"The Cotton Bond Bubble" or How the Confederacy Might Have Won the Civil War

As a companion piece to July 1st "Hey, Hey, Ho, Ho, Marx and Engels Got To Go!" a repost from June 17, 2013:

I know, I know, from Virginia into the Old South the conflict is sometimes known as The War of Northern Aggression.
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.

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.”
Follow Disunion at twitter.com/NYTcivilwar or join us on Facebook.

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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.”

Previously:
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:

 

Hoare's Bank have taken most of their archives off the internet so disregard the links with strikethroughs in the post below:
March 19, 2013
The Amazing Archives of England's Oldest Private Bank: Junk Bonds from 1863

Pardon me, I meant 'High-yield'.

I've mentioned the archives of C. Hoare & Co. a half dozen times, from the scholarly work of Temin & Voth to the bite-sized ephemera of their archivist's "Manuscript of the Month".
In August 2011 I pointed to one in particular:

Posted October 2010 Coupon Bond, 7% Cotton Loan, 1863
That last little story is almost a parable, it has so many instructive principles and lessons.
We'll link to more next week.
Thanks to C. Hoare & Co. for sharing

Since then the bank has published a compendium, "Through the Years: Tales from the Hoare's Bank Archive" (50 page PDF) that brings together 40 of these tiny treasures.
Despite the attraction of the rest of the manuscripts, I keep going back to that 1863 Cotton Loan:

Although now officially designated Meeting Room 9, the bank’s newest meeting room is still universally referred to as the Coupon Room. The framed examples of stock certificates and coupon (bearer) bonds that hang on its walls serve as reminders of a not so distant past, when the bank routinely administered shares and bonds on behalf of customers, clipping the interest coupons and remitting them for payment. Many more bonds, some beautifully illustrated, form part of the bank’s archive. One of the mostinteresting relates to the 7% Cotton Loan of 1863, otherwise known as the Erlanger Loan.

In 1863 the United States of America was in the grip of civil war. Two years earlier, eleven Southern States had seceded from the Union and formed what became known as the Confederate States of America. But the Confederacy’s economy, based on agriculture rather than industry, was ill- equipped to sustain a war that required large numbers of weapons, ships and other goods
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Early hopes that Britain and France would join the fight against the Unionists were soon dashed, while a blockade of Southern ports prevented much needed supplies being able to enter the region.

Huge quantities of a new Confederate currency were printed, but this merely led to inflation, which in turn ate into the Confederacy’s dwindling revenue
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By the end of 1862 it was clear that a new approach was required if the South was to generate enough money to continue the war.

The most obvious solution was a European loan based on the South’s most valuable commodity: cotton. But the political and military uncertainty that surrounded the

Civil War made European banks wary of committing themselves Both Rothchild’s and Barings’ refused to underwrite such a loan.

Eventually, in early 1863, the Confederacy managed to negotiate a contract with a Paris bank, Emile Erlanger & Co . Under the terms of the agreement, Erlanger & Co undertook to issue £3M or $15M (c. £129M today) of Confederate bonds, redeemable over twenty years.

The bonds would be made available to Erlanger and Co at $77 per $100, and sold on by them for $90, with the bank pocketing the difference as well as a 5% commission on each sale and 1% on each interest payment
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Investors were to receive 7% interest, payable in twice-yearly instalments, and two annual payments representing 1/40th of the principal sum
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Alternatively, the bonds could be redeemed for cotton at a rate of 6d per pound
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As cotton was then trading at four times that figure, the bonds offered speculators an attractive return, if they could figure out a way to beat the blockade

During the spring of 1863, Confederate agents worked hard to publicise the bonds. Offices were opened in Paris, Amsterdam, Frankfurt, London and Liverpool, although ultimately it was British investors who were most attracted to the scheme.

The bonds themselves were issued in four denominations: £100 (Fr 2,500 or 4,000lbs cotton), £200 (Fr 5,000 or 8,000lbs cotton), £500 (Fr 12,500 or 20,000lbs cotton) and £1,000 (Fr 25,000 or 40,000lbs cotton).

The one shown here, illustrated with an image of Liberty clutching a Confederacy flag and leaning against bales of cotton, was fort he maximum £1,000.

Presumably it was purchased by a bank customer, although as coupon bonds are unregistered instruments the owner’s name does not appear on the certificate.

The signatures of four men do though: Emile Erlanger (loan banker), J Henry Schröder (London banker), Colin J McRae (Confederate agent) and John Slidell (Confederate commissioner)....

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