Interesting: History of governments' borrowings from capital markets

A story of how "financial renovation" led to financial innovation

(Based on a news report in Financial Times, 19th Sept 2005)

According to history books, the first recorded instance of a marketable sovereign bond cropped up in 12th century Venice, where the rulers started to raise money from their citizens by issuing notes that promised to repay the funds after a period with 5 per cent annual interest.

However, drawing from subsequent experience in France and the Netherlands, it was the English government which arguably gave birth to the first set of co-ordinated debt market policies in the 17th century.

In 1693, England was bankrupted by war with France and the royal family's reputation was so poor it was unable to bully local bankers into extending loans.

So parliament asked officials to produce a plan to raise finance over a number of years, and consulted some Dutch, French, German and Scottish advisers operating in London at the time.

While London has long been an international marketplace, using foreigners in this way was contentious but set a trend that continues to this day. Mr Marès, who is French, is but one of a number of non-British now helping to sell UK debt.

The first foreign advisers produced some striking debt management schemes, one of which led to the creation of the Bank of England.

Among the most successful was the "tontine", essentially a longevity bond, launched in 1693 and promising a fixed rate of interest (initially set at 10 per cent) as long as the investor, or a designated individual, was alive. Interest was shared by investors whose designated individual was still alive. Thus tontines were a bet on a life. Investors appeared to make rational decisions, most of them designating a young girl who was deemed to have the best chance of a long life.

"Investors quickly found they should pick a child but not a toddler, who would have a greater chance of dying in infancy," says Mr Marès. In the 18th century came the "consol" for consolidated annuities, a bond more similar to those we know today. This was a bond that paid a fixed rate of interest, usually 2-4 per cent. However, the consols generally had no expiry date.

More schemes proliferated. prompting a very modern sense of anxiety about the soaring national debt. David Hume, the 19th century political economist, declared: "Our madness [in becoming endebted] had exceeded the madness of the Crusaders."

As this anxiety grew, the government took steps to consolidate outstanding instruments into one common pool of debt to make it more liquid and thus easier to trade. By the late 19th century, most of the consols, tontines, lottery bonds and other instruments had been converted into a small number of national bonds, eventually known as "gilts".

An author of the modernisation of the debt market was William Gladstone, the Victorian prime minister. However, by modern standards his role was not entirely glorious: Gladstone was running the government's bond programme and was also making a tidy profit trading them.

"Insider dealing wasn't considered inappropriate at the time," says Mr Marès. "It was customary for the people involved in debt management to trade on the basis of the information they held."

Other financial precedents have helped pave the way for today's dealmakers. "The bankers and advisers [in earlier centuries] were very creative, very innovative," says Mr Marès, as he waves a couple of dusty tomes borrowed from the Bank of England and Treasury archives.

"We tend to forget about what they did but the past can teach bankers today a thing or two."