Governments versus Bankers in the Pre-1914 Sovereign Debt Market

Abstract

Most of the literature on sovereign debt focuses on the supply side of the market—the banks that underwrite loans and the final creditors that hold bonds—and assumed that governments were passive when negotiating borrowing conditions. This chapter addresses the role of governments as independent decision-makers. Governments decided whether to grant exclusivity to a single patron bank or to negotiate with competing banks to reduce borrowing costs. Both options entailed positive and negative payoffs. Patron banks could raise the governments’ reputation and create business connections. Exclusivity also increased the chances that banks would grant cheap rescue loan in times of crisis to prevent their clients from defaulting. By agreeing on exclusivity, however, governments would not bargain for better deals with other underwriters. The outcomes of lending negotiations depended on the relative power of governments and banks. Both players were strong when they counted with good reputation among the public. Yet premier banks became weak when they were exposed to governments that faced debt crises, for these troubled clients could threaten to default to pressure for the issuing of rescue loans.