From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Schroders reports on the views of D'Maris Coffman, a financial historian from the Winton Centre for Financial History at the University of Cambridge, who shared her insights at the Schroders Secular Market Forum recently. If you are interested in Morningstar featuring your content, please provide your details and/or submit your article here.
The period in the late nineteenth and early twentieth century known as the ‘Belle Époque’ is perhaps best remembered in Europe as a peaceful time of optimism and technological advancement, but it was also a crucial time for bond markets and may provide some solutions to the debt problems faced in Europe today. This is the view of D'Maris Coffman, a financial historian from the Winton Centre for Financial History at the University of Cambridge who shared her insights at the Schroders Secular Market Forum recently.
Coffman, who is director of the Winton Centre for Financial History at Newnham College, described the era between 1873 and 1913 as the first era of financial globalisation. She singled out a quote from JM Keynes which summed up the international spirit of that time:
“The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages; or he could decide to couple the security of his fortunes with the good faith of the townspeople of any substantial municipality in any continent that fancy or information might recommend.”
Bond Market Similarities
As well as being the era in which financial globalisation began in earnest, Coffman described the Belle Époque as ‘a period in which bond markets were structurally more similar to those today than anything that happened between 1914 and 1989.’ Citing the work of colleagues at the International Monetary Fund, Hebrew University of Jerusalem, and University of Tasmania, Coffman argues that there are significant parallels.
What brought about the more mature bond markets of the past two decades was the Latin American debt crisis of the 1980s, Coffman thinks, and the Brady Bonds used in part to resolve it.
‘The European union, Asian bond markets and Latin American bond markets all came out of a moment of crisis in the 1980s, made possible by the end of the Cold War,’ she said.
Structure of Nineteenth Century Bonds
Back in the late nineteenth century, however, sovereign bonds were highly diverse in terms of instruments and the way they were collateralised, and the market was supported by a sophisticated financial press.
Bonds were very long duration, with maturities of between 20 and 80 years. They were treated like perpetuities and yields were simply calculated by dividing the coupon by the price. They also often contained highly idiosyncratic clauses. For example, many bonds from developing markets included lottery clauses whereby each year 5% of an issuance would be selected for redemption via a lottery.
Almost all international bonds were denominated in sterling, and those that were not usually contained exchange rate clauses.
Significantly, many bonds of late nineteenth century also contained collateral agreements which meant that bondswould be serviced either by specific tax or export revenues. The result was that if a sovereign borrower defaulted, creditors could seize control of those assets. There was, however, a principle of sovereign immunity to prevent, for example, the British seizing a country’s ships when in port to service bond payments. But where collateral agreements detailed specific revenue sources, international creditors could get access to them.
Creditor Action
The reason this is relevant today is because mechanisms for creditor action against defaulters are emerging again. The Chinese government has started unilateral negotiations with Greece, offering to accept concessions, such as the operation of particular port, in lieu of interest payments, or in exchange for a liquidity infusion with which to service other bondholders.
Coffman argued that such deals could become increasingly de rigeur as there are signs that sovereign immunity is breaking down. She cited the example of the vulture hedge fund Elliot Associates which in the nineties bought convertible loans from Peru, then refused to convert them to Brady Bonds, and sued the government. When Peru quickly settled the dispute, Elliot Associates received six times the amount it would have got through the proposed Brady Bond settlement.
To look at how creditor action can work and to assess how governments can collateralise debt as a potential solution to default problems, Coffman talked in detail about the Corporation of Foreign Bond Holders. It was set up in 1868 and provided a forum for British creditors to coordinate their actions in dealing with foreign government bond defaults.
Collateral Clauses and the Ottoman Empire
Because of the nature of the collateral clauses often written into bond agreements, there were takeover opportunities for bondholders working together. They could in theory simply seize control of a Russian rail road or a Queensland mine in order to generate the revenue to service a bond. However, in practise this seldom happened, Coffman said, and sometimes there was a debt for equity swap whereby bondholders could acquire equity in industrial ventures, but more often an international committee would be set up.
She singled out the Ottoman Empire as an example of how international creditor action worked. As a result of lobbying by international bondholders the Council for Ottoman Debt Administration was set up in 1881. The council was made up mostly of creditors to the declining empire and they worked directly with Ottoman tax authorities and got funds directly from the government’s tax revenue coffers. They realised that the revenues assigned in the original collateral agreement were not generating the necessary capital, so they were able to negotiate for even more of the country’s revenues. Coffman compared the situation to what the Chinese have been doing with Greece recently.
On one hand, this system was a great success, she said. Creditors were repaid, while the Ottomans were able to borrow more cheaply on international capital markets in the last two decades of the 19th century than in their domestic market. But on the other hand, some have argued that the concessions destroyed the sovereignty of the Sultan and slowed down the Ottoman Empire’s integration with European markets.
Parallels Today
Coffman drew parallels with the situation today concerning the likes of Greece and Italy. ‘They had an international committee working with revenue authorities so they could make sure that tax revenues collected went directly to bondholders without being siphoned off and used for some sort of domestic project,’ she said. ‘That is the interesting thing in dealing with Greece and Italy today. We all know the representations the Greeks made in joining the EU were not accurate and with the Italians we can see that public revenue disappears all the time. The question is whether or not it is feasible for creditor organisations to somehow work with fiscal authorities to top-slice public revenue, like in the 19th century.’
Between the years 1877 and 1913 the number of loans in default in international bond markets fell dramatically – something Coffman puts down to the actions of such organisations as the Corporation of Foreign Bond Holders.
The Latin Monetary Union
A key parallel Coffman made between the Belle Epoque and today was the emergence of the Latin Monetary Union (LMU) in 1865, which has clear similarities with the single European currency of today.
It was part of Napoleon III’s plan to marginalise the British by building a trading bloc within Europe made up of France, Belgium, Italy and Switzerland, and to internationalise the French franc. The nations agreed to change their national currencies to a standard of 4.5 grams of silver or 0.29 grams of gold - a ratio of 15.5 to 1 - and make them freely interchangeable
‘If it was meant to increase trade in France and other LMU countries, then it succeeded, but if it was meant to internationalise the franc it failed miserably,’ Coffman said.
It did create a miniature currency union however. But, with clear parallels to today’s euro, newer entrants and more peripheral countries caused difficulties.
Spain and Greece joined the LMU in 1869 and immediately saw the benefits as they found their bond spreads decreasing. However, they then became the serial defaulters of the 19th century.
Then, in 1889 once Serbia, Romania and Bulgaria broke free from the Ottoman Empire and established their independence, they turned to the LMU as well. They thought that if they could establish convertibility in the bloc and issue their loans in francs, they would get access to much cheaper capital than they would if they worked with the British or if they turned and worked with the same people overseeing the Ottomans and forcing them to make concessions to service their debts.
‘The LMU became a way out for bad sovereign borrowers of the 19th century,’ Coffman said.
In conclusion, Coffman said she thinks the way forward for debt markets is in the ‘renewed scope for international creditor action’.
‘I don’t think the IMF and the World Bank are going to be able to handle this situation, and the track record of the ECB doesn’t encourage a great deal of faith that central bank coordination will solve the problem either. As to what forms these creditor actions might take, you have a range of very creative and diverse solutions from the 19th century which may show the way forward.’
Important Information
The views and opinions contained herein are those of D’Maris Coffman and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
All views expressed in this third party article are those of the author(s) alone and not necessarily those of Morningstar. Morningstar is not responsible for the comments nor will it be liable in any way for any information provided by the author.
