Bonds and Brands: Foundations of Sovereign Debt Markets, 1820–1830

Abstract

How does sovereign debt emerge? In the early nineteenth century, intermediaries' market power and prestige served to overcome information asymmetries. Relying on insights from finance theory, we argue that capitalists turned to intermediaries' reputations to guide their investment strategies. Intermediaries could in turn commit or else they would lose market share. This sustained the development of sovereign debt. This new perspective is backed by archival evidence and empirical data, and it suggests why strong but undemocratic states could borrow.“A good name is worth more than a gem.”Yiddish proverb

Hamlet Without the Prince of Denmark: Relationship Banking and Conditionality Lending in the London Market for Foreign Government Debt, 1815-1913

“…And they did not walk away as the security aged. Lending certainly did not occur in an environment dominated by conflicts of interest, as usually portrayed by advocates of the importance of bondholders' committees (Flandreau and Flores 2009). Instead, foreign lending occurred in the well-organized, hierarchical international bond markets, where huge piles of capital served to collateralize government debt.…”

“…In this context, sovereign debt may emerge as bankers are sorted into a -pyramid‖: prestigious bankers have monopoly power and specialize in high-grade securities, while ordinary underwriters are competitive and deal with low-grade bonds. Flandreau and Flores (2009) show that Rothschilds was the leader during the 1820s; it surpassed all other banking houses in terms of market share, capital stock, and performance of issues. Prestige was used as 7 Wright (2004) To what extent did prestigious banks deliver reliable outcomes throughout the 19 th century?…”

“…In addressing the question, this paper combines information on expected and realized returns. For a given bank, if realized returns tend to equal expected ones (i.e., if ex post performance resembles the promises made 8 Previous research suggests Flandreau and Flores (2009) interpretation of the 1820s applies throughout the 19th century-a natural outcome given that market share supported credibility, which in turn protected market share and so generated persistence. Rothschilds retained its leadership in London sovereign issues until World War I, with Barings (the other prestigious house) never too far behind.…”

“…Flandreau and Flores (2009) The relevance of these arguments for the 19 th -century international organization is obvious.…”

“…22 Previous authors have identified three such cycles in the 19 th century: the early 1820s boom, which petered out in late 1825 and early 1826 (Jenks 1927;Flandreau and Flores 2009); the long boom of the years 1850-1870, which imploded in stages between 1871 and 1876 (Jenks 1927;Suzuki 1994); and finally the protracted expansion that begun in the late 1870s, stalled in 1889, and then reversed with the Argentine default and -Barings crisis‖ of 1890 (Ford 1962). …”