The credit crunch: what can we learn from history?
Chris Bowlby talks to two medieval historians and a professor of finance about a 13th-century financial crisis that bore striking similarities to today’s credit crunch
The credit crunch may seem full of bafflingly unfamiliar modern terminology. But more fundamental causes like a loss of confidence and sudden refusal to lend money can be found in all kinds of historical periods.
Nor should we assume that today’s international dealing in clever – perhaps too clever - financial products is purely a modern phenomenon. An unusual and imaginative collaboration at the ICMA Centre, University of Reading between a professor of finance and two medieval historians has been using modern forms of analysis to uncover the drama behind surprisingly sophisticated medieval trading involving monks and monarchs as well as bankers.
Chris Bowlby has interviewed Dr Adrian Bell, Professor Chris Brooks and Dr Tony Moore about a medieval credit crunch, and asked them how one of its principal victims, King Edward I of England, might have coped with today’s version. Here’s what they had to say:
How sophisticated was medieval banking?
Reply: As early as the 13th century, innovative practices had been developed to smooth the unpredictable and unreliable cash flows experienced by large institutions and governments.
Much of this ingenuity was driven by the need to circumvent restrictions on charginginterest (reflecting the religious disapproval of usury). Examples include the use of forward contracts in the wool market between monasteries in England and Italian merchant societies, where cash loans would be repaid in wool, and the provision of pension schemes by religious institutions.
However, the heart of the new medieval financial industry was merchant banking, including government finance. In effect, Edward I had an early form of current account with the Ricciardi of Lucca, Italy, that incorporated an extensive overdraft facility.
Edward was able to use this easy access to credit to fund the armies and castles that helped conquer Wales. To meet Edward’s demands, the Ricciardi could raise additional funds from other merchant societies across Europe, in the same way as modern banks turn to the interbank lending markets.
All this demonstrates a precocious ability to price and market financial products. Our research demonstrates that medieval merchants, using abaci and roman numerals, were just as capable of calculating forward prices and interest as modern financiers using mathematical models and computer spreadsheets.
How much did a medieval credit crunch look like that of today?
We have identified a ‘credit crunch’ in 1294, which shares remarkable parallels with today’s difficulties – the main cause being a lack of liquidity in the money market. In the 1280s, there had been a glut of easy money as merchant societies managed large sums of clerical taxes raised for the Pope, enabling them to lend money to kings and each other. In the early 1290s, the Pope called in much of his money and the French king levied a huge tax on the Italian merchants in France. The final straw was the unexpected outbreak of war between England and France in 1294.
Edward I called on his bankers to raise the money needed to fund his armies. Unfortunately for the Ricciardi, they were unprepared for this eventuality as their assets were tied up in loans and trade. In normal times, the Ricciardi would have sought to raise short-term loans from their fellow merchants but in 1294, like today, the wholesale money markets were frozen.
Worse still, the Anglo-French war had cut communications between England and Italy, undermining the merchants’ ability to transfer credit or update their account books. The resultant uncertainty, combined with the fear that Edward would default on his debts, meant that merchant societies were unwilling to lend to each other.
The reactions of bankers to both medieval and modern credit crunches are strikingly similar. In 1294, the Ricciardi said that “it seems that money has disappeared”. Seven centuries later, in September 2008, a senior banker lamented in The Times that “there is no capital left in the world”.
How did political leaders deal with the crisis?
Unlike modern governments, Edward had no intention of bailing out the bankers. He probably felt personally betrayed by their failure. Moreover, in the face of war with France (soon to be joined by Scotland and a rebellion in Wales), his over-riding concern was to scrape together as much money as possible to pay for an army.
In response to the Ricciardi’s default, Edward in effect froze all of their assets in England and did the same to all other Italian merchant societies, taking into his hands all of the wool (and other goods) that had been purchased in that year by ‘alien’ investors. This isn’t too different from the British government freezing all Icelandic assets until the status of British savings in Icelandic banks had been resolved.
The Ricciardi were effectively bankrupted by the crisis of 1294, and were followed by a string of other banks.Although it would appear that Edward I was the aggrieved party, history has not been kind to him, or to English kings in general, tainted with a reputation for breaking Italian banks.
This is perhaps because Italian chroniclers sought to blame Edward rather than admit their own failings (much like our banks today seeking to blame American sub-prime mortgages for the systemic flaws in their business models). Despite the fall of the Ricciardi, Italian merchants continued to lend to Edward, suggesting that he still had a sound credit rating.
Pundit from the past: Edward I
How would the ‘Hammer of the Scots’ have dealt with today’s financial crisis?
Although both originated in crises of liquidity, there are significant differences between the credit crunches of 1294 and today. The Reading research team remind us that, even if its financial practices look surprisingly modern, “the wider medieval economy was still much less dependent on credit than the modern economy”. Moreover, “medieval bankers were operating in a very different financial environment where there was little or no official regulation, but where there were extreme penalties when they were seen to have failed to meet their obligations”.
Once Edward realised that finance for his military enterprises had dried up, “extreme penalties” must have been on his mind. The ‘Hammer of the Scots’, who expelled the Jews from England, clearly had a ruthless streak.
As the Reading team point out, Edward dealt with his Italian bankers “immediately, unilaterally and without sympathy”. His initial advice in today’s crisis, they suggest, “would probably be to place senior executives under house arrest – most likely without trial, until the government could recover as much as possible from their assets and estates”.
The US government has been prepared to lock up senior executives following the Enron and Worldcom scandals “and we could expect that Edward I would approve”.
But they caution against suggesting that Edward I would simply have hammered the bankers. Edward himself may have regretted allowing the Ricciardi to fail, “since, during the war of 1294–7, he was forced to turn to moneylenders who lacked the resources of the Italians and charged much higher rates of interest.
Taking punitive action today would also reduce the availability of loans and, given the greater reliance of the modern economy on credit, this would have much more serious consequences for the country”.
So Edward might have advised us to ensure that some in the banking world remain able to lead a revival. The Reading team note that when the Frescobaldi (who succeeded the Ricciardi as royal bankers) complained that their involvement with the English king had led to a run on their bank, Edward recognised the justice of their claim and promised them £10,000 in compensation.
"Although far smaller in absolute terms, when compared to annual government expenditure, this commitment is proportionately greater than the £50 billion recapitalisation recently announced by the Chancellor of the Exchequer,” they say. So Edward might have counselled that some leniency towards bankers is justified for political leaders who will hope to borrow large sums again when a crisis is over.
Dr Adrian Bell and Professor Chris Brooks of the ICMA Centre have been awarded a grant to investigate the use of credit finance by medieval monarchs www.icmacentre.ac.uk/medievalcredit
This series is produced with History & Policy. You can find out more about them and read their papers at www.historyandpolicy.org.