender to affect the rate of interest (or the value of the collateral). What, however, seems to be missed here is that the more the undervaluation, the less likely it is that the condition for default, i.e., 1 + r* !is greater than^ z, will ever be reached.(8)
Finally, it must be noted that, since in usufructuary mortgage the borrower does not make any out-of-pocket payments to the lender, there is no question of arrearage, a necessary condition for default. In addition, the nominal value of the amount to be amortized remains constant. Therefore, the borrower's incentive to repay and repossess his land should be undiminished.(9) This, along with the low ratio of loan to the value of the collateral, ought to make repayment easier. Therefore, the key mechanism for appropriation in Bhaduri's model, viz., accumulation of principal and interest to the point where it exceeds the value of the land, is simply not there.
III
The Opportunity Cost of Funds
AN ANALYSIS of the opportunity cost of loanable funds must incorporate returns from alternative investment outlets. Writers on rural credit usually identify the rates of interest in the organized money markets as the appropriate opportunity costs of loanable funds (Bottomley, 1964b; Bhaduri, 1977).(10)
However, in a peasant society, land is the principal source of livelihood, and all studies on rural investment opportunities have found that purchase of land is considered to be a sound investment. One study shows that land purchase, rather than government securities, is the preferred choice among rural investors in South Asian countries (Rahman, 1978). In many rural areas, lenders are often well-to-do farmers who also engage in moneylending on the side.(11) It is, therefore, not too far-fetched to argue that rural investors view land purchasing and money-lending as interchangeable means of acquiring land.(12) Therefore, returns from land purchase and land mortgage should be comparable--the opportunity cost of lenders' funds should be about equal to returns from land purchase.
Return from an acre of land used for agricultural production has two components: the returns from farming and capital gains. An important reason for buying land in rural areas is the capital gain that accrues to the landowner. Undeniably, the price of land, like the price of any other commodity, may go up or down. However, land price, whether in urban or in rural areas, has been going up significantly for the last two decades in all LDCs. From an investor's point of view, while there may be some uncertainty about the actual rate of capital appreciation, the average rate in all the countries of South Asia has been in excess of 10%. In Bangladesh, the price of land doubled every four years between 1969 and 1982, and the rate of appreciation has been well in excess of the general rate of inflation (see Table 1).
Table 1
SUMMARY OF ANNUAL RURAL LAND PRICE INDICES IN BANGLADESH
1975-82
Year Index of Land Change in Land Rate of General
Price Price (%) Inflation (%)
(1969 - 70 = 100)
1975-76 432 --
1976-77 577 34 -3.38
1977-78 690 20 30.5
1978-79 832 21 12.9
1979-80 959 15 13.12
1980-81 1132 18 10.3
1981-82 1245 10 12.78
Source: Statistical Yearbook of Bangladesh, 1987. (BBS)
International Financial Statistics, 1988. (IMF)
IV
Internal Rates of Return on Moneylending
WE BEGIN by calculating the internal rate of return for ULMs and proceed to compare the returns from land purchase and moneylending under some simplifying assumptions. We assume that a farmer-cum-moneylender has a certain amount of money, denoted by A, which he can use either for land purchase or for moneylending, and that the land purchased and the land mortgaged are of equal productivity. The net returns per acre from farming is y, and m denotes the annual rate of increase in the real value of land (which is given by the annual rate of increase in the price of land minus the rate of general inflation). Other variables are: q, the rate of default, and u, the indicator of undervaluation of collaterals. The farmer is assumed to be risk-neutral and compares only the monetary return from these investments. We disregard any administrative cost.(13)
For an investment of A, land purchased is equal to A/p acres. Net income from A/p acres is (A/p) y. Annual capital gains is given by A m. Therefore, annual rate of return on investment, denoted by K, is given by the following equation:
Annual Return from Land Purchase:
K = (A/p) y + A m / A = y/p + m !2^
To calculate the rate of return from moneylending we look at three alternative scenarios. In all three, the rate of capital appreciation for land (m) is non-negative, but we start with no default and no undervaluation. We relax these assumptions in subsequent cases.
Case 1. m !is greater than^ 0, q = 0, u = 1
What is the impact of an increase in the price of land? The conventional approach is to view the increase as a risk-reducing influence. After all, if the nominal amount of debt is fixed, and the value of the collateral goes up, the risk of loss in case of default is lessened.
However, increase in price of land affects the lender in another way. The opportunity cost of the moneylender's funds is equal to the rate of return from land purchase. Since, the latter is given by y/p + m (from eq. !2^), an increase in m increases the opportunity cost of loanable funds. If the default rate is zero, as assumed here, the mortgagee does not benefit from the increased value of a collateral. Therefore, return from moneylending is less than that from land-purchase by the amount of appreciation in the price of land.
This case highlights the dual role of land in a ULM, and shows how an increase in the price of land affects the lender from two totally different avenues: lowering of risk in case of default and increasing the opportunity cost of funds. However, since the loan is fully collateralized and we are assuming that the probability of default is nil, the impact due to lower risk is marginal.(14) Therefore, it is the increase in opportunity cost which is the more dominant effect of an increase in the price of land. We can conclude that moneylending is an inferior choice to land purchase.
Case 2. m !is greater than^ 0, q !is greater than^ 0, u = 1
A high rate of default normally increases the lender's cost, and thereby contributes to the high rate of interest that prevails in rural credit markets. In an usufructuary mortgage, however, since the lender has legal possession of the mortgaged land, he bears no risk on this account.(15) Thus, if we focus on loans secured by land, ironically, it is advantageous for the lender if loans are defaulted (unless, of course, the value of the collateral is less than the loan). If all loans are defaulted, i.e., the rate of default is 100%, the two forms of land acquisition, viz., purchase and mortgage, become equally profitable, assuming that the mortgagee does not have to incur any additional cost to retain the land. Given our assumption that u = 1, for anything less than 100% default rate, land purchase is more profitable.
Let me illustrate the point made above and show how the percentage of loans that are defaulted affects the relative profitability of usufructuary mortgage vis-a-vis outright purchase. Let q be the proportion of loans defaulted where 0 !is less than or equal to^ q !is less than or equal to^ 1.(16) Assuming no undervaluation of collateral, the size of land purchased or acquired as a security is A/p. However, since we are now taking into account default and subsequent foreclosure, we need to recognize that there is a difference between apparent (R) and realized rate of interest (!Mathematical Expression Omitted^).(17) R is still given by (y/p) u (see eq. !1^ in section II). !Mathematical Expression Omitted^ is given below.
Expected Annual Return from Moneylending (realized)
!Mathematical Expression Omitted^
The first term in !3^, viz., y/p represents the income from cultivating the land collateral. The second term, on the other hand, is the value of the transferred collateral weighted by the probability of default. As an example, let us take A = 10,000, p = 1,000, y = 100 and m = .2. Substituting these numbers into eqs. !2^ and !3^, we get
Annual Return from Land Purchase
y/p + m = 100/1000 + .2 = .1 + .2 = .3
Expected Annual Return from Moneylending (realized)
y/p + (q) m = .1 + (q)(.2)
If q = 1, i.e., all loans are defaulted, then returns from land purchase and moneylending are equal. On the other hand, for any 0 !is less than or equal to^ q !is less than^, and m !is greater than^ 0, mortgaging is less profitable than land purchase.
Case 3. m !is greater than^ 0, 0 !is less than or equal to^ q !is less than or equal to^ 1, u !is greater than or equal to^ 1
In this most general case, we consider the effect of undervaluation of collaterals. As discussed before, the higher the value of u, i.e., the greater the extent of undervaluation, the more the land a person can bring under his jurisdiction through moneylending for a given amount of loan. Using the magnitudes discussed before, viz., A (for amount of investment), p (for market price of land per unit), and !Mathematical Expression Omitted^ (for price of land as collateral), the size of land taken as collateral is !Mathematical Expression Omitted^. As u goes up, for a given p, !Mathematical Expression Omitted^ goes down and, hence, !Mathematical Expression Omitted^ goes up.
If we use !Mathematical Expression Omitted^, instead of A/p, to calculate expected returns from moneylending, we get a modified version of !3^,
Expected returns from moneylending:
!Mathematical Expression Omitted^
The first and second terms in !4^ represent the income from cultivation and appropriation of the collateral, respectively. Using the numbers from our hypothetical example we find,
!Mathematical Expression Omitted^
Realized return from mortgage will now depend on two variables u and q. Again using the numbers from the example given above, we can see in Table 2 how different combinations of u and q determine returns from mortgage. One especially notices that for a given level of undervaluation (u), as the default rate goes up so does the rate of return. On the other hand, for a given rate of default, the rate of return goes up with u, as expected.
V
Some Implications
AS MENTIONED BEFORE, the opportunity cost of moneylenders' funds is given by the rate of return from land purchase. Therefore, in equilibrium, K in equation TABULAR DATA OMITTED !2^ should be equal to !Mathematical Expression Omitted^ in equation !4^. To see the implication of this condition, consider equation !5^ and assume that the opportunity cost of funds is 30%, i.e., !Mathematical Expression Omitted^.
Combinations of u and q that will make {.1 + (q)(.2)} u = .3 can be looked up from Table 2. Two such combinations of u and q are (2.5, .10) and (1.5, .50). We can also plot these combinations of q and u for !Mathematical Expression Omitted^ = .3 on a graph. The resulting line has a negative slope, as in Figure 1. This line, which shows combinations of q and u that make moneylending as profitable as land purchase, will shift if any of the parameters change. We can draw a family of such "isoquants" for different values of !Mathematical Expression Omitted^. Other maps can be drawn by varying the value of the parameters of the equation !4^, viz., p, m and y.
To further draw out the implications of equation !5^, solve it for u taking specific values of !Mathematical Expression Omitted^ and q, the default rate. In equation !5^ if we substitute !Mathematical Expression Omitted^ = .3 and q = 0 and solve for u, we get u = 3. Or, in other words, if the default rate is zero, then the value of u that equates the return from moneylending and land purchase is 3. Therefore, even if the moneylender undervalues the collateral by two-thirds, the realized rate of interest is 30%--which is just equal to the opportunity cost of funds. The observed implicit rate of interest is 90%, three times as much, since R = (y/p) u as derived in equation !1^.
To summarize our discussions, the following conclusions can be drawn. First, in the presence of a secular increase in the real value of land, with zero defaults, returns from moneylending are less than those from land purchase. Only when the rate of default is 100% are the returns the same. Since a situation where q = 1 is unrealistic, cases 1 and 2 are ruled out, by the principle of reductio ad absurdum. This also implies that case 3 is the only logical possibility. In equilibrium, returns from land (K) and moneylending !Mathematical Expression Omitted^ are equal. By comparing equations !2^ and !4^, which show returns from land purchase and moneylending, respectively, it is evident that if m !is greater than^ 0 and q !is less than^ 1, the equality of K and !Mathematical Expression Omitted^ can hold only when u !is greater than^ 1.
Second, as the rate of default goes down, so does the realized rate of return from moneylending. However, a lower rate of default and a higher rate of undervaluation offset each other in the determination of the realized rate of return. Undervaluation of collateral increase the apparent rate of interest, but its impact on the realized rate depends on the rate of default: A higher rate of default increases the realized rate of return. Even if the coefficient of undervaluation, viz., u, is very high, the realized rate of return may only be equal to the opportunity cost of the moneylender's funds owing to a low rate of default.
One might even say that the extent of undervaluation is more a reflection of the anticipated rate of default (which is beyond the lender's control) than of his ability to extract a high level of monopoly profit. This hypothesis is contrary to what Bhaduri and others have proposed as an explanation for the undervaluation phenomenon. For example, Bhaduri writes, ". . . the general unmarketability of such collateral in the organized market for assets also gives the private money lender the economic power to place a low valuation on the collateral offered by poor peasants." (Bhaduri, 1972). Thus, Bhaduri attributes the undervaluation to lender's monopoly power and to the unmarketability of the collateral.
The point made in this paper is that there may be another explanation for undervaluation. Land is undervalued not because it is unmarketable, in fact it is a very marketable asset which accounts for its rapid appreciation. Neither is monopoly power of the lender the only logical explanation for undervaluation. We saw that land could be undervalued because of the high opportunity cost of loanable funds and could be viewed as the market's way of compensating the lenders for the low (i.e., less than 100%) rate of default and a high rate of appreciation of land value.
VI
Summary and Conclusions
A DIFFERENT PERSPECTIVE has been given for the role of default rate in interest determination. A high rate of default, viewed from this angle, leads to a higher rate of return, and vice versa. This statement contradicts one school of thought on rural credit. If the collateral is land which is transferred to the lender, a high rate of default does indeed benefit the lender.(18)
We also notice that undervaluation of land provides a means of augmenting the rate of return from lending. However, this undervaluation, as Bhaduri argues, may not necessarily be an instrument to induce a high default rate. Rather it may be a mechanism to give the lender some leverage against the low rate of default which brings down the rate of return.(19) Undervaluation takes place not because of a high default rate, as is often argued in the literature, but because of a low rate of default. Undervaluation also does not promote a high rate of default.
Finally, the implicit rate of interest is positively related to the movements in the price of land. From the policy maker's point of view, this means that if interest rates have to come down, or investible resources have to move out of unproductive investments such as the purchase of land, then the rate of inflation in land prices has to be slowed. Experience in other developing countries suggests that relieving pressure on the land is one way to slow down inflation in land prices and speculative activities centered on land. This is often accompanied by creation of employment and investment opportunities in the non-farm sector.
Notes
1. One possible explanation for collecting interest indirectly is that in Muslim societies charging interest for loans is looked down upon, partly because of religious sanctions against it.
2. South Asian countries where usufructuary land-mortgages can be found are India, Bangladesh and Pakistan.
3. See also Bertocci (1972) and Rashid (1983) for similar views.
4. The definition of the undervaluation, !Mathematical Expression Omitted^, used here is found in Bhaduri (1977). In the interest of comparability with his analysis, this definition has been used in this paper without any modification. However, as one reviewer points out, this definition of undervaluation abstracts from time, and highlights the static nature of the analysis.
5. Taka is the currency unit in Bangladesh and it is abbreviated to Tk. Henceforth, I shall use the Taka to denominate all values.
6. There are other types of assets/services that also serve as collaterals for loans in the informal market: labor services, standing crops, livestock, poultry, trees, jewelry, etc. Bhaduri's analysis might be valid for some of these collaterals. However, the acceptability of these collaterals may be limited. For example, labor services may not be acceptable as a collateral to a moneylender-cum-cultivator who does not hire casual labor. In addition, for an average farmer in need of cash, it would be difficult to borrow a large sum of money on the promise of future labor services or through crop hypothecation.
7. In Bhaduri's paper, r* refers to the optimal rate of interest.
8. The logic for the last statement is as follows. First of all, as the extent of undervaluation goes up, the amount borrowed against a given collateral goes down, or putting it differently, the ratio of loan to collateral is a decreasing function of u. Now, it is reasonable to assume that the greater the market value of a collateral compared to the amount owed, the greater is the borrower's incentive to repay and repossess the collateral. Therefore, the rate of default (q) becomes an inverse function of u, i.e., dq/du !is less than^ 0. Since dR/du !is greater than^ 0, this implies that dq/dR !is less than^ 0, contradicting Bhaduri's conclusion that dq/dR !is greater than^ 0.
9. It is possible that the borrower's economic position may deteriorate as a consequence of the loss of productive assets to the moneylender. See Rashid (1983, 189), for a brief discussion on the impact of usufructuary mortgage on the borrower's ability to repay. This possibility is not addressed in this paper.
10. See Bottomley (1964b, 303), "The opportunity cost of lending where the moneylender has spare cash will be related to the rate of return on fixed interest securities."
11. A recent field study shows that, "a major part of the credit is now provided by the wealthy people to whom money-lending is a subsidiary occupation." (Rashid, 1983, 137).
12. See also Rashid (1983) who states that, "High relative preference for land collateral has led to substitution of outright purchase by mortgage as a process of land acquisition." (193).
13. Administrative cost component in ULMs is negligible. Two factors that usually contribute to high administrative costs are: small size of loans and the relatively short term (or seasonality) of most loans. Both of these cost-increasing factors are weak, if not non-existent, for ULM. Findings from a recent field survey support this hypothesis (Rashid, 1983, 213). (See Bottomley, 1963a, for a discussion of administrative costs.)
14. In a more realistic situation, the probability of default is greater than zero but very low (see also the following note). In that case, an increase in the price of collaterals lowers q for the following reason. Inflation decreases the ratio of loan to collateral; since default rate varies directly with the latter, we can conclude that dq/(dp/dt) !is less than^ 0. (See, also the discussions in section II.)
15. In fact, it is the borrower who often bears a different type of risk. During recent field surveys, it was brought to the attention of this researcher that, in a few cases the mortgagee may decline to accept repayment. Further inquiry showed that this may happen if the land has been in the possession of the mortgagee for a long time and if he can count on the support of village elders who would inevitably be asked to adjudicate in this type of situation.
16. In the present study, it is assumed that q, y and m are known with certainty. Since the objective of this exercise is to illustrate the basic ideas, I shall not get into cases where these parameters are stochastic.
17. We assume there is no cost of foreclosure. As discussed in the introduction, default and foreclosure occur when the borrower is unable or unwilling to repay the loan and redeem the collateral. Given the complex nature of the formal and informal arrangements that accompany ULMs, the terms default and foreclosure have connotations somewhat different from that in the west.
18. Bertocci acknowledges this in his comment, "once land is mortgaged as loan collateral, the possibility of foreclosure allows the lender to anticipate the eventual full possession of the land. . ." (Bertocci, 1972).
19. U Tun Wai writes "Rates of default have been exceptionally low . . ." for loans secured by collaterals (112). A recent field survey in Bangladesh shows that defaulting is frowned upon and borrowers are intent upon repossessing their land (Rashid, 1983).
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International Monetary Fund, International Financial Statistics, 1988. Washington, D.C.: IMF, 1988.
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Rahman, Atiqur, Agrarian Structure and Capital Formation. Unpublished Ph.D. dissertation. Cambridge University, 1979.
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The Solution to the Problem of the Solution
LEGEND HAS IT that the Indian inventor of chess, Sessa, on being asked by the King what reward he would accept for this, replied he wanted only one grain of wheat for the first square of his 8 X 8 board, and to have this amount doubled for each subsequent square.
The King readily agreed and asked his vizier to tell him how much this came to. The calculation took many days until the answer, 18,446,744,073,709,551,615, was derived. The answer far exceeded the amount of grain available. How was the King to make good his promise?
The solution of this problem was to invite Sessa to come to the granary and count out his own reward.
Secretary Bentsen and Land Values
CLINTON'S ELECTION SPEECHES suggested a significant change in approach from Bush. Ordinary folk were to be retrained for new jobs, and to be provided with better health and education. There was to be an increase in infrastructural investment, and more democratic consultation. The rhetoric was good, but the realities are now upon us. And it appears that his administration does not have the capacity to engineer a change in the structure of the economy of the kind that leads to full employment. Why? A prime reason is the president-elect's choice of Treasury Secretary: Lloyd Bentsen.
Bentsen is precisely what the US economy does not need. The wrecking tactics of the Reagan/Bush strategy--which favoured the rent-seekers against the wealth-creators--will be continued under Bentsen.
But Bentsen may be even more successful in these wrecking tactics than his Republican predecessors. Why? Because the election of a Democrat as president means a break in the congressional gridlock which bedevilled the Bush administration. George Bush spent years besieging Congress to cut the capital gains tax, on the grounds that this would encourage capital formation. He failed, for the wrong reasons. For had he succeeded, land values would have boomed even further]
A Democrat in the White House now means that Clinton's men will get what they want from Congress. And Lloyd Bentsen favours tax breaks for real estate and the oil and gas sectors--the policies which, under Ronald Reagan in the early 1980s, sowed the seeds for the S&L frauds and the bankruptcies in the banking sector.
Bentsen wants to raise the rental value of land and natural resources at a time when, for the sake of sustainable growth, rents ought to be reduced or stabilised at current levels.
If Bentsen succeeds in his aspiration (his daddy made his fortune by moving to Texas and becoming one of the largest landowners) he will generate a mini-boom in the land market of the kind that was fostered under President Kennedy's attempt to change the tax system and encourage growth ( . . . ). That boom in land prices led to the predictable bust. So if Clinton (who played the Kennedy card hard in the election) copies this aspect of his hero's economic strategy, the US economy would be on-course for a downturn just before the '96 election.
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