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Credible commitments and constitutional constraints: state debt repudiation and default in nineteenth century America

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Abstract

Between 1839 and 1842 the United States suffered through an acute debt crisis. Over this period, eight states and one territory defaulted, five of which outright repudiated all or parts of their outstanding debts. However, for many of those same states, reentry into capital markets occurred relatively rapidly and at rather favorable terms. The question then arises, how and why was this possible? This work attempts to explain this phenomenon by suggesting that soon after default or repudiation many states enacted constitutional amendments meant to significantly constrain and credibly commit future governments from overextending credit and simultaneously to pursue time-consistent public policy. I explore this by examining the impact that these newly imposed constitutional amendments, which limited both the type and amount of debt and created stronger procedural safeguards for issuing debt, had on average bond prices, gathered from New York market data. Overall, my results show that newly constrained states had higher average bond prices than states that did not impose constitutional limits on debt financing, suggesting that markets did, in fact, perceive these constitutional changes to be binding and credible.

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Notes

  1. Information is freely available at www.Intrade.com.

  2. Although the causes and consequences of the panic are still debated today and would require work well beyond the scope of this paper to fully explain them, it is known that most of the sovereign borrowing that did occur through this period happened between 1837 and 1841. Thus, this would suggest the panic of 1837 affected banking much more so than sovereign debt. In fact, it appears that Maryland, which placed an $8 million loan on the market in the middle of the panic, was the only state unable to find a ready buyer for its bonds.

  3. This data is freely available at http://www.eh.net/databases/early-us-securities-prices.

  4. All bonds traded during this time had a par value of $100.

  5. By breaking down each bond by the maturity this allows me to increase what is a relatively low sample size, as some states issued multiple bonds which matured at different times. This also allows me to better account for the inherent risk associated with different bonds as, ceteris paribus, a bond maturing at a later date will be relatively more risky which will thus affect its price. For robustness I will later change this assumption.

  6. In 1855 there were only 31 states in the Union, growing to 33 by 1860. Along with this, in 1855 the states of New Hampshire and Wisconsin had negligible debts of $75,000 and $100,000 respectively making the effective number of states with any substantial debt at 22. In 1860 New Hampshire still only had a negligible debt of $50,000, leaving the effective number of states with any substantial debt in that year at 25.

  7. Popular agitation in Maryland began in the early 1840’s and was echoed by subsequent governors in their annual messages. Although a constitutional convention wasn’t held until 1850, it was largely due to a long-standing debate over the procedural technicalities stipulated in the state’s original constitution regarding the amendment process (Harry 1902). Citizens in Indiana voted in favor of a convention in 1848, which received strong support from Governor James Whitcomb in his annual message to the legislature of that year (House Journal of 1848). In Kentucky voters approved a proposed constitutional convention in 1847, which met in October of 1849 and convened in December of that year (Kentucky Legislative Research Commission 2003). Finally, Ohio voters also voted for a convention in October of 1849 (Smith 1851).

  8. For 9 of the 79 observations there was no distinguishable maturity rate given. Therefore, I assume that each of these bonds matured after 10 years from the first date that data is obtained. For instance, if a state has an unknown maturity on a bond in 1855, I assume a maturity rate of 10 years in 1855 and 5 years in 1860. Although not reported, I considered several other maturity rates for unknown bonds, but found little material change in the results.

  9. Obviously manipulating the dependent variable in this manner would require a similar manipulation of the variables for length to maturity and the coupon rate. Therefore, when multiple bond prices are averaged together I simultaneously average the years to maturity and coupon rate for those observations.

  10. Again I average both the coupon and maturity rate variables in a fashion to reflect this change in the dependent variable.

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Acknowledgments

The author would like to thank Christopher J. Coyne, Adam Pellillo, Russell S. Sobel and Laura R. Stealey as well as two anonymous referees for invaluable comments and suggestions. The author would also like to acknowledge the financial support of the Mercatus Center at George Mason University where he was a Visiting Scholar during the fall of 2010. Any remaining errors or omissions remain the sole responsibility of the author.

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Dove, J.A. Credible commitments and constitutional constraints: state debt repudiation and default in nineteenth century America. Const Polit Econ 23, 66–93 (2012). https://doi.org/10.1007/s10602-011-9114-z

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