A Brexit warning from the ages

The financial world is speculating how far British Prime Minister Theresa May will go in the game of brinkmanship with Europe. If financial history — and I mean history — is any guide, things might get rocky.

This month marks the 350-year anniversary of a significant date for the English, when their embryonic bond market resumed trading in April 1677, after a five- year closure known as the “Stop of the Exchequer.” This obscure chapter in medieval monetary history provides relevant take-aways for Brexit.

In late 1671, King Charles II of England was preparing for a soon- to- be- triggered war against the Dutch, then the financial and commercial centre of continental Europe. The sentiment in the English street was that the Dutch were getting the better deals in international trade. They reckoned that a respectable war would help resolve commercial matters in their favour. But battles are expensive — the King was still paying for prior skirmishes. What to do?

He asked the major bankers — who had lent money in the past — for a loan to outfit a fleet of 60 ships, but they flat- out refused, claiming they had already extended more than enough credit via the treasury orders ( instruments not dissimilar from modern- day mortgage- backed securities). Under treasury orders anticipated tax revenues were used as collateral for advances. And, as the rev- enues from the customs, excise and hearth taxes were received at the Exchequer, they would be redirected to the bankers who held the securities.

So the king defaulted. This was the last time the English formally announced a suspension of payments on their debts. He announced that revenues that had been assigned would instead be redirected to pay other immediate cash expenses, such as outfitting the navy. The amount of debt on which he defaulted was approximately one year’s worth of government revenues, which at the time was slightly over £1 million, or £100 million to £200 million in today’s terms.

Naturally, t he bankers were outraged and demanded repayment. When the king didn’t budge they retaliated against ordinary Englishmen. The bankers froze all deposits and threatened non- payment to their depositors until the assets would resume trading.

For the first few years the bankers could not redeem and received no i nterest on their treasury orders. Then, sometime in early April 1677, the Exchequer was reopened and interest payments were resumed, but with a very clever catch. The government decided to bypass the bankers entirely and go directly to depositors. The bankers (i.e. crown’s creditors) had to assign the rights to interest directly to their own retail deposit- ors. Instead of bailing out the bankers and hoping the money would ( eventually) flow to consumers, it flowed directly to consumers.

This process wasn’t easy or painless. It took 34 years of protracted litigation until the holders of the banker’s assignments got the matter resolved, but in the end they received perpetual annuities for their troubles.

And the original bankers? Most went bankrupt — that is what happens with leverage in the absence of limited liability — and many ended up in debtor’s prison, with some suicides and escapes to the continent. All in all this was a tragedy (for them) of Shakespearean proportions, but with little sympathy from the English masses.

Back to 2017, bond yields are stable and nobody in their right mind is thinking default. But for those in the financial services industry who assume the British would never do anything to harm bankers and credit markets, it might be worth remembering what they did in the ’ 70s; the 1670s.

THIS MONTH MARKS THE 350-YEAR ANNIVERSARY OF A SIGNIFICANT DATE FOR THE ENGLISH.