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Lending to the Borrower from Hell

Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II

Mauricio Drelichman
Hans-Joachim Voth
Copyright Date: 2014
Pages: 344
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  • Book Info
    Lending to the Borrower from Hell
    Book Description:

    Why do lenders time and again loan money to sovereign borrowers who promptly go bankrupt? When can this type of lending work? As the United States and many European nations struggle with mountains of debt, historical precedents can offer valuable insights.Lending to the Borrower from Helllooks at one famous case--the debts and defaults of Philip II of Spain. Ruling over one of the largest and most powerful empires in history, King Philip defaulted four times. Yet he never lost access to capital markets and could borrow again within a year or two of each default. Exploring the shrewd reasoning of the lenders who continued to offer money, Mauricio Drelichman and Hans-Joachim Voth analyze the lessons from this important historical example.

    Using detailed new evidence collected from sixteenth-century archives, Drelichman and Voth examine the incentives and returns of lenders. They provide powerful evidence that in the right situations, lenders not only survive despite defaults--they thrive. Drelichman and Voth also demonstrate that debt markets cope well, despite massive fluctuations in expenditure and revenue, when lending functions like insurance. The authors unearth unique sixteenth-century loan contracts that offered highly effective risk sharing between the king and his lenders, with payment obligations reduced in bad times.

    A fascinating story of finance and empire,Lending to the Borrower from Helloffers an intelligent model for keeping economies safe in times of sovereign debt crises and defaults.

    eISBN: 978-1-4008-4843-0
    Subjects: Economics, History

Table of Contents

  1. Front Matter
    (pp. i-vi)
  2. Table of Contents
    (pp. vii-viii)
  3. Acknowledgments
    (pp. ix-xvi)
  4. Prologue
    (pp. 1-8)

    Can government borrowing be made safe? As we are finishing this book, the world is grappling with the aftermath of the financial crisis of 2008. What began as a problem in the securitized market for US mortgages became a major crisis first of banks and then governments. All over the developed world, debt levels have spiraled upward in recent years. In Europe, the cost of sovereign borrowing has become sky-high for countries whose creditworthiness is in the slightest doubt; several governments have already lost market access for their bonds. Financing troubles have spelled austerity, making the downturn worse and leading...

  5. Chapter 1 Lending to the Sound of Cannon
    (pp. 9-44)

    Gio Girolamo Di Negro was not a happy man as he pored over his account books in Genoa during winter 1596.¹ His company, dedicated to commercial ventures and credit operations, was making a profit—but only a small one. All told, Gio Girolamo controlled a little less than a hundred thousand Genoese lire. He was immensely rich compared to the dockworkers and his own servants. At the same time, his fortune was small compared with the financiers forming the upper classes of Genoese society. With his current profits of about 3 percent annually, Gio Girolamo would never become as rich...

  6. Chapter 2 Philip’s Empire
    (pp. 45-73)

    It was a cold autumn night in October 1469. Two Castilian gentlemen sat down at an inn near the Aragonese border and ordered a hot meal after a long day of travel. Their servant, a shabbily dressed young man in his late teens, took their traveling clothes and then went to tend to the mules outside. A few tables over, two scruffy characters were drinking cheap wine and gambling at cards. What could have been an everyday scene in any inn on the Iberian Peninsula contained the seeds of high political drama. The seedy-looking men were actually working for Bishop...

  7. Chapter 3 Taxes, Debts, and Institutions
    (pp. 74-104)

    Early modern kings evoke images of absolute rule, crystallized in the famous statement attributed to Louis XIV:“L’État, c’est moi.” Modern economic research often refers to this image when characterizing European states between 1500 and 1800.¹ As a generation of revisionist historians has convincingly argued, royal power in the early modern period was in practice never unconstrained.² Instead, “absolutism” is probably best viewed as a social arrangement to the mutual benefit of both the elite and the Crown, with the former providing crucial support to the latter.³ For the celebrated case of France, Roland Mousnier (1974) famously showed that Louis...

  8. Chapter 4 The Sustainable Debts of Philip II
    (pp. 105-131)

    For a long time, Philip II’s defaults have been blamed on a disastrous combination of the Crown’s unsustainable fiscal situation, on the one hand, and myopic lenders, on the other. Braudel famously argued that each bankruptcy ruined different bankers, who were quickly replaced by another, equally irrational wave of entrants. He concluded that “every time the state declared itself bankrupt, bringing contracts to a violent end, there were always some actors who lost, fell through a trap-door, or tiptoed away towards the wings” (Braudel 1966, 362).

    Assessing lender rationality is a complex problem, which we address in the following chapters....

  9. Chapter 5 Lending to the Borrower from Hell
    (pp. 132-172)

    On Thursday, October 12, 1307, the Grand Master of the Order of Templars, Jacques de Molay, was carrying a heavy burden: he was a pallbearer at the funeral of Catherine of Courtenay, sister-in-law to Philip IV of France. The young noble woman had died at the age of thirty-two. Only nobles in favor at court were accorded the special honor of acting as pallbearers. Also present at the funeral were the king and every member of the royal family as well as most of the leading officials.

    The next morning, bailiffs woke de Molay before dawn, bearing a warrant for...

  10. Chapter 6 Serial Defaults, Serial Profits
    (pp. 173-210)

    The king continued to borrow massively throughout his reign, using the help of bankers to raise short-term financing. The Genoese banking network kept incentives aligned; the king’s best strategy was to service his debts, so that he had access to capital markets in the future. Here we look at the bankers’ side: How much did they profit as a result of “lender power”? We calculate returns on lending to the Castilian crown, taking into account defaults and the bankers’ cost of funds. Our calculations demonstrate that loans to Philip II were highly profitable. Defaults and reschedulings reduced the rate of...

  11. Chapter 7 Risk Sharing with the Monarch
    (pp. 211-242)

    In early October 1591, lookouts near Cadiz could see the sails of the Spanish treasure fleet on the horizon. After crossing the Atlantic from Havana, the galleons’ final leg of their journey saw them sailing up the Guadalquivir River. They put into harbor under the walls of Seville and unloaded their well-guarded cargo: many tons of silver, mined in modern-day Bolivia using the latest chemical processes as well as forced labor. At the Casa de la Contratación, the value of imports was assessed in detail; one-fifth had to be paid as tax.

    The previous year, two rich fleets had reached...

  12. Chapter 8 Tax, Empire, and the Logic of Spanish Decline
    (pp. 243-270)

    Non sufficit orbis—the world is not enough. When Sir Francis Drake’s men stormed the Spanish governor’s palace in Santo Domingo in 1586, they found a coat of arms displaying a map of the world. It was adorned with a horse rising triumphantly on its hind legs; the Latin motto was prominently displayed above.¹ What sounds like hubris to modern ears (and will remind readers of a James Bond film) was not an exaggeration for contemporaries: in the days of Philip II, Spain’s empire had no equal. After the takeover of Portugal, Philip II ruled virtually all of the Americas,...

  13. Epilogue Financial Folly and Spain’s Black Legend
    (pp. 271-280)

    Financial folly. The very words conjure up images of overpaid bankers, venal politicians and ruined savers, economic chaos and disastrous collapses in market confidence. Financial folly is a common explanation for booms and busts, bubbles and irrational exuberance in stock and bond prices. Reinhart and Rogoff’s monumentalThis Time Is Differentputs excessive optimism of financiers at the heart of financial crises. Recurrent crises, in their view, reflect swings in investor sentiment: as good returns accumulate, initially skeptical investors gradually become blue-eyed optimists who start to believe that this time is indeed different. Once a crisis hits, sentiment collapses and...

  14. References
    (pp. 281-296)
  15. Index
    (pp. 297-310)
  16. Back Matter
    (pp. 311-312)