With two weeks to go before the sesquicentennial of the Battle of Gettysburg we'll probably have a few posts on the hostilities.
I've mentioned the 7% Cotton Loan of 1863, otherwise known as the Erlanger Loan, a couple times in connection with the Hoare's Bank archives, links below. It is one of the more important junk bonds in history.
From the New York Times' Opinionator blog, Jan 30, 2013:
It’s a story recognizable to anyone who dealt with toxic derivatives in the early 21st century: on Jan. 29, 1863, the Confederate Congress secretly authorized the Paris-based bankers at Erlanger et Cie. – which rivaled Rothschild for European royalty connections – to underwrite $15 million of Confederate bonds, denominated in British pounds or French francs.
But unlike ordinary bonds backed only by the faith and credit of the issuing country, at the option of the holder an Erlanger certificate could be converted into a receipt for a pre-specified quantity of cotton. Furthermore, the conversion rate was fixed at 12 cents a pound, regardless of the commodity’s market price, at the time about 48 cents. On top of that, the bonds paid a handsome 7 percent annual interest rate.
Put another way, a buyer of a £1,000 bond could convert it into 80 500-pound bales of cotton worth almost £4,000. If the price of cotton continued to rise, the underlying bond’s conversion-value would climb in lockstep. European investors flocked to the bonds, including the future British prime ministers William Gladstone and Lord Cecil.
But like any too-good-to-be-true investment, there was a catch: the cotton was located in the Confederacy. Upon conversion, Confederate authorities were obligated only to deliver the bales to a point within “ten miles of a navigable river or railhead,” where the new owner must arrange transport to the final destination.
This arrangement was an obvious boon to blockade runners, a fact that didn’t escape the men at Erlanger. It quickly founded the innocuously named European Trading Company, essentially a blockade-running line for its bondholders. For a fee, the company’s ships would pick up the cotton, slip past Union warships and deliver it to Cuba. Its chief vessel completed 73 round trips between Mobile and Havana before running aground in May 1865.Previously:
The service wasn’t cheap, though, and so while a few rich investors made use of it, the majority had to take another avenue: hoping the Confederacy would win the war. Consequently, the market price for the bonds fluctuated in response to the successes or failures of Confederate armies.
Initially, the conversion feature was so attractive that the $15 million offering was oversubscribed with orders for $80 million. But Erlanger’s terms were greedy: it was to earn a commission of 5 percent, in addition to being allowed to purchase the bonds at 77 percent of face value, while reselling the initial issue at 90 percent of face. In other words, nearly a fifth of each investor’s money would be siphoned off by the Erlanger syndicate as middlemen. Despite the immense demand for the bonds, Secretary of State Judah Benjamin accepted the deal only because, he figured, it would make European financiers financially invested in Confederate success.
Upon issuance, the bonds quickly rose from their 90 percent offering price to 95 percent in market trading, but then began to drop. Unfortunately for the Confederacy and its new financial allies, initial buyers were required to deposit only 15 percent of the purchase price, with the balance not due until the settlement date of April 24, 1863.
Meanwhile, Union diplomats in Europe scrambled for ways to discredit the loan. About a week before the settlement date, stories appeared in London newspapers describing how years earlier, Jefferson Davis had publicly defended Mississippi’s default on a bond issue mostly held by Europeans when he was a United States senator from that state.
Erlanger panicked and threatened to cancel the offering – while keeping its commission guarantee – unless the Confederacy agreed to stabilize the price by using some of the deposited funds to buy bonds on the open market. Ultimately about $6 million of the $15 million issue was used in this manner. As always with murky activities involving large sums of money, a full accounting is impossible, but Erlanger and the Confederacy are each estimated to have retained about $3 million of the issue.
While Erlanger is often credited with originating the “cotton bond,” it wasn’t the only one to develop the idea at the time, thereby forcing the company to compete for the business. But it had an advantage: Frédéric Emile d’Erlanger had fallen in love with Mathilde Slidell, a daughter of John Slidell, the Confederate envoy to the Court of Napoleon III. Mathilde was a stunning beauty who grew up on her father’s Louisiana plantation, where French was the lingua franca. (She and Baron d’Erlanger married in 1864.)
The Confederacy used its share of the bond proceeds to purchase munitions and to make deposits on oceangoing ironclads, ships that might have broken the blockade had they ever been delivered. After the war, Erlanger continued to prosper, financing American railroads and international telegraphic communications, among other ventures. In 1869 Mathilde sent the first telegraphic message from France to the United States over an Erlanger-financed facility. The family supported the arts and charitable causes, including the still-operational Erlanger hospital in Chattanooga, Tenn., and the first Paris performance of Richard Wagner’s “Tannhäuser.”
Shortly after the war, President Davis admitted that the Confederacy had misplayed King Cotton. It had encouraged an embargo, hoping to create a “cotton famine” and thus pressure British and French diplomatic recognition. But it should have adopted a March 1861 proposal made by Benjamin, the attorney general at the time: purchase as much cotton as possible and immediately send it to England, where the stockpile might be gradually sold as needed to raise funds. If the plan had been embraced Davis would promptly have become a richer president than Lincoln: more than three million bales rested unused in the Confederacy at the time of secession. If swiftly transported to England, Davis concluded, it could have been converted to enough hard currency to have “more than sufficed all the needs of the Confederacy during the War.”
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Sources: Frank Owsley, “King Cotton Diplomacy”; Tom Horton, “History’s Lost Moments”; Burton Hendrick, “Statesmen of the Lost Cause”; Gene Dattel, “Cotton and Race in the Making of America”; Jay Sexton, “Debtor Diplomacy”; Dean B. Mahin, “One War at a Time”; William C. Davis, “Look Away.”
The Amazing Archives of England's Oldest Private Bank: Junk Bonds from 1863
If Britain's Oldest Private Bank Could Survive the South Sea Bubble, You Can Get Through This: More of C. Hoare & Co's Amazing Archives
Here's one of the bonds that managed to get four coupons clipped, most are missing just one or two:
