Debtors-Creditors Relationship

Since the introduction of loans (initially without interest and then with it) the relationship between debtors and creditors has been tricky; initially unregulated and based on custom contracts, money-lending tended to become more standardized.
The first innovation was the charge of interest based on risk: for instance, lending money to a merchant in the Venice of the Renaissance was quite risky especially when shipping cargos to and from the Far East. Except that lending money at interest for Christians was a sin. Jews could instead do it and developed a network of ‘credit banks’ over the centuries, which explains some of the financial power they carried through to modern times. But the relationship with Venice was far from idyllic and not always Jews could enforce their rights in courts. Defaults were common. Venice itself had to ask money to Jewish banks, but because the State could control their status as citizens and grant them or not certain rights, temptation for defaults was high there too.

Owners-Managers Relationship

Companies that borrowed money to develop their business can raise money by issuing bonds or shares. In both cases the shareholder and the bondholder are creditors, but the main difference is that the first one owns a part of the company and the other one does not. The owners can appoint company managers for the day-to-day operations of the company and can tell them what the main goals are. Bondholders instead can claim priority for repayment. Such a structure (in particular the one of the joint-stock, limited liability company) was a fundamental innovation for 3 reasons:

1. It allowed trading of such ownership, first on informal basis and then regulated by a marketplace (stock exchange), thus allowing investors to ‘divest’ and not to have their capital tight to the destiny of the company for all its life.
2. It renders the company financially dependent from owners’ money and other lending bodies, but does not include other goods or wealth that shareholders own separately (concept of limited responsibility).
3. Legal responsibility of the company lies on the appointed managers. They are responsible for company misconduct vis-à-vis ‘stakeholders’ and the society.

The first company to enjoy a widespread shareholdership was the Dutch East India Company, formed in 1602. Thousands of people invested in the company although even large investor had little power as shown by the fact that the directors obtained not to publish the first 10 years accounting books. And the company was so successful that it was not liquidated as planned in 1612. For this reason there was a need allow the initial shareholders to divest; hence the first stock exchange of the financial history which was created in Amsterdam, and it was a lively one with all the cries and gestures typical of such places. And the newly born Amsterdam Exchange Bank provided the monetary system to enable the market to function, including supply of credit for collaterals, etc. A new economy was born.

Government-Bondholders Relationship

Another great innovation was the introduction of government bonds: in order to finance their expansions (i.e. wars) states need(ed) money and the easiest way is to get it from their citizens; initially this was obtained by raising taxes, and more or less brutally. However, this incentivizes evasion and rebellion.
Instead, by promising to repay it with interest facilitates collection and aligns the citizens with the national interest. Naturally, more creditworthy institutions find it easier to collect money and at lower cost. First example is Florence in 1270. This first case in particular was compulsory for all citizens and that was to avoid the Church usury accusations. It worked well because a few thousand wealthy individuals could contribute more and at the same time control the city’s institutions and finances (alignment of interests).
A defeat in war meant also paying for the winners’ debt: in the end if states go bankrupt they just default, partially or totally, on their investors (citizens in this case) as happened very frequently in the course of history. In particular, Spain became a ‘serial defaulter’ by “suspending payments to creditors in 1557, 1560, 1575, 1596, 1607, 1627, 1647, 1652 and 1662”. In their war with Dutch provinces Spain was less effective in raising money then the enemy merchants, but also had little incentive to repay their debts as opposed to local governments.

We mentioned Venice, but during those centuries Florence banks were so powerful they could afford to lend outside their borders and had offices all aver Europe and beyond. They even lent to Edward III of England at the start of the 100 years war with France. However, the king defaulted bringing down the Peruzzi and Bardi banks.

Governments were in such need of money that the bond markets were widespread with banks and rich families developing into market intermediaries. This is when the Rothschilds started their ascent. They were so powerful they could change events by granting or not loans to struggling governments. They were also the first large scale speculators (and also the first insider traders…). For example, during the American Civil War, Rothschild was asked to provide finance by the Union and the Confederation. By choosing one side they significantly contributed to define the winner, not least because the Confederate bond market tumbled on the news. Incidentally, by using cotton as collateral, the Confederate could still raise money and finance their war (at least until an embargo on cotton came to effect).