Financial innovations are frequently born of necessity and this is true in public finance just as much as in corporate finance, banking, and beyond. It is often when the public finances are in the most dire shape that creative thinking is most needed. Sometimes, the solutions conjured up set governments on the right course. Though at least occasionally, maybe even most of the time, it leads only to further trouble down the line. Late-medieval Venice, a leading commercial city, experienced the latter. This was perhaps caused by a crucial feature of the Venetian fiscal system and one many modern states could only wish to have in their toolkit: the forced loan.
In the latter half of the Middle Ages, Venice had become the preeminent European naval power in the Eastern Mediterranean. The Republic of Venice controlled an empire spanning the eastern coast of the Adriatic, Crete, and Cyprus. Some of these territories were captured as early as during the Crusades, which coincided with the expansion of Venetian power. Economically, Venice was enriched through its control of trade between Europe and the East. This dominant position was expensive to maintain, especially for a single city. Financing frequent wars, along with the need to finance trade, made the city a center of financial innovation, both fiscal and commercial.
The financial revolution that occurred in Italy in the Middle Ages, much like that of Britain in the late-17th century, was born of necessity. The Venetian state was broke by the mid-12th century, with expenses outstripping what local taxation was able to provide. As a result, the government turned to borrowing, a creative solution in an era before sovereign bonds existed. Initially, it asked the city’s wealthiest for loans. A voluntary loan in 1164 was among the first instances of long-term state borrowing in the form of a syndicated loan by a European country. The loan of 1,150 silver marks (each consisting of a half-pound of silver) was secured by eleven years’ worth of revenues from the markets in Rialto.
There was a problem with borrowing though: the city had to compete with higher yielding investment opportunities, and sovereign debt was new to the scene. To avoid high interest charges, the government in Venice opted to require its taxpayers to subscribe to its loans. The first of these forced loans was raised in 1167 and was used to finance a war underway against the Byzantine Empire. For its part, the Consilium Sapientium (Great Council) that governed the city-state pledged not to borrow for another two years. The next of these loans didn’t come until 1171.
Regarding these forced loans, men of property were required to subscribe in proportion to their wealth, or more specifically to the level of taxes that they paid. Issues were authorized by the Great Council to supplement what could be borrowed for shorter durations voluntarily. Individually, subscriptions were often for 0.5% to 1% of the taxpayers’ wealth, but considering that not every year brought a new forced loan, the amount was manageable and preferred by many to regular taxation.
By the mid-13th century, there were several different loans outstanding simultaneously, of varying terms, together comprising the Venetian state debt. The complexity meant that governments at this point often had to conduct audits to find out just how indebted they were. The decision was made in 1262 to consolidate the public debt into a new fund; the outcome of this fiscal restructuring was what was later called the Monte Vecchio (literally ‘Old Mountain’ but more appropriately translated as ‘Old Fund’).
The Monte Vecchio was essentially a single series of perpetual obligations, called prestiti, of which new issues were occasionally made. In 18th century Britain, the consol was an equivalent instrument. In Venice, these bonds paid 5% interest semiannually, in March and September, for over 100 years. Periodic principal repayments were made when funds became available but over the centuries the general trend in state indebtedness was upward.
However, there were protections offered to bondholders. The Consilium Sapientium decreed that the government would reserve merely the first 3,000 lire (roughly 500 ducats) a month in tax revenue for itself. Beyond that, revenue went to pay interest on the Monte Vecchio, and only once interest was paid could the government claim the residual. Confidence in the bonds was high enough that they traded in a secondary market, especially important given that many holders were unwilling investors anyway. The model of a single consolidated perpetual state debt would be returned to frequently in Venetian fiscal history. Two centuries later, the Monte Vecchio, was complemented by newer series of bonds, collectively called the Monti (the ‘Funds’).
New issues of forced loans were critical to funding Venice’s wars against Genoa in the 14th century. The wars brought the stock of debt under the Monte Vecchio from 154,000 ducats when it was established to over 500,000 ducats after the conclusion in 1299 of one of the many wars with Genoa. The debt pile grew to just over 1 million ducats by 1314 though three decades of peace allowed some repayments to be made on the bonds, bringing the ‘Old Mountain’ of debt back down to 423,000 ducats by 1343.
The Venetian Monte Vecchio introduced a new asset class to late-medieval European investors. Investments in the Old Fund were used to finance retirements and endow charities. However, these were the early days of the sovereign bond market and there were risks. For the first century following the restricting of 1262, the state continued to pay its 5% interest continuously and there were no losses in principal. However, prices for the bonds were about to get very volatile. Venice’s frequent wars, including those fought against Genoa, caused the stock of public debt to surge in the late-1370s, prices fell from 90% of face value to 18% as the public debt reached 4.7 million ducats. The plunge was prompted by a suspension of interest payments in 1378 that lasted until 1382.
Though credibility in the Monte Vecchio was damaged, it was not irreparably ruined. In 1389, there was a second restructuring of Venice’s debt. This time, a sinking fund was established, and funded with increased customs duties, in order to gradually retire portions of the debt on a less discretionary basis. The sinking fund led to a small amount of debt paydown during the subsequent decade, restoring credibility and raising prices on the prestiti to over 60% of face value. However, wartime deficits continued to do more harm to the state’s finances than periodic principal payments could repair. New wars in the early 15th century, some against a new foe, the Ottoman Turks, caused debt to balloon still further, to 9 million ducats by 1428. Bond prices fell back below half of face value.
By this point, the Monte Vecchio was increasingly beyond repair. Interest payments were frequently missed in the 1400s and interest payments on the bonds was cut unilaterally for secondary holders. Faced with this blatant disregard of earlier promises, by 1440, money locked in the Fund was trading hands at a mere 18.5% of face value. Expensive wars continued to be waged against the Ottomans in the 1460s and 1470s, further encumbering the public finances. Interest by this point was significantly in arrears. Some payments due in the 1470s were not received until decades later, in the subsequent century.
As was mentioned earlier, the Monte Vecchio was later complemented by new series of bonds in order to move on from past failures. These new Monti formed a mountain range of debt, with nearby peaks far younger but growing fast. For example, in a third debt restructuring, the Monte Nuovo was created in 1482 to finance a war against the Duchy of Ferrara. Under this series of new prestiti, interest payments were secured by new taxes.
However, prices for the new bonds fell much like they did for the old ones. They lost value during and after continued wars against the Ottomans at sea and against the French on land in Italy. A great defeat against a French army at the Battle of Agnadello in 1509 took the prices on the Monte Nuovo bonds down to 40% of face value. Uncreatively, the next series of prestiti was christened the Monte Nuovissimo, created in 1509, when the bonds of the Monte Nuovo became as depressed as those of the Monte Vecchio were a few decades earlier. This was not enough though; when each of these series were trading at massive discounts to face value, they were supplemented by still a newer series. The Monte di Sussidio, created in 1526, replaced the Monte Nuovissimo. By this point, the remaining bonds of the old Monte Vecchio were trading at under 10% of face value.
Perhaps it was the willingness to raise forced loans that encouraged bad fiscal habits in late-medieval Venice. It also helps explain the rock bottom prices of old issues in the secondary market. New forced loans depressed prices for old ones as people had to liquidate to fund their new subscriptions. This was a weakness in the system of forced loans; being able to disregard market forces with impunity by forcing subscriptions was likely to degrade the fiscal credibility of the bond issuer. The practice was no doubt morally questionable; those forced to participate in the loans wondered why it was that they had to pay face value for the bonds while secondary market purchasers could purchase the same prestiti at depressed prices. The scheme went on though and the Monte Vecchio was not completely redeemed until the late-16th century.
Whatever its faults and ancient peculiarities, there was something modern about the Venetian system of public debt. For one, a secondary market in sovereign bonds, at least one in which detailed records survive to today, was not something ubiquitous in medieval finance. Indeed, it was an invention of late-medieval Italian city-states. So, whatever its peculiarities, including the state’s frequent use of forced loans, there were similarities. Bad borrowers requiring frequent debt restructurings are not unknown to investors in dodgy state bonds today. They have their antecedents in the first issuer of modern sovereign bonds in Northern Italy centuries ago.
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1. “Chapter 11: The Commercial Revolution of the Resident Merchants.” Venice and History: the Collected Papers of Frederic C. Lane, by Frederic Chapin Lane, Johns Hopkins Press, 1966, pp. 136–154.
2. “Chapter 11: Venice’s Monte Vecchio, An Overview.” The Venetian Money Market: Banks, Panics, and the Public Debt, 1200-1500, by Reinhold C. Mueller, John Hopkins University Press, 2019.
3. “Chapter 8: Bonds and Government Debt in Italian City States, 1250-1650.” The Origins of Value: the Financial Innovations That Created Modern Capital Markets, by William N. Goetzmann and K. Geert. Rouwenhorst, Oxford University Press, 2005.
4. Fratianni, Michele, and Franco Spinelli. “Did Genoa and Venice Kick a Financial Revolution in the Quattrocento?” Working Papers 112, Oesterreichische Nationalbank (Austrian Central Bank), Jan. 2007.