Sunday, May 13, 2018

UPDATED—Think You Know Sovereign Debt? "Lending To The Borrower From Hell: Debt and Default in The Age Of Philip II, 1556-1598" (and a tiny treasure)

Update: had a rotted link on "Riding the South Sea Bubble". Fixed
Original post-
With news of Argentina in 2018—and faint echoes of 1890 (more later today), here's a recollection from 2013:

The closing of Switzerland's oldest private bank got me thinking of England's oldest private bank, C. Hoare & Co which got me thinking of their experience in the 1720's: "Riding the South Sea Bubble"* which got me wondering what the authors of that paper were up to.
Here is Hans-Joachim Voth, ICREA/Universitat Pompeu Fabra:

Philip II of Spain accumulated debts of over 50% of GDP. He also failed to honor them four times. We ask what allowed the sovereign to borrow much while defaulting often. Earlier work emphasized either banker irrationality or the importance of sanctions, in line with Bulow and Rogoff (1989). Using a unique dataset on 438 lending contracts derived from the archives, we show that neither interpretation is supported by the evidence. What sustained lending was the ability of bankers to cut off Philip II’s access to smoothing services. Lenders contracted with the king in overlapping syndicates, effectively creating a network of bankers. We analyze the incentive structure that supported the cohesion of this bankers’ coalition, and examine how it survived across the biggest defaults in Philip’s reign. In particular, we argue that the effectiveness of lending moratoria was sustained through a ‘cheat-the-cheater’ mechanism, in the spirit of Kletzer and Wright (2000). Since the king needed to smooth his expenditure in the face of major revenue and spending shocks, the ability of bankers to cut him off from funding was sufficient to sustain cross-border lending.
So much for Dictum meum pactum. Here's the paper, 37 page PDF.

See also our 2011 post: "How Venice Rigged the First, and Worst, Global Financial Crash" which lets Edward III off the hook for ruining the Bardi and Peruzzi families.

*From deep in the link-vault comes a tiny treasure, an analysis of Hoare's trading during the South Sea bubble (62 page PDF):
Riding the South Sea Bubble
This paper presents a case study of a well-informed investor in the South Sea bubble. We argue that Hoare’s Bank, a fledgling West End London bank, knew that a bubble was in progress and nonetheless invested in the stock: it was profitable to “ride the bubble.” Using a unique dataset on daily trades, we show that this sophisticated investor was not constrained by such institutional factors as restrictions on short sales or agency problems....MORE