JUROS
The Crown’s main way of borrowing was to issue juros—annuities or perpetual bonds. These instruments were akin to French rentes, Dutch renten, and Genoese compere. They originated in the medieval period, when they were used by monarchs to reward distinguished service by their subjects. At that time, juros mostly took the form of lifetime pensions, payable from specific revenue streams. By the fourteenth century, juros were regularly used as a way of raising funds in exchange for surrendering the right to future revenue. Juros gradually saw their term being lengthened to two lives and eventually in perpetuity.28
The value of juros was determined by a number of characteristics. Chief among them were their term (lifetime or perpetual), their yearly payment, and the revenue stream backing them. Juros were referred to by the inverse ratio of their yearly payment to their nominal amount. For example, a bond that paid 5 percent interest on its face value would be designated as being of “veinte mil al millar,” or a thousand units of interest for each twenty thousand of principal. The actual yield of juros, of course, depended on the price at which they were sold. Throughout the sixteenth century, most bonds traded at par, and their median yield was 7.14 percent, or one unit of interest for every fourteen of capital. Juros issued as part of bankruptcy settlements usually paid 5 percent interest.
To offer the Crown a chance to benefit from a fall in interest rates, most juros were redeemable at the sovereign’s discretion; a few were not callable. All juros were issued to a specific person, who was the only one authorized to collect the annual payments. The Crown, however, regularly granted requests for the transfer of title of perpetual juros in exchange for a fee.29 Thus, while juros were never true bearer bonds, there is ample evidence of a healthy secondary market for them.
One important feature of juros was that they only bound the monarch to service them as long as the tax stream backing them produced sufficient funds. In that sense they represented a contingent claim on fiscal resources, with the lender bearing the downside risk. Juros carried different levels of seniority, indicating the order in which they would be paid. Seniority had an impact on the price at which juros could be sold. Junior bonds fetched lower prices, and the gradient became steeper the more doubts there were about the health of a given tax stream. Because the possibility of nonpayment was already part of the original loan contract, when specific tax revenues dried up, it did not constitute bankruptcy to fail to service juros.
The sixteenth century was a golden era for Castilian long-term debt. During the reigns of Charles V and of Philip II, juros were considered among the safest investments in Europe. They could be found in the portfolios of banks and sophisticated investors throughout the continent. A number of factors contributed to the prominent standing of juros among international financial assets. First, as discussed above, they could only be issued against tax streams designated by the Cortes as ordinary. These revenues were typically stable. Second, although juros could be found in investment portfolios throughout Europe, the vast bulk of them were held by Castilian elites. Defaulting on juros would have had a large political cost for the king. Finally, while the king was technically not responsible for the consequences of underperforming revenue streams, the Crown’s actions show that there was an implicit guarantee against catastrophic losses. When the taxes on silk production in Granada collapsed due to the Morisco rebellion of 1568, for example, the king compensated the holders of the tax farm by releasing them from their obligations and granted them juros for the value they had already paid.30 Throughout the sixteenth century, juros accounted for the vast majority of Castilian borrowing, averaging well over 80 percent of outstanding debt.
Data on juros are scant, and the nature of the archival record makes it difficult to reconstruct their stock on a yearly basis. Only a small proportion of the relevant holdings are cataloged; compiling estimates of outstanding debt on an annual basis has so far proven impossible.31 Instead, we have snapshot data for select years.
Table 3 shows the available estimates for the stock of juros and their service. These were obtained through official inquiries commissioned by the king. The fact that he ordered these surveys demonstrates how difficult it was for the royal treasury to keep track of the stock of outstanding debt. Surveys were particularly important around the defaults, which explains their timing. In chapter 4, we use these estimates, our new series of short-term borrowing, our reconstruction of military expenditures, and the logic of the fiscal budget constraint to construct estimates of the annual stock of juros for the duration of Philip II’s reign.
Table 3. Juros and their service (in millions of current ducats)
Source: Debt estimates for 1560, 1565, and 1598 are from Artola 1982. The figure for 1575 is from De Carlos Morales 2008. Service estimates are from Ruiz Martín 1965; Ulloa 1977.
† Calculated using 1565 stock of juros
†† Figure from 1596
Juros were sold in a variety of ways. Initially they were acquired directly by wealthy nobles and institutions. As the market thickened, the king’s secretaries would conduct an informal auction, in which they sounded out potential investors in order to place a new bond on the most favorable terms possible. Starting in the 1560s, though, most juros were sold through the same Genoese bankers who underwrote the king’s short-term loans. Bankers often chose to accept juros as repayment for a loan and then sold the bonds to their clients abroad. Finally, large amounts of juros were issued as part of the debt conversions agreed to in the settlements of the Crown’s bankruptcies.
Table 3 depicts a progressive decline in the average yield of juros during the second half of the sixteenth century. This reflects a combination of factors. First, interest rates were experiencing a long secular decline in Europe. Castile benefited from the overall trend (Stasavage 2011). Second, strong Castilian economic growth made juros a safe investment. Finally, the settlements of the 1575 and 1596 defaults added a sizable amount of juros carrying 5 percent interest to the existing stock, thus lowering the average interest cost of long-term debt. Still, it should be noted that interest costs were already coming down well before these settlements.
ASIENTOS
While juros accounted for the bulk of the Crown’s borrowing, short-term lending instruments, called asientos, attracted most of the attention of contemporaries and modern-day scholars alike. Juros could only be issued against a little more than half of all revenues—again, those designated by the Cortes as ordinary. This left a sizable free cash flow, which could be leveraged using short-term debt. While doing so, the Crown and its bankers created a sophisticated, flexible financing instrument that would be inextricably linked to Castile’s financial fortunes for a century.
The term “asiento” literally means “contract,” and it was used to refer to a wide variety of agreements. The most famous was the one chartering the slave trade. Whenever we speak of asientos in this book, we mean financial contracts between the king and private bankers. Charles V first used asientos to seal short-term lending agreements with the German Fugger and Welser families.32 The first Fugger loan famously allowed Charles to outspend Francis I in buying electoral votes and thus secure the imperial Crown in 1519. Later asientos helped to finance military campaigns all over the continent. At a time when American silver production was still in its early stages, it was the growing economy of Castile that supplied the resources to service asientos.
The asientos between Charles V and the German bankers were largely personal loans. The king took them out in his own name, and the links between the German banking families and House of Habsburg certainly played a big role in the negotiations. The contractual forms were typically straightforward—a delivery of funds, followed by one or several repayments with interest. Many times, there also would be a currency conversion advantageous to the banker.
Toward the end of Charles’s reign, Genoese bankers had already begun to provide funding on a scale comparable to that of the Fugger family. As the crisis resulting from the i
nsurgency of Moritz of Saxony deepened, the emperor had to ask for extensions of his repayment dates. Anton Fugger, writing in 1553, was not impressed with the way in which the Spanish court dealt with old debts, complaining about “the recklessness with which debts are not paid” (Ehrenberg 1896). He suggested bribing the king’s personal secretary, Francisco Eraso, to speed up repayment. As a matter of fact, only the timely arrival of American silver rescued Charles V’s financial position. Despite these difficulties, Charles V had staked his reputation on the servicing of his loans. In the secret instructions left to Philip II on his abdication, the emperor sought to impress on his son the need to honor his financial commitments, even at the expense of obligations to his own subjects (Fernández Alvarez 2004, 1979).33
FIGURE 5. The first page of an asiento. Source: General Archive of Simancas, Ministry of Culture, Spain, CCG, 86.
On taking the throne, Philip found an accumulation of old debts and limited resources to service them. He did not follow his father’s advice for long; the crisis he inherited resulted in a first payment stop on asientos in 1557, soon followed by the second one in 1560. The Genoese appear to have settled their claims quickly and on advantageous terms. The greater—and more complicated—debts of the German bankers, especially the Fugger, took much longer to negotiate. Hans Fugger had to travel from Augsburg to Madrid in person to settle the matter, which he accomplished by August 1562. The agreement saw the interest rate on debts reduced to 5–9 percent per year, plus an extension of the debt maturity. One-fifth of the debts was settled with juros from the Casa de la Contratación, which soon lost about half of their face value; another fifth came from silver revenue; an additional fifth was from rent payments of the military orders in Spain (maestrazgos); only 10 percent arrived in the form of cash (Kellenbenz 1967). The king also agreed to repay in part by handing over the right to exploit the rich mercury mines at Almadén. Even when payments were made, taking them out of Spain was difficult, as silver exports required an additional permit. While there is no exact way to calculate the net losses to lenders in the 1557–60 settlement, there is no question that the Fugger in particular were left with a worse deal than the Genoese, receiving less money and over a longer period than their competitors.34
Short-term lending had resumed in full by 1566, with several Genoese families now accounting for the bulk of the debt market. The Genoese introduced a number of innovations that made asientos less risky, allowed for a wide variety of contingencies, and aligned the king’s repayment incentives with those of the bankers.35 The first and perhaps most important change introduced by the Genoese involved spreading the risk of short-term loans. Rather than commit the bulk of their financial fortunes to the volatile repayment record of the Crown, the Genoese sold off most of each loan to smaller investors. After agreeing to underwrite an asiento for the king, bankers would offer shares in it at the European payment fairs as well as to smaller investors in Genoa. This practice allowed them to transfer as much risk as they wished while collecting a financial intermediation fee that averaged 1 percent. In this way, the Genoese bankers leveraged their network of business associates and ability to tap into international capital markets. As a result of early-modern “financial engineering,” the large families that underwrote the asientos usually had only a limited and controlled exposure to the Crown. When Philip II defaulted on 14.6 million ducats of short-term debt in 1575, for instance, only four families had an exposure in excess of 100,000 ducats of their own capital.36 This spreading of risk was multitiered. The smaller banks buying shares in the asientos would in turn offer fractions in their own participation to retail customers in Genoa, in other Italian cities, and at the local exchange fairs. The short-term financing of the Spanish Crown thus became a multinational affair, trickling down to all levels of society with the ability to aggregate individually modest amounts into large loans. The similarities with modern-day financing structures are striking. Genoese bankers “securitized” loans to the king by selling them to other investors, much as the Wall Street firms do to this day. The aggregation of savings in multiple steps is reminiscent of modern bond funds, with the savings of many collected in larger pools so as to finance large bond issues.
Interestingly, the Genoese system of risk transfer differed radically from the one used by the German banking families. The Fugger, for example, borrowed themselves against their name and net worth, and then lent to their creditors in the classic way of bankers. For instance, in 1563, the bank’s capital amounted to 5.4 million florins, of which 2 million was equity and 3.4 million were debts of various kinds. For a long time, Fugger debt (Fugger-Briefe, literally “Fugger letters”—debt obligations issued by the Augsburg banking house) was considered almost risk free.37 As late as the mid-1550s, the Fugger could borrow at rates of 8–10 percent in Antwerp—less than almost any other borrower, including the city of Antwerp itself (Ehrenberg 1896). When problems mounted as a result of Philip II’s first bankruptcy, rolling over these debts became increasingly difficult; members of the Fugger family ultimately had to add funds from their personal fortunes and borrow at much higher interest rates.38
The Genoese also used other clauses to increase the effective return of their asientos. Usury laws were in force and periodically invoked. As a consequence, no one was willing to explicitly charge interest in excess of the legal maximum. This limit varied between 8 percent at the beginning of Philip’s reign and 16 percent by the time of his death. Many asientos commanded far higher rates. Some of this excess return was obtained in the old-fashioned way by contracting in different currencies and inflating the exchange rate. Contracts also specified disbursement and repayment in different precious metals; the differences in their relative valuation across European cities afforded arbitrage opportunities for informed lenders. The Genoese, however, created an even more important channel for generating additional profits through their preeminent position in the juros market.39
When they entered the world of Castilian sovereign finance, the Genoese brought with them over 150 years of experience in managing the state debts of Genoa through the Casa di San Giorgio. This institution acted as a central clearinghouse for long-term loans, called compere, which shared essentially all the characteristics of Castilian juros in the sixteenth century.40 The Genoese, therefore, had on their side a vast expertise in dealing with the nuances of tax-backed securities; they could readily assess the health of tax streams securing the loans, calculate yields based on the characteristics of each issue, and split large issues for resell to retail investors. This knowledge was put to good profit in dealing with the Crown. In many asientos, the bankers requested that the king post collateral in the form of juros as a repayment guarantee for the principal and interest. If the king failed to repay the short-term loan as agreed, the bankers could then sell the collateral juros (called de resguardo) on the open market and recoup their investment. If the king repaid, the bankers had to return juros of the same value. The bankers used their clout with the king to demand the best available juros as collateral. Often they would then be allowed to substitute the original bonds for others of the same face value and seniority, but backed by inferior revenue streams. These bonds could be purchased below par on the open market, thus presenting an arbitrage opportunity to the banker.
The practice of swapping discounted bonds for others trading at par was common during the failed experiment to issue juros against the revenue of the Casa de la Contratación in 1565. The revenues of the Casa de la Contratación—one-fifth of all silver remittances arriving in Seville—were a royal prerogative, and hence not subject to the Cortes’s approval. This in theory rendered taxes on silver ineligible to back juros, but the king nonetheless pushed ahead. It soon became clear, however, that the bullion was being transferred to the central treasury or otherwise spent before it could be made available to service the bonds. As a result, the juros quickly lost up to 50 percent of their value. Genoese bankers specialized in buying them on the open market at a discount and
had them credited at par when returning them as part of the collateral on asientos. The episode highlighted the wisdom of only issuing long-term debt on revenues controlled by the Cortes. Juros were never again issued on extraordinary income or over royal prerogatives.41
Another innovation introduced by the Genoese in their asientos was the use of contingency clauses. Most contracts specified the source of funds intended for repayment, but also stipulated alternative scenarios. For example, a banker might be promised a hundred thousand ducats from the silver brought by the first fleet arriving from the Indies. The contract might further stipulate that if the fleet did not arrive by a specific date, the banker might be entitled to a penalty rate, collect payment from other sources, or liquidate the collateral. The combination of contingency and collateral clauses allowed the king and bankers to contract over a wide variety of states of the world at a time when long-distance trade and large-scale military enterprises created large volatility in the Crown’s cash flow. Adverse events—such as the late arrival of a fleet or failure of a particular tax stream—allowed the king to lengthen the repayment period of a contract, switch collection locations, and even lower overall payments. In other cases, the bankers were given the option to obtain early repayment by selling the collateral even if the loan was in good standing or cancel additional disbursements of funds.
Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World) Page 13
