The Mutuum Contract in Anglo-American Law

The mutuum contract, as noted in the previous post, is the basis of fractional reserve banking, and involves the loan of money to a bank as a mutuum, giving it ownership of the money, and the promise by the bank to return on demand money up the same amount. This is a demand deposit.

I will quote here some useful sources on the mutuum contract in the US and British law.

First, we can turn to the work of the American jurist John Bouvier (1787–1851) in his compendium of American law called The Institutes of American Law (4 vols, 1851) on the nature of mutuum in US law in the 19th century:

SECTION 2. OF GRATUITOUS LOAN FOR CONSUMPTION, OR mutuum.1089. Mutuum, or loan for consumption, is a contract by which the owner of a personal chattel, of the kind called fungibles,(c) delivers it to another by which it is agreed that the latter shall consume the chattel, and return at the time agreed upon, another chattel of the same kind, number, measure or weight, to the former, either gratuitously or for a consideration; as if Peter lends to Paul one bushel of wheat, to be used by the latter, so that it shall not be returned to Peter, but instead of which Paul will return to Peter another bushel of wheat of the same quality, at a time agreed upon.

By fungible, in this definition is meant any personal chattel whatever, which consists in quantity, and is regulated by number, weight and measure, such as corn, wheat, oil, wine and money, (a)

The person who delivers the article to be used is called the lender, the other is called the borrower.

1090. This contract differs essentially from a loan for use, or commodatum. In the latter the title to the property in the thing lent remains with the lender, and, if it be destroyed without the fault or negligence of the borrower, the loss will fall on the lender, the rule res perit domino, applying in such case. On the contrary, by the loan for consumption, or mutuum, the title to the thing lent passes to the borrower, and in case of loss, he must bear it. Mutuum bears a strong resemblance to barter or exchange; in a loan for consumption the borrower agrees to exchange with the lender a bushel of wheat, which he has not, but expects to obtain, for another bushel of wheat which the lender now has and is ready to part with.

§ 1.—Of the nature of the contract of loan for consumption.
Art. 1.—What constitutes the essence of this contract.
1091. There must be, 1, something lent which is consumed by use; 2, that it be delivered to the borrower; 3, that the property in the thing be transferred; 4, that the borrower agree to return as much in kind; and, 5, and lastly, the parties agree on all these things.

1092.—1. There cannot be a loan for consumption unless there be a thing loaned, which is to be consumed, and it must be lent for that purpose.

1093.—2. It is also of the essence of this contract that the lender deliver to the borrower the thing lent. But there are some exceptions to this rule; if Peter agrees to lend to Paul one thousand dollars, which money has been already delivered by Peter to Paul on a special deposit, the agreement will of itself change the property; while it was on deposit it was at the risk of the depositor, but the moment the contract is turned to a loan, the money is at the risk of the borrower, the title to it being then in him.

1094.—3. The title to the thing loaned must be transferred to the borrower; a transfer of the possession without an intention of transferring the property, would not oblige the borrower to return other property of the same kind. It is sometimes difficult to say when the transfer has been made so as to convey the title.(a)

1095.—4. The borrower who receives the things loaned must agree to return the same quantity, weight or number, of the same kind of goods. If Peter were to borrow of Paul one hundred bushels of corn, and agree at a future time to pay him in money, for the corn, one hundred dollars, the contract would not be a loan for consumption, but a sale; and if, instead of money, he agreed to return to him seventy-five bushels of wheat, the contract would be a barter or an exchange.

1096.—5. As in all other contracts, the parties to this must agree upon all the essential matters which belong to it.” (Bouvier 1851: 441–443).

This is clearly the legal framework under which fractional reserve banking was conducted in the US, and obviously English law influenced American law on this point.

Henry Dunning Macleod in his Theory and Practice of Banking (6th edn; 1902) also gives us a very good summary of the legal principles (writing as he was in the UK):

“When a man lends a book, or any other chattel, to his friend, he never parts or dispossesses himself of the property in it. He is entitled to have that very book, or the very chattel, back again. There is no exchange, and no new property created. And only one party can have the use of the book, or the chattel. But in all cases whatever of a loan of money, the lender absolutely cedes the property in the money to the borrower, and it becomes his absolute property. What the lender does acquire is the right, or property, to demand back an equivalent amount of money, but not the specific money. A loan of money, is therefore, always an exchange, and in all such cases, there must, by necessity, be a new property created; and this property may be sold and transferred like the money itself.

In the loan of a book, or a chattel, the right to it, or property, of the lender, is never severed from it; in a loan of money, the right, or property, of the lender in it is always severed from it, or rather, transferred to the borrower; and the new right, or property, created in the lender is termed a Debt, or Credit, and when the debt is paid, or, in common language, the loan returned, this new property is destroyed.

Hence we see that there are two distinct species of loan: the one where the lender has the right to have the very thing returned, the other where he has only the right to demand to have an equivalent amount returned. Now all commercial loans are of the latter species: they are all sales, or exchanges, and they are never of the former sort; and all the confusion on the subject has arisen from not observing this distinction.” (MacLeod 1902: 81).

Appendix

There are some other useful sources below. And it should be noted that European law was itself based on Roman law, where the mutuum was also understood as a loan where ownership of the money passed to the bank; this was the legal framework for money loans that were recallable on demand by the creditor in ancient Rome (Gamauf 2006).

(1) Alexander Pulling in the British journal The Bankers’ Magazine (1851):

“The English term loan has a variety of meanings. It is used to designate, 1st, the commodatum of the Roman law … a transaction by which an article of use, such as a book, a horse, &c, is gratuitously delivered by the owner to another for his mere use or accommodation, on the simple condition of the borrower returning it in the same state in which he received it. 2ndly. The mutuum, or gratuitous loan of those things which in the phraseology of the Scottish law are called fungibles, and can be used only by actual consumption or expenditure, such as corn, wine, money, or the like, the lender of which absolutely abandons the ownership on condition of the borrower substituting by way of return the specific value in number, weight, and measure. 3rdly. The foenus, or loan at interest, which in most countries has been the subject of artificial regulations.” (Pulling 1851: 202).

(2) In a case called Dawson et al vs. the Real Estate Bank that came before the Supreme Court of Arkansas in 1845 we have a test case clarifying the nature of money left at a bank:

“In order to ascertain what power the bank had over the funds of Dawson, and the duty enjoined upon her by law, it is necessary first to determine whether they were held as a special or general deposit. If the funds were held as a special or general deposit, the authorities all agree that the bank had no right to use or dispose of them; but was bound simply to keep them and restore to the depositor the identical funds deposited. If they were held either as a general or irregular deposit, the rule appears to be equally well established that, upon such deposit being made, the legal interest in the money or thing deposited, became immediately vested in the bank, and the relation of debtor and creditor was thereby created between the parties; that is, as between the bank and Dawson, the latter became the creditor and the former his debtor, to the amount or value of the deposit. And in such case, the bank having acquired the absolute property in the thing deposited, could lawfully dispose of them in any manner she pleased, her obligation being only to restore to the depositor the like sum or value in kind with interest, but not the identical thing deposited. Commercial Bank of Albany vs Hughes, 17 Wend. 94 Foster et al. Ex’s vs. The Essex Bank 17 Mass. R. 477. Story Com. on Bailment 60. lb. 66.

From a careful consideration of the authorities on this subject, we understand the general rule to be, that where money, not in a sealed packet, or closed box, bag or chest, is deposited with a bank or banking corporation, the law presumes it to be a general deposit, until the contrary appears; because such deposit is esteemed the most advantageous to the depositary, and most consistent with the general objects, usages, and course of business of such companies or corporations. But if the deposit be made of any thing sealed or locked up or otherwise covered or secured in a package, cask, box, bag or chest, or any thing of the like kind of or belonging to the depositor, the law regards it as a pure or special deposit, and the depositary as having the custody thereof only for safe keeping, and the accommodation of the depositor.” (Pike 1845: 296–297).

Although the language is unusual, it seems that the “special or general deposit” must be the depositum and that “general or irregular deposit” refers to a mutuum. The tradition of sealing money in a bag, chest or box to indicate that it was to be held in safekeeping as a depositum (not as a mutuum) goes right back to English banking practices that have been examined by Selgin (2010).

(3) In April 1843 a case called Downes vs. The Phoenix Bank of Charlestown came before the New York circuit court where the nature of mutuum is also an issue:

“The usual course of such business is, for the dealer to deposit his money with the bank, to be repaid upon his checks or drafts, or in taking up his notes or acceptances made payable at the bank. It is not strictly a deposit, nor a bailment of any kind; for the same thing is not to be returned, but another thing of the same kind and of equal value. In the civil law it is called a mutuum, or loan for consumption. Except where the deposit is special, the property in the money deposited passes to the bank, and the relation of debtor and creditor is created between the parties. (Commercial Bank v. Hughes, 17 Wend. 94.) Still, the commonly received opinion is, that the banker cannot be sued for the money until after the customer has drawn for it, or in some other way required its repayment. Mr. Justice Story says, the bank is to restore the money ‘whenever it is demanded.’ (Story On Bailm. 66, § 88; and see Marzetti v. Williams, 1 Barn. Ad. 415; Chit. On Bills, 547, ed. of1839; Chit. Jr. On Bills, 44.) Judging from the ordinary course of this business, I think the understanding between the parties is, that the money shall remain with the banker until the customer, by his check, or in some other way, calls for its repayment: and if such be the nature of the contract, the banker is not in default, and no action will lie, until payment has been demanded. No one could desire to receive money in deposit for an indefinite period, with a right in the depositor to sue the next moment, and without any prior intimation that he wished to recall the loan.” (Denio 1845: 299).

BIBLIOGRAPHY

Bouvier, John, 1851. Institutes of American Law, R.E. Peterson, Philadelphia.

Denio, H. 1845. Reports of Cases Argued and Determined in the Supreme Court and in the Court for the Correction of Errors of the State of New-York. Vol. VI., Gould, Banks and Co. New York.

Gamauf, R. 2006. “Mutuum,” in H. Cancik and H. Schneider (eds), Brill’s New Pauly: Encyclopaedia of the Ancient World (Vol. 9), Brill, Leiden. 382–383.

MacLeod, H. D. 1902. Theory and Practice of Banking (6th edn), Longmans, Green, Reader, & Dyer, London.

Pike, A. 1845. Reports of Cases Argued and Determined in the Supreme Court of Law and Equity of the State of Arkansas Volume V. B. J. Borden, Little Rock.

Pulling, Alexander. 1851. “The Law of Money Lending—No. I.,” The Bankers’ Magazine; Journal of the Money Market 11: 202-208

Selgin, G. “Those Dishonest Goldsmiths,” April 14, 2010
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1589709

If Fractional Reserve Banking is Fraudulent, Why isn’t the Insurance Industry Fraud?

That is the question never properly answered by opponents of fractional reserve banking (FRB), and a blatant logical contradiction in their anti-FRB position.

The Rothbardians might argue as follows: an institution taking money from its clients and contractually obliged to return to them exactly what they are rightly entitled to is fraudulent when such an institution could never honour all the clients’ claims at one time, if all or even a large number required some or all of the money they are entitled to. If so, they have destroyed the basis of the insurance industry, as has been pointed out by Gene Callahan here (“The ‘Immorality’ of Fractional Reserve Banking Revisited,” May 23, 2009).

The argument that FRB is fraudulent merely because there are certain possible circumstances when the bank cannot fulfil its promise to pay all its clients on demand is utterly unconvincing.

First, virtually all business investment and insurance industries could be regarded as inherently unstable, like FRB, because the future is uncertain. But the insurance industry – just like FRB – can be operated profitably over long periods and is stable. When some unforeseen event happens like a massive natural disaster, the insurance companies could be overwhelmed by claims and collapse, because they cannot pay. If all or a very large number of the policy-holders of an insurance company suddenly needed insurance payments over a brief period, the company might not be able to honour all its claims or find a credit line to allow it to do so. But that is not an even remotely serious argument against insurance, because all business activity involves risk and uncertainty, and both clients of a business and the business itself can never escape uncertainty and the possibility that the business’s contracts might not be honoured.

In the same way, FRB might be stable over long periods. But, when some unforeseen event happens (a collapse in export demand, rumours about some bank, a change in subjective business expectations), the FRB bank might be overwhelmed by a bank run and collapse, because it cannot pay. The issue is whether it can meet demand from its depositors out of reserves, sale of financial assets and loans from other banks, without a liquidity crisis. Many FR banks are perfectly capable of doing that in a crisis, while others are not. That some banks cannot honour all their claims under certain unusual circumstances is not a serious moral argument against FRB. If it were, then all insurance industries would be unacceptable on moral grounds as well.

The anti-FRB libertarians will no doubt then fall back on the argument that insurance is not fraudulent because when you pay premiums that money becomes the property of the insurance company, and is not money retained as your property, whereas in FRB you do retain ownership of your demand deposit money. But that shows the most contemptible ignorance of the nature of FRB.

If you put your money into a mere holding warehouse, then the owners or managers of the warehouse have no property rights with respect to your money stored there (such money is legally known as a depositum, which means “something given or entrusted to another for safe-keeping”). The identical deposit must be returned to the owner or, in legal terms, it must be returned in specie (“in its own form”).

But, when a modern fractional reserve bank takes money for a new deposit, this is actually a personal loan to the bank, which is why the bank can pay interest for it. The money in the deposit becomes the property of the bank. The money is a loan, or legally a mutuum, which means “a contract under which a thing is lent which is to be consumed and therefore is to be returned in kind” (the modern sense of the English word “deposit” is thus misleading when it refers to money in fractional reserve banking). The depositor who lends the money gets a credit (or IOU) from the bank and a promise to pay interest: “the very essence of banking is to receive money as a [m]utuum” (MacLeod 1902: 318). The money has been “sold” to the bank as a mutuum and is to be returned in genere (“in general form”), which means you do not necessarily get the same money back, but just an equivalent amount with interest. In demand deposits, you have lost your absolute property rights to the money when you lent it to the bank, and instead have entered into a contract with the bank to allow them to use it, even though they are obliged to return to you on demand money to the same amount in whole or in part from their other reserves, other unused deposits, sale of financial assets or lending from other banks (MacLeod 1902: 324). This can also be expressed in this way:

“General deposits are obligations of the bank to pay money. They may be payable on demand or at a stated time in the future. The great bulk of commercial bank deposits are payable on demand. They create between the bank and the customer the relation of debtor and creditor, the title to the deposit passing to the bank, while the depositor acquires a right to receive a stated sum of money” (Johnson 1911: 117).

It is certainly true that many members of the public may be ignorant of these facts above. Yet if you have failed to read your fractional reserve bank contract, whose fault is that? As a client, you ought to understand the contract that you sign. The solution to the problem of modern people not understanding the nature of fractional reserve banking is simply legislation to make banks explicitly explain to potential customers how FRB works. Specifying to clients that the property rights to the money had passed to the bank and in return an IOU or credit had been granted to the depositor, that the bank lends your money out, and that it will return not the same money but other money from its reserves will solve the moral problem of clients not understanding the nature of FRB. Under these circumstances, FRB is not fraud. It is a free contract.

The Rothbardians like to tout themselves as the most pure, heroic defenders of free markets. They are not. The anti-FRB Rothbardians are coercive, anti-freedom violators of private liberty and free contract in their opposition to FRB.


Appendix 1: Fractional Reserve Banking under Roman Law

I’ll quickly deal with the status of FRB in ancient Rome here, because when discussing the subject you frequently find anti-FRB libertarians invoking the work of Huerta de Soto (2006), and arguing that FRB was illegal or considered immoral at Rome.

In fact, Roman law appears to have allowed FRB under the mutuum contract, a real contract under which a fungible good like money was lent to a bank and ownership of the money passed to the bank. The bank was required to return an equivalent amount of money, after a certain time or on demand.

In Roman law, there were a number of types of real contract (contracts re), as follows:

(1) mutuum (loan for consumption);
(2) commodatum (loan for use);
(3) pignus (pledge), and
(4) depositum or depositum regulare (bailment for safe keeping).

In Roman law, there was also a type of contract called the depositum irregulare which, when involving money, allowed the transferral of ownership (dominium) of the money. Because money can be regarded as representing a certain value, what is deposited is a quantity of a thing (quantitas) and not an individual thing itself (corpus). The depositor thus receives back the same quantity (tantundem) of money, not the same money itself (Zimmermann 1990: 215–216).

In the time of the Roman jurists Ulpian/Gnaeus Domitius Annius Ulpianus (c. 170–223 AD) and Papinian/Aemilius Papinianus (142–212 AD), however, it appears that the depositum irregulare was merely considered to be a type of mutuum, and it may well be that the whole legal concept of depositum irregulare is a development of later legal theorists, unknown to jurists of the second or third century AD (Oudshoorn 2007: 135–136; cf. Adams 1962; for the specialist literature, see Seidl 1951; Geiger 1961; Litewski 1974; and Gordon 1982). Therefore the mutuum was the legal framework and concept under which fractional reserve banking was conducted in ancient Rome (Zimmermann 1990: 218). Whether the mutuum was a time deposit or a demand deposit depended on the type of contract between the two parties, and there is no reason to think that fractional reserve banking was held as either immoral or illegal (for how Roman law influenced Medieval law on banking, see Dotson 2004: 89–92).

The evidence for the existence of FRB in the Roman Republic and Roman Empire is overwhelming (Harris 2006: 11; Harris 2011: 236). There is not one shred of evidence that it was regarded as immoral or prosecuted as a crime.

But let us suppose, for the sake of argument, that in fact the Romans did regard FRB as immoral. Even if correct, that would be a red herring and an informal fallacy called the appeal to tradition/argumentum ad antiquitatem, irrelevant to the question whether in the modern world FRB is immoral and fraudulent. The Romans, for example, had sumptuary laws to prohibit the consumption of certain luxury goods, supposedly to stop the spread of immoral luxury and preventing the moral and physical health of Romans from degenerating. Is that a remotely convincing argument by itself for prohibiting consumption of certain luxury goods today? Not in the least.

BIBLIOGRAPHY

Adams, B. 1962. “Haben die Römer depositum irregulare und Darlehen unterschieden,” Studia et documenta historiae et iuris 28: 360–371.

Dotson, John E. 2004. “Banks and Banking,” in C. Kleinhenz (ed.), Medieval Italy: An Encyclopedia. Vol. 1, A to K, Routledge, London. 89–92.

Geiger K. 1961. Das depositum irregulare als Kreditgeschäft, Freiburg.

Gordon W. M. 1982. “Observations on depositum irregulare, III,” in Studi in onore di Arnaldo Biscardi (vol. 3), Ed. Cisalpino-La Goliardica, Milan. 363–372.

Harris, W. V. 2006. “A Revisionist View of Roman Money,” Journal of Roman Studies 96: 1–24.

Harris, W. V. 2011. Rome’s Imperial Economy. Twelve Essays, Oxford University Press, Oxford.

Huerta de Soto, J. 2006. Money, Bank Credit and Economic Cycles (trans. M. A. Stroup), Ludwig von Mises Institute, Auburn, Ala.

Johnson, J. F. 1911. Banking Principles, Alexander Hamilton Institute, New York.

Litewski W. 1974. “Le dépôt irrégulier,” Revue internationale des droits de l’Antiquité 21: 215–262.

MacLeod, H. D. 1902. Theory and Practice of Banking (6th edn), Longmans, Green, Reader, & Dyer, London.

Seidl, E. 1951. “Der Eigentumsübergang beim Darlehen und Depositum irregular,” in Festschrift für F. Schulz, Böhlau, Weimar. 373–379.

Selgin, G. 2000. “Should We Let Banks Create Money?” Independent Review 5.1: 93–100.

Selgin, G. A., and White L. H. 1996. “In Defense of Fiduciary Media – or, We are Not Devo(lutionists), We are Misesians!,” Review of Austrian Economics 9.2: 83–107.

Oudshoorn, J. G. 2007. The Relationship Between Roman and Local Law in the Babatha and Salome Komaise Archives: General Analysis and Three Case Studies on Law of Succession, Guardianship and Marriage, Brill, Leiden and Boston.

Zimmermann, R. 1990. The Law of Obligations: Roman Foundations of the Civilian Tradition, Juta & Co, Cape Town.