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

Mauricio Drelichman and Hans-Joachim Voth

Economics working papers from Vancouver School of Economics

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.

Keywords: sovereign debt; default; lending coalitions; sanctions; reputation (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-his
Date: 2008-07-07, Revised 2010-09-06
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http://mauricio.econ.ubc.ca/pdfs/borrowerfromhell.pdf

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Journal Article: Lending to the Borrower from Hell: Debt and Default in the Age of Philip II (2011) Downloads
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Persistent link: http://EconPapers.repec.org/RePEc:ubc:bricol:mauricio_drelichman-2008-8

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