Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World)

by Mauricio Drelichman

  Did the threat of sanctions or their actual imposition compel Philip II to service their debts? Our new evidence strongly suggests that this is not the case. The decision by the Genoese to stop transfers was not only ineffective; it also made no difference to the mutiny, considered by Conklin as the crucial punishment. Philip II’s financial position in 1576 was clearly not comfortable. Yet sanctions proper require a punishment beyond a stop to normal lending, and such sanctions never materialized. Whatever the Genoese did in addition to suspending lending obviously did not work.

  MARKET POWER AND REPUTATION

  Philip II exempted one banking family from the bankruptcy decree: the Fugger. They were essential for transfers between 1575 and 1577, when the vast majority of royal funds that reached Flanders did so through their correspondents. Yet not even the Fugger family lent after 1575. We now describe how this simple fact can help us shed light on what sustained lending to a sovereign monarch such as Philip II.

  Lending to the king of Spain happened in an “anarchic” environment, in the sense of Kletzer and Wright (2000). The monarch could not credibly commit to repay his lenders. In many cases, he failed to honor the letter of the contract: more than 20 percent of the loan documents contain detailed references to promised payments that had not been made as agreed in earlier contracts with the same lender. This even applied to juros, widely considered a particularly safe asset. While Philip II never rescheduled juros, payments could be less than promised if they were secured against a poor tax stream.32

  The king had access to few smoothing mechanisms: short-term borrowing, depositing funds with bankers, and long-term borrowing. Given urgent, volatile spending needs, only the first of these mechanisms was practical. Foreign bankers could and did default on the king’s deposits. Enforcement across borders was slow and complicated. For example, we know of a case where a Genoese banker failed to return a deposit of 300,000 ducats that he held on behalf of the king. The issue was then settled through the intervention of a second banker, who agreed to lend an equivalent sum at a preferential rate in exchange for the king dropping the proceedings against the banker who defaulted.33 In such an environment, depositing funds with a banker was not an alternative to borrowing.34 Issuing juros was not a viable alternative either. New issues required the authorization of the Cortes, and even when authorized, their sale was a drawn-out process. In addition, the same Genoese bankers who dominated the asiento business also enjoyed a near monopoly over the intermediation of juro issuance (Castillo 1963). With more than 150 years of experience operating the Casa di San Giorgio, the Genoese had a keen understanding of a sole financial agent’s power when lending to a sovereign. While Castile had no comparable arrangement, Genoese bankers maneuvered to gain a commanding position in both short- and long-term debt markets. When the king defaulted on short-term debt, he found that lenders also held a tight grip on juros—his only alternative way to borrow. Finally, placing long-term debt is usually a more involved operation than contracting short-term loans. Even economies with much more developed financial and economic systems in the twentieth century typically financed wars initially with short-term debt, which they then later consolidated into long-term bonds (Roesler 1967). Just like other warring princes, Philip II could effectively ramp up spending ahead of revenue only through short-term borrowing.

  THE GENOESE COALITION

  To keep the king from defaulting, incentives other than direct penalties must have been at work. Our data suggest that the lending structure was key. The Genoese provided funds in overlapping groups. Approximately one-third of all transactions involved more than a single banking family.35 This created a de facto network or alliance of financiers who would act as one—a lenders’ coalition. Contemporaries referred to the Genoese as a close-knit group, subject to the same treatment by the king, and acting largely in concert.36

  Some of the co-lending relationships involved multiple loans by stable groups of bankers. For example, Lucián Centurión and Agustín Spinola together lent no fewer than seven times during 1566–67. In other cases, the co-lending occurred only once. Most of the network members were engaged in repeated interactions with each other. The Grimaldo and Spinola families often co-lent, as did the Judice, Doria, Centurión, and De Negro families. One family stands out as the “spider in the web”: the Spinola. Their transactions involved sixteen other banking families as partners. The Doria family, the next most influential, joined forces with seven other dynasties. The Doria and Spinola networks were linked through mutually provided loans as well as by the fact that both families co-lent with the Grimaldo, Lercaro, Marín, and Maluenda families. Many of these families also played a leading role in Genoese politics beginning in the 1270s. Figure 14 provides an overview of the network’s structure.

  The numbers below family names show the total lending in thousands of 1566 ducats. The thicker lines indicate higher average lending (scaled by the log of lending volume). The Grimaldo, Lomelín, de la Torre, Centurión, Spinola, Grillo, Cattaneo, Lercaro, and Gentil families are all linked in the four contracts stipulated in the medio general, but for clarity of exposition those links are not shown here.

  We define all transactions by bankers who co-lent—either through joint loans or sharing business partners—as network lending. This must constitute a lower bound on the actual business and family relationships between bankers. Even under this restrictive definition, bankers in the network accounted for a large share of transactions and lending volume. There are only twenty-seven families (out of sixty-three in total) in the largest network we identify, but they account for 72 percent of the principal and almost the same proportion of all transactions (see table 13).

  FIGURE 14. The Genoese network

  Figure 15 shows network and nonnetwork lending by year. Over time, the size of the network was broadly stable. Before the bankruptcy of 1575, network members accounted for 80 percent of lending; after it, they accounted for 67 percent. There were two years when the king borrowed or transferred funds without any support of network members. In 1576, no banker was lending to the king, and the entire amount transacted consisted of transfers by nonnetwork members. In 1582, the king borrowed almost exclusively from the Fugger, the most prominent family outside the network.37

  Table 13. Network lending (millions of 1566 ducats)

  Source: AGS, Contadurías Generales, Legajos 86–93.

  FIGURE 15. Lending by network members, 1566–1600

  Co-lending was not the only way in which the network operated. In many cases, collateral was passed from one banker to the next.38 This practice made it much more difficult for the king to selectively default on members of the Genoese coalition. Lenders left out of a deal could seize cross-posted collateral. Thus, network cohesion was enhanced by the use of juros. Collecting debts on behalf of other bankers was also common. Often, the king borrowed from one banker and agreed to repay another banker’s loan as part of the new deal. The king also promised repayment through other bankers. All these agency relationships hindered side deals.

  For example, the king borrowed 80,000 ducats from Lucián Centurión and Agustín Spinola in 1569.39 Half the repayment was promised in the form of tax revenue; the other half was from a group of seven Genoese bankers.40 This type of arrangement made it difficult for the king to default and then enter into a special deal with the Spinola family. The Spinola were substantial backers of Philip, lending the largest quantity (17 million ducats) of all the banking families. Yet in these two contracts alone, had the Spinola cut the other bankers out of any arrangement, funds equal to half the principal could have been seized. Similarly, on March 5, 1595, the king agreed to borrow 330,000 ducats from Francisco and Pedro de Maluenda. Repayment was promised via Adán de Vivaldo, from whom the king also borrowed. Vivaldo, a Spanish banker, did not co-lend with the Genoese in any of our contracts. This illustrates that multilateral relationships among bankers transcended mere co-lending. Some of the relationships that emerge from our sources link members of th
e network that did not co-lend. The Lomelín and Grimaldo families never joined the same syndicates. Nonetheless, as part of a lending contract between the king and Baltasar Lomelín, in 1588 both Esteban Lomelín and Doña Sasandra de Grimaldo were allowed to change the tax stream against which their long-dated debt was secured (a transaction that increased the value of the debt they held).

  Cooperation among bankers also extended beyond lending. In 1567, for instance, Tomás de Marín accepted a deposit of 300,000 ducats from the king in Milan, but then failed to repay. Nicolao de Grimaldo stepped in, agreeing to lend the king the same amount if the case against Marín was dropped. The deposit at Marín’s bank was converted into a perpetual rent in favor of the king at 8 percent interest.41 As another example, in 1587 the king entered into an asiento for a million ducats with Agustín Spinola. In it, the king agreed to drop a number of lawsuits against three other bankers, Lucián Centurión, Antonio Alvarez de Alcócer, and Manuel Caldera.42 Bankers also used their network clout to force the king to honor his commitments. A 30,000-ecu loan by Francisco Spinola in 1588, say, included a clause that required the king to settle an old debt with Lorenzo Lomelín.43

  We argue that network membership and syndicated lending were crucial in sustaining sovereign borrowing. For this contention to stick, there should be no other reasons for co-lending. For example, larger loans might require greater resources than those available to a single banking family. Pooling therefore could reflect capacity constraints. The data, however, do not support such an interpretation. Single-family loans are actually slightly larger (by 1 percent) than multifamily loans. Loan duration was similar too—26.4 months for single-family loans versus 25.5 months for the rest. Transfers, another possible reason for co-lending, are also more common in the single-family loans than in the multifamily ones. All other observables, including interest rates, the use of collateral, and contingency clauses, show no major differences. We conclude that loan requirements or simple capacity constraints on the part of lenders cannot be the reason for co-lending.

  Just like the European nobility and ruling dynasties, banking families frequently use marriage as a tool to strengthen business links.44 We use the partial genealogies for seven Genoese banking families documented in the Doria Archive of Genoa to explore the intermarriage among them (Saginati 2004). In figure 16, we add information on intermarriage within the Genoese network. Importantly, there was overlap between co-lending and intermarriage; the connections between the Spinola and the Grimaldo, Gentil, Centurión, and Doria were particularly strong, as were those between the Centurión and the De Negro. In each case, these links involved both financial and family “co-investments.” There were also fresh links between network members who had not lent together, such as the Sabago and Doria. Even though our intermarriage data cover only seven families, we find that the six that intermarried among each other while also co-syndicating loans accounted for 47 percent of all network lending.

  There were also five other families that intermarried with other network members, but did not co-lend with the families they married into. They contributed 9.5 percent of total network lending.45 Co-lending was only one dimension of other key connections. Since our genealogical data is limited, these results constitute a lower bound on the ties that transcended joint lending.

  FIGURE 16. Structure of the network based on co-lending and intermarriage

  CHEAT-THE-CHEATER ENFORCEMENT

  Two factors interacted to make lending to Philip II sustainable: the stability of the bankers’ network and its dominant role in lending. The Genoese coordinated their actions closely. Because of his financing needs, Philip II could not do without the Genoese coalition. Therefore, he eventually had to settle with the bankers when they imposed a moratorium on him. This also made it unappealing for outsiders to start lending. This illustrates the significance of market structure, along the lines articulated by Natalia Kovrijnykh and Balázs Szentes (2007) and Mark Wright (2002).

  Genoese market power derived from control over the only means that allowed “intertemporal barter” (Kletzer and Wright 2000), especially within the (short) time horizons necessitated by wartime financing. Because of the Genoese’s controlling positions in both the markets for juros and asientos, the king basically had no alternative but to obtain financing from them. Crucially, there was no entry of new lenders and no disintegration of the dominant Genoese network. Our preferred interpretation emphasizes cheat-the-cheater enforcement, with the risk of being cheated as a result of other lenders’ actions as the main reason for no new bankers entering.

  A crisis defines the value of a coalition. In our data, we observe the Genoese lenders going through two crises: the defaults of 1575 and 1596.46 In both, the king needed cash urgently. The Sack of Antwerp had weakened Spain’s position in the Low Countries, and victory began to look unlikely. Similarly, the threat of an English invasion in 1596 forced heavy spending to build fleets, outfit armies, and strengthen fortifications, while expenditures in Flanders proceeded apace. During these episodes, both the Crown and individual bankers from the network explored the possibility of a side deal. None was concluded, nor did any new lenders enter into one. A combination of social enforcement mechanisms (among the Genoese) and incentives (for the Genoese and all other potential lenders) was responsible for this outcome.

  During the debt renegotiations of 1576–77 and 1596–97, the king’s representatives attempted to undermine the coalition’s cohesion. They focused on the Spinola family as well as selected large bankers. Despite offering preferential treatment of old debts in exchange for fresh loans, no deal was concluded. In 1576, Lorenzo Spinola and Nicolao de Grimaldo engaged in protracted private negotiations, but failed to come to an agreement with the Crown (Lovett 1982, 12–13; De Carlos Morales 2008, 170). Eventually Nicolao took part in the medio general. Although Lorenzo did not participate in the negotiations of the general settlement, his brother Agustín (a member of the family partnership) did. Overall, 93 percent of the loans in default were rescheduled. The remaining ones were contracts with small bankers who did not take part in the negotiations but instead were offered the same terms at a later date. In 1596, Ambrosio Spinola played a double game. He negotiated on behalf of other network members while discussing a special deal for himself. The Crown also offered favored treatment to a small syndicate. In the end, all bankers again settled on identical terms through a general agreement (Sanz Ayán 2004, 34–36). We do not know exactly what was on the minds of the Genoese banking families as they decided to maintain the moratorium, but it seems likely that the tight network of mutual commercial and other relationships kept opportunistic behavior by select banking families in check.

  By analyzing the behavior and writings of bankers outside the coalition, we can gain further insight into the motivations of both the Genoese and other lenders. Throughout the second half of the sixteenth century, Philip borrowed from thirty-six families that did not belong to the Genoese network—a “competitive fringe” in the jargon of industrial organization. The most important bankers outside the network were the Fugger, who were responsible for the majority of transfers to Flanders during the 1575 suspension. The Crown clearly considered these services when it decided to continue to service its debt with the Fugger. The Royal adviser Dávalos de Sotomayor said as much: “Your majesty has the inexcusable obligation … of paying back the Fugger, who are not affected by the decree, somewhat less than two [million ducats]” (cited in Lovett 1982, 13).

  The fact that the Fugger debt was still serviced despite the decreto, the general suspension of payments, could be seen as supporting the sanctions view—that the ability to cut off transfers to Flanders sustained lending. This is not correct. As the last lenders who had not been defaulted on the Fugger had greater market power since they were still willing to transfer funds. At the same time, and despite their advantageous position, they did not extend fresh funds at the hour of greatest need for the Spanish monarchy. What the absence of any lending operations
by the Fugger family demonstrates is that lending and transfers were kept strictly separate; the threat of sanctions was not enough to support continuous access to credit.47

  The Fugger tried to benefit from the crisis in the Netherlands and the Crown’s need for funds. Their agent in Spain, Tomás Miller, actually suggested a loan to pay Spanish troops in the Low Countries (Lovett 1982, 13).48 In the end, there was no new lending by the Fugger until 1580. Their private correspondence tells us about the reasons why they did not seize the seemingly attractive opportunity to lend to the king when the latter was desperate for cash. What stopped them was the fear of being defaulted on if they lent during the moratorium.

  The Fugger family in Germany took a dim view of the new loan proposed by Miller. Hans Fugger maintained a lively correspondence with his brother Marx, in which they discussed everything from high finance and politics to hunting dogs and the merits of sweet Italian wines. In a crucial exchange, Hans told Marx in emphatic terms that Miller had to be stopped. Otherwise, the Fugger would be cheated and would eventually end up being affected by the payment stop:

  Day after day, we have to render more and more services to the king (of Spain)…. [T]his makes it imperative that Tomás Miller is stopped; if not, we will fraudulently and mockingly be thrown into the decree [affected by the payment stop].49

  If a new loan were to be extended, Hans feared that

  the Spaniards will forever take advantage of us, they will suck us dry and exploit our position, and if we don’t do everything they say, they will throw us into the decree, and … mistreat us like the Genoese, whose fate we have before our own eyes.50

  What was on Hans’s mind is clear enough: after receiving fresh funds, the king would default on them, too. Thus, the Augsburg banking family decided to do as the Genoese were doing—cut off lending—even though they had not suffered a default. They did so despite the fact that they were still offering transfer services to the king of Spain. The Fugger’s concern illustrates what Kletzer and Wright (2000) call a cheat-the-cheater mechanism. Because they would not be able to satisfy all the king’s demands, the Fugger considered it a virtual certainty that they would be cheated and defaulted on. The reason they could not satisfy every possible demand by Philip is also clear: his smoothing needs were simply too large. Eventually the king would have to settle with the Genoese. Then the Fugger family would lose everything. The Genoese were already furious with the Fugger for transferring funds to the Low Countries and in retaliation “tried to do them at Court all the harm they could” (Ehrenberg 1896). There is every reason to believe that the same logic that kept the Fugger from lending was constraining the behavior of other bankers. Thus, the power of the cheat-the-cheater mechanism reflected the Genoese coalition’s market power, deterring insider defections as well as outsiders. Syndicated lending was a key factor sustaining the market power of the dominant banker coalition.51