Mandelbrot
The Accountant
The charges were lurid and invented: heresy and spitting on the cross. Across France that same day, hundreds of Templars were seized. Under torture de Molay confessed, then recanted. Seven years later he was burned at the stake on an island in the Seine, within sight of the royal palace.
The Templars had done nothing except lend money to a king who had fought an expensive war against England and could not pay it back. There was no court above the king to hear their case. He was the borrower, the judge, and the man who lit the fire.
Drelichman and Voth open with this scene to set up a puzzle. Two hundred and fifty years later, another Philip, Philip II of Spain, borrowed far more heavily, fought far longer wars, and suspended payments to his bankers four separate times. Yet his creditors kept their throats. More than that, they kept lending, and they grew rich doing it. The Genoese families who financed the largest empire the world had yet seen walked away, on average, wealthier than when they started.
The thesis the authors defend is uncomfortable for anyone trained to read a missed payment as a red flag. Philip II’s suspensions were not the flailing of a deadbeat. They were the designed outcome of contracts that priced bad luck before it arrived. Lending to the borrower from hell, it turns out, was one of the better businesses of the sixteenth century.
What Did I Get Out of It
The Borrower Who Is Also the Judge
Every credit decision rests on a quiet assumption: if the borrower stops paying, someone can be made to pay. A court compels it, or a claim on collateral substitutes for it. Sovereign lending removes that floor.
Molay’s fate illustrates the heart of the problem of sovereign lending. Because the borrower is also the supreme judge and lawmaker, there can be no appeal to higher authorities if contracts are broken.
Strip away the enforcement mechanism and lending becomes an act of faith, or a bet that the borrower keeps paying because paying serves him. The authors are precise about why this matters. A king does not default the way a company defaults, because nobody can drag him into a room and seize his assets. He pays when payment buys him something he wants more than the cash he keeps by not paying.
A sovereign is a special kind of borrower-one that cannot be taken to court or otherwise forced to honor their contracts. This can lead to opportunistic behavior
The question that organizes the whole book follows from this. If Philip could have walked away at any time, and if walking away cost him nothing in a courtroom, why did he always return to the table and settle? The answer is not morality. Philip executed loyal subjects when it suited him, including the Counts Egmont and Horn. The answer is that something other than the law was holding the arrangement together.
Defaults as Insurance, Not Betrayal
The word default carries a verdict. It tells you someone broke a promise. The data in this book tells a different story.
Once a bankruptcy was triggered, bankers could afford to postpone collecting on their loans and reduce the interest rates. In effect, the bankers offered insurance to the king, collecting premiums in good times and paying out in bad times
The bankruptcies were not accidents that befell the relationship. They were a feature of it. In normal years the king paid rates far above what safe long-dated bonds returned, and the bankers pocketed the spread. In bad years, when a silver fleet failed to cross or two war fronts opened at once, payments stretched and rates fell. The lenders had been collecting the premium the entire time. The suspension was the claim. Bernstein’s history of risk walks the long road toward pricing uncertainty; here is a market that had already arrived, four centuries early.
The contracts spelled it out. Each asiento carried contingency clauses, options that let the king delay if the fleet was late, or let the banker swap his exposure for safer bonds if the king’s position weakened. Modern credit calls these covenants. The financial sophistication is striking: present value was understood, annuities and perpetuities were priced correctly, even the stub period before the first interest payment was accounted for. These were not naive men handing gold to a charming monarch.
lending was contingent on a wide variety of circumstances, including the timing of the arrival of the silver fleets and the performance of specific tax streams… Defaults were nothing more than an extension of this uncertainty.
Two conditions made a default excusable rather than opportunistic. It had to happen in a verifiably bad state of the world, and it had to be followed by compensation once the storm passed. The genuinely uninsurable events, the ones no contract could anticipate, were the opening of simultaneous wars and the destruction of the Armada. Those triggered the across-the-board reschedulings, the kind of shock that sits outside any model written beforehand. What the authors never find, across the entire database, is a single case of outright repudiation. The king bent the letter of his obligations constantly. He never once denied that he owed.
Strength in Numbers
If the law could not protect the Genoese, what did? Not the king’s conscience. Their own structure.
Since these lenders were strongly connected among themselves, they “acted as one” in times of crisis; none cut a side deal, despite numerous offers from the royal camp… Sovereign lending-and the lives and limbs of his creditors-were effectively protected by their market power.
The Genoese were a coalition that solved an enforcement problem no court could touch. They co-lent in overlapping groups, passed collateral from one family to the next, collected debts on each other’s behalf, and intermarried to bind the business together. Each of these moves made it harder for the king to peel off one banker with a sweet private arrangement. Try to default selectively, and the lenders left out of the deal could seize cross-posted collateral. The network was its own enforcement. The collateral passing between families is the part that stayed with me, because it is skin in the game built into the plumbing of the deal rather than left to honor.
cheat-the-cheater incentives … ensured that a simple lending moratorium of the Genoese was sufficient to force a powerful monarch like Philip II to pay his debts
The mechanism is game theory, played for empires. The king needed the next loan more than he needed to escape the last one, because war does not wait. The moment the coalition stopped lending, the military situation began to rot, and the cost of that rot always exceeded whatever he saved by stiffing his bankers. The threat to withhold future credit was the whole of the lenders’ power, and it worked precisely because the king’s appetite for war never ended. The attempts to undermine the coalition, to lure the Spinola family into a separate peace, came to nothing. There was no entry of new lenders and no fracture in the dominant network.
Selling Shares in a King’s War
The Genoese did not sit on all of this risk. They sold it down.
effective “risk transfer” mechanism. Savers invested in a share of a loan made by bankers, not in deposits held by the banker-an early form of syndicated lending. Investors shared in both the upside and downside of loans to the king
Gio Girolamo Di Negro, the Genoese merchant whose winter accounts open the book, never met Philip II. He bought a slice of a loan underwritten by a relative in Madrid, paid a one percent intermediation fee, and earned the same terms the principal lender earned. The structure is securitization, three centuries before the word existed. A large loan, too big and too risky for any one balance sheet, gets sliced and distributed to investors who want the yield and can absorb a piece of the loss. The same arithmetic of slicing and selling reappears in every era, including the synthetic equity of the South Sea decade that followed.
In good times, a large number of investors, big and small, benefited from the asientos. When payments were suspended, many parties shouldered the losses with diversified portfolios, ensuring that most would weather the storm unscathed.
The genius was not the yield. It was the distribution of the loss. A suspension that would have ruined a single concentrated lender instead landed in fragments across hundreds of diversified portfolios, each one able to carry its share. The system survived the 1596 bankruptcy because no participant held enough of it to be destroyed by it. That is a shock absorber engineered into a financial network. I spend a lot of time trying to find where risk actually sits in a structure rather than where the labels claim it sits, and this was an early, working answer to that question. The principal lender kept his monopoly on the relationship with the king and shed most of the exposure at the same time.
The Poisoned Chalice
Why Spain, the only superpower of its century, drifted into decline while a smaller rival overtook it.
Our Spain has set her eyes so strongly on the business of the Indies, from where she obtains gold and silver, that she has forsaken the care of her own kingdoms; and if she could indeed command all the gold and silver that her nationals keep discovering in the New World, this would not render her as rich and powerful as she would have otherwise been
A contemporary wrote that in 1600, while the silver was still arriving in Seville. The mechanism he sensed but could not name is the heart of the authors’ argument. American silver was a royal prerogative, outside the reach of the Cortes, the assembly that approved ordinary taxes and set a ceiling on long-term debt. With silver, the king could borrow against a revenue stream nobody could vote down. He no longer needed to bargain with anyone. The single standing control on royal spending lost its grip.
It was the weakness of the imperial center, not the omnipotence of Habsburg rulers, that was crucial for economic and political decline-its inability to force through change, centralize, streamline, and tax effectively and evenly.
The popular story has an all-powerful absolutist king crushing his subjects. The reverse was nearer the truth. The silver let the Crown avoid the slow, expensive work of building a state that could tax fairly and govern coherently, because it never had to strike the grand bargain that would have forced those reforms. The windfall removed the pressure that builds institutions. The decline did not announce itself; it accumulated, the same way a great library fades rather than burns. I have watched smaller versions of this. A unit with its own pool of cash stops submitting to the controls that bind everyone who depends on the central budget. The discipline was never really in the rules. It was in the need. Remove the need and the rules quietly become suggestions.
Who Is This For
This is an academic book wearing a popular title. There are regressions, a discussion of why the authors use modified internal rate of return instead of IRR, present-value tables, and a careful accounting of haircuts down to the percentage point. The 1575 settlement imposed a write-off near 38 percent in present-value terms; the 1596 settlement, a milder 20 percent. If that sentence made you curious rather than tired, you will enjoy the book. If it made you tired, the first chapter and the conclusion carry most of the argument, and you can read those alone.
It rewards anyone who works with credit risk, or with the stranger category of borrowers who cannot be sued. It rewards anyone who has tried to write a contract that survives contact with a counterparty more powerful than whoever is meant to enforce it. And it rewards anyone interested in how institutions rot from comfort rather than crisis, which turns out to be the more common way.
The book sits against a long tradition that reads default cycles as financial folly and as the recurring delusion that this time is different. Drelichman and Voth concede the pattern is real, then show that the most famous early case of serial sovereign default was not folly. It was insurance, priced and paid.
What it changed in me is smaller and more specific. I had carried the lazy equation that a serial defaulter is a reckless borrower and a foolish lender. The book took that apart. Philip II suspended payments four times and remained solvent the entire while; his bankers funded the largest empire yet built and still earned roughly four points a year above safe bonds for the trouble. The default was not the failure of the system. It was the system working as designed. I finished it less interested in whether a borrower has ever missed a payment, and more interested in whether the losses were priced before they arrived, and where they finally came to rest.