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Lending to the Borrower from Hell: Debt and Default in the Age of Phillip II

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  • Drelichman, Mauricio
  • Voth, Hans-Joachim

Abstract

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.

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File URL: http://mauricio.econ.ubc.ca/pdfs/borrowerfromhell.pdf
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Bibliographic Info

Paper provided by Vancouver School of Economics in its series Economics working papers with number mauricio_drelichman-2008-8.

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Length: 37 pages
Date of creation: 07 Jul 2008
Date of revision: 06 Sep 2010
Handle: RePEc:ubc:bricol:mauricio_drelichman-2008-8

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Web page: http://www.economics.ubc.ca/

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Keywords: sovereign debt; default; lending coalitions; sanctions; reputation;

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References

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  1. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-97, December.
  2. Harold L. Cole & Patrick J. Kehoe, 1994. "The role of institutions in reputation models of sovereign debt," Staff Report 179, Federal Reserve Bank of Minneapolis.
  3. Drelichman, Mauricio, 2005. "The curse of Moctezuma: American silver and the Dutch disease," Explorations in Economic History, Elsevier, vol. 42(3), pages 349-380, July.
  4. repec:spo:wpecon:info:hdl:2441/605 is not listed on IDEAS
  5. Drelichman, Mauricio & Voth, Hans-Joachim, 2010. "Serial Defaults, Serial Profits: Returns to Sovereign Lending in Habsburg Spain, 1566-1600," Economics working papers mauricio_drelichman-2010-, Vancouver School of Economics, revised 04 Jul 2011.
  6. Jeremy I. Bulow & Kenneth Rogoff, 1987. "A Constant Recontracting Model of Sovereign Debt," NBER Working Papers 2088, National Bureau of Economic Research, Inc.
  7. Rose, Andrew K., 2005. "One reason countries pay their debts: renegotiation and international trade," Journal of Development Economics, Elsevier, vol. 77(1), pages 189-206, June.
  8. Carlos Álvarez, 2003. "The Role Of Institutions To Solve Sovereing Debt Problems: The Spanish Monarchy´S Credit (1516-1665)," Working Papers in Economic History wh030804, Universidad Carlos III, Departamento de Historia Económica e Instituciones.
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  11. Natalia Kovrijnykh & Balázs Szentes, 2007. "Equilibrium Default Cycles," Journal of Political Economy, University of Chicago Press, vol. 115, pages 403-446.
  12. Mauricio Drelichman & Joachim Voth, 2006. "The sustainable debts of Philip II: A reconstruction of Castile's fiscal position, 1566-1596," Economics Working Papers 1121, Department of Economics and Business, Universitat Pompeu Fabra, revised May 2009.
  13. Flandreau, Marc & Jobst, Clemens, 2005. "The Ties that Divide: A Network Analysis of the International Monetary System, 1890 1910," The Journal of Economic History, Cambridge University Press, vol. 65(04), pages 977-1007, December.
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  17. Benabou, Roland, 2013. "Groupthink: Collective Delusions in Organizations and Markets," IZA Discussion Papers 7322, Institute for the Study of Labor (IZA).
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  19. Rui Pedro Esteves, 2007. "Quis custodiet quem? Sovereign Debt and Bondholders` Protection Before 1914," Economics Series Working Papers 323, University of Oxford, Department of Economics.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Lending to the borrower from hell
    by Economic Logician in Economic Logic on 2009-01-08 18:04:00
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Cited by:
  1. Peter Benczur & Cosmin Ilut, 2011. "Evidence for Dynamic Contracts in Sovereign Bank Lending," Working Papers 11-06, Duke University, Department of Economics.
  2. Vesperoni , Alberto, 2013. "War Finance and the Modern State," NEPS Working Papers 6/2013, Network of European Peace Scientists.
  3. Mauricio Drelichman & Hans-Joachim Voth, 2013. "Contingent Sovereign Debt Contracts: The Historical Perspective," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, vol. 11(3), pages 28-32, October.
  4. Rohan Pitchford & Mark L. J. Wright, 2013. "On the contribution of game theory to the study of sovereign debt and default," Oxford Review of Economic Policy, Oxford University Press, vol. 29(4), pages 649-667, WINTER.
  5. Mark Aguiar & Manuel Amador, 2013. "Sovereign Debt: A Review," NBER Working Papers 19388, National Bureau of Economic Research, Inc.
  6. Johnson, Noel D. & Koyama, Mark, 2014. "Tax farming and the origins of state capacity in England and France," Explorations in Economic History, Elsevier, vol. 51(C), pages 1-20.
  7. Drelichman, Mauricio & Voth, Hans-Joachim, 2010. "Serial Defaults, Serial Profits: Returns to Sovereign Lending in Habsburg Spain, 1566-1600," Economics working papers mauricio_drelichman-2010-, Vancouver School of Economics, revised 04 Jul 2011.

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