Why do Sovereign Borrowers Post Collateral? Evidence from the 19th Century

71 Pages Posted: 3 Nov 2021

See all articles by Marc Flandreau

Marc Flandreau

Centre for Economic Policy Research (CEPR)

Stefano Pietrosanti

affiliation not provided to SSRN

Carlotta Schuster

United Nations - Conference on Trade and Development (UNCTAD)

Date Written: October 7, 2021

Abstract

This paper explores the reasons why sovereign borrowers post collateral. Such behavior is paradoxical because conventional interpretations of collateral stress repossession of the assets pledged as the key to securing lenders against information asymmetries and moral hazard. However, repossession is generally difficult in the case of sovereign debt and in some cases impossible. Nevertheless, such sovereign “hypothecations” have a long history and are again becoming very popular today in developing countries. To explain sovereign collateralization, we emphasize an informational channel. Posting collateral produces information on opaque borrowers by displaying borrowers’ behavior and resources. We support this interpretation by examining the hypothecation “mania” of 1849-1875, when sovereigns borrowing in the London Stock Exchange pledged all kinds of intangible revenues. Yet, at that time, sovereign immunity fully protected both sovereigns and their assets and possessions. Still, we show that hypothecations significantly decreased the cost of sovereign debt. To explain how, we stress the pledges’ role in documenting sovereigns’ wealth and the management of revenue streams. Based on an exhaustive library of bond prospectuses collected from primary sources, matched with a panel of sovereign bond yields and an innovative measure of sovereign fiscal transparency, we show that collateral minutely described in debt covenants served to document and monitor sovereign resources and development prospects. Encasing this information in contracts written by lawyers served to certify the quality of the resulting data disclosure process, explaining investors’ readiness to pay a premium.

Keywords: Collateral, Information, Sovereign debt, Informal enforcement, Financial innovation, Contract innovation.

JEL Classification: N20, G24, K12, K33, H63

Suggested Citation

Flandreau, Marc and Pietrosanti, Stefano and Schuster, Carlotta, Why do Sovereign Borrowers Post Collateral? Evidence from the 19th Century (October 7, 2021). Institute for New Economic Thinking Working Paper Series No. 167, Available at SSRN: https://ssrn.com/abstract=3952152

Marc Flandreau (Contact Author)

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Stefano Pietrosanti

affiliation not provided to SSRN

Carlotta Schuster

United Nations - Conference on Trade and Development (UNCTAD) ( email )

Palais des Nations
Office E 8074
Geneva, 1211
Switzerland

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