DP7276 Lending to the Borrower from Hell: Debt and Default in the Age of Philip II, 1556-1598

Author(s): Mauricio Drelichman, Hans-Joachim Voth
Publication Date: April 2009
Keyword(s): early modern state finances, incentive compatability, Philip II, serial default, sovereign debt, state capacity
JEL(s): F21, F34, N23
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7276

Philip II of Spain accumulated debts equivalent to 60% 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. Using new archival data, 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. We analyze the incentive structure that supported the cohesion of this bankers' coalition. Lending moratoria were sustained through a "cheat the cheater" mechanism (Kletzer and Wright, 2000).