Bankruptcy in the Age of American Independence

By Bruce H. Mann

Harvard Univ. 344 pp. $29.95


The Financial Roots of Democracy

By James Macdonald

Farrar Straus Giroux. 564 pp. $30

Two new books about the historical roots of debt could hardly be more timely. American consumers owe more than $1.7 trillion, not even counting home mortgages. A record 1.5 million bankruptcies were declared over the past year. Meanwhile, war with Iraq could cost as much as $2 trillion, roughly equivalent to a full year's U.S. federal budget, and much of it likely to be financed by borrowing.

Bruce H. Mann's Republic of Debtors opens in 1800 as debtors toast America's first national bankruptcy law. How far the young country had come since the sermons of Samuel Moody and Cotton Mather, who condemned debt as moral turpitude. Mann shows how insolvency in America shed its status as grievous sin and became a mere business risk.

In A Free Nation Deep in Debt, James Macdonald employs a much broader historical canvas to argue a provocatively sweeping claim: that the growth of government debt is linked to both the conduct of war and to the emergence of democracy. Macdonald, a former investment banker, traces the history of government borrowing from "what could be called the first foreign-bond issue," which took place in 283 B.C. "when the city of Miletus, on the Ionian coast of modern-day Turkey, borrowed 12 talents from the neighboring city of Cnidus," through the days of profligate medieval kings, to the patriotic savings bonds that financed the wars of the 20th century.

Macdonald's study is a challenging yet fascinating work. Though readers not versed in finance will have to digest it slowly, they will find a wealth of material here, written clearly and accessibly. By the early 14th century, credit markets were thriving in Italy. Yet government bankruptcies were rife, because there were no incentives to control the size of the public debt. Soon the Netherlands also created markets for trading government debt, but it collected regular taxes from its league of cities and held the debt in check. This helped it win independence from Spain in 1648 after 80 years of war. "Even if the country has no money," wrote a 17th-century Dutch pamphleteer, "it still has its credit, and the enemy has neither funds nor credit, that I could not deny that we might wear out the enemy through this war, because this land has sufficient funds."

War prompted governments to borrow, even as the resulting birth of citizen-creditors laid the foundation for profound political change. A government funded willingly had to be more accountable than one that borrowed only from the privileged classes, who expected to be repaid in more privileges as well as cash. The disastrous state of royal finances in England, for example, led to the Glorious Revolution of 1688, which toppled James II. Adapting the Dutch model, England set out to build a stable parliamentary government, reliable tax revenues and a system of long-term borrowing to support its credit markets. In 1694, it created the Bank of England, which issued bank notes not secured by coin and bullion. For the first time, a government could manipulate the money supply and thus prices; this began England's rise as a world financial power.

For Macdonald, the American Revolution crystalized the link between debt and democracy. The infant United States of America was the first nation to rely on paper money instead of coins and bullion -- that is, to finance itself entirely by debt. The debate over how to handle the money supply and Revolutionary War debts created financial chaos and Wall Street's first crash, in 1792.

Robert Morris, a financier of the American Revolution and briefly the wealthiest man in America, nearly convinced the new nation to issue currency backed by future tax revenues as the English and Dutch did, instead of printing dubious notes like "a common prostitute among chaste and respectable maidens." This would have increased the national debt but made it payable.

Instead, Morris was among those who lost their fortunes during the inexperienced government's tug-of-war over debt. Landlords and creditors wanted a solid currency. Tenants and debtors wanted the greenback to weaken and thus lighten their obligations. Merchants wanted a steadily growing money supply without inflation. In the end, the mercantile class prevailed under policies instituted by Alexander Hamilton.

Bruce Mann's account of bankruptcy in revolutionary America portrays Morris as a greedy speculator who nonetheless deserved pity and grudging admiration for standing up to his creditors. Broke, Morris holed himself up in his Pennsylvania country home, his own "Castle Defiance," for seven months. In 1798, he ended up in debtors' prison.

Republic of Debtors is rich in bracing anecdotes and dramatic characters such as Morris. Its detailed portrait of early American life makes up in part for the book's scattered organization and tendency to repeat itself.

Mann, a professor of law and history at the University of Pennsylvania, illustrates the powerful moral and political forces that inflamed the bankruptcy debate in 18th-century America. Many Americans considered their economic troubles to be the fault of poor government. If a man's business failed through no fault of his own, then how could his insolvency be a sin? In the 1750s and 1760s, pamphleteers -- many of them writing from the very debtors' prisons they decried -- raised a clamor for the end of such prisons. If debtors were not free, then how were they different from slaves? Meanwhile, creditors wanted to keep other creditors from stepping ahead in line for payment and to prevent crafty debtors who used jail to avoid paying. Nationalists argued against federalists in favor of a commercial bankruptcy law that was enforceable across state lines.

The commercial interests that propelled the 1800 Bankruptcy Act into being also doomed it. Applause for the law masked boos and hisses, for it promised relief only to large commercial borrowers. The majority of debtors -- small merchants and farmers -- remained out in the cold. The law was repealed after only a few years.

More than two centuries later, Congress again wants to make it harder to declare personal bankruptcy. This time, commerce has redeemed the humble American consumer, who now is lauded in the business media as the hero keeping the U.S. economy above water. With bankruptcies up 8 percent in the last year and the law tightening, we may soon see a new debtors' revolt akin to that of 18th-century entrepreneurs. Benjamin Franklin's alter ego Father Abraham has come back to haunt us with his warning: "He that goes a borrowing goes a sorrowing." *

Michele Wucker is a senior fellow at the World Policy Institute, where she specializes in Latin America, immigration and international finance.