In lieu of substantive commentary about banks scrambling to avoid regulatory definition as too big to fail (until they’re on the verge of failure, of course) I wanted to write about the fact that though it’s little-discussed today the United States of America was substantially forged as a result of a massive bailout.
The setting was New York City, then-capital of the then-new United States of America in the fall of 1789. The Revolutionary War had been won years ago, but the constitution was brand new. What’s more, the war had been a long one. A long one financed primarily by state governments. And one financed with a large degree of debt. That debt took two forms. To an extent, both the Continental Congress and state governments took out loans, and then used the money raised by loans to pay for things. And to an extent both the Congress and state governments found themselves paying soldiers with promissory notes. Fight now, and when we win the war we’ll pay you back. Of the course of the war years, the value of those promissory notes had often declined sharply below face value. Liquidity constrained soldiers and veterans had sold their notes for cash money to late 18th century vulture investors.
In his “report on public credit”, Alexander Hamilton proposed a kind of double bailout. First, all debts owed by state governments would be assumed by the federal government which had greater fiscal capacity to raise taxes without wrecking the economy. Second, with all the debt consolidated under federal aegis, the debt would all be paid off in full to the present owner of the paper. James Madison objected to both such bailouts. On the one hand, he felt that there was no reason citizens of less-indebted states should pay the debts of more-indebted ones. And on the other hand, he felt that though an obligation existed to fulfill Congress’ commitment to actual Revolutionary War soldiers there was no reason that hardworking people should be taxes to pay the full face value of securities owned by speculators.
Ultimately, Hamilton’s view prevailed and the debt was consolidated and paid. Yet Madison’s arguments about fairness seem unimpeachable. Here we are taxing a nation of farmers to transfer wealth to bond speculators. Why do that? But Hamilton’s argument that acting swiftly and decisively in this regard would establish the credit of the United States, give America access to capital, and ultimately boost the prosperity of the nation seems amply vindicated by history. And here were are, over 200 years later, citizens of a country with the very best credit in the world poised on the brink of an easily avoidable debt default as a side-consequence of dangerous political brinksmanship.