Securitizations are often regarded as innovations of modern finance, products of the last three decades and not the last three centuries. In fact, pooling financial assets together and selling tradable instruments backed by that pool is not so novel a practice as one might think. Over two centuries ago, bankers were pooling life annuities, contracts stipulating payments contingent on someone’s lifespan, into primitive securitizations. These annuity pools even helped fund a great part of the public debt of France, one of the most indebted countries at the time. Of course, this meant French debt was not a particularly good credit and these annuity pools suffered accordingly. Regardless though, these historical securitizations stand as a testament to the financial ingenuity of financiers in ages past.
French Deficits
France in the 18th century was a fiscal basket case. Whereas governments with excessive debt burdens would usually be wise to adjust revenues and expenses accordingly, the French state preferred tinkering with the composition of the debt instead. The 1700s saw three French sovereign defaults. The first one came in 1713-15 during the War of Spanish Succession and others in 1759 and 1770, during and shortly after the Seven Years War respectively. Naturally, large state expenditures during the American Revolutionary War did not help matters either.
Sovereign defaults were not the only remarkable trend in French debt in this period. There was also a sharp change in the nature of state borrowing. The debt gradually evolved from being composed of short-term bills to comprising life annuities and perpetuities. Life annuities (rentes viagère) had peculiar appeal, namely, the difficultly in conceptually separating the interest and principal components of the obligation. This allowed the French state to obscure its borrowing costs, useful in any era but particularly so in an era when usury still carried stigma. Meanwhile, borrowers believed that this ambiguity would protect them from the unilateral interest rate reductions that characterized earlier defaults. Indeed, life annuities were relatively unscathed by the earlier nonpayments.
Under the annuity scheme, the beneficiary would pay the French government a large initial sum and received the promise of semiannual payments for life. In this way, an insurance product was being utilized as a form of debt financing. At first, the size of the future annuity payments sensibly varied based on the age of the beneficiary. Younger buyers received smaller payments than older ones given their longer remaining lifespans.
Accounting for average lifespans during the 18th century, these annuities carried implied annual interest rates of at least 6-7%. They would eventually climb to 10% per year as French government borrowing grew. Indeed, the need to finance larger deficits led the state to throw prudence out the window. In 1757, annuities began being offered that paid out a flat sum regardless of the buyers age; thus, a 20-year-old beneficiary received as much in annual payments in exchange for his lump sum as someone forty years older.
Further, the beneficiary need not have been the same person as that on whose life the payments were contingent. That is to say someone in 18th century France could have bought an annuity from the state whose payments were made according to the lifespan of a younger or healthier third person. Since someone could pick their young child for this purpose, the implied interest rates underpinning these annuities were very generous by historical norms.
Intriguingly, because buyers had to go through the trouble of documenting the survival of this third person to continue receiving the annuity, many picked famous people as the referenced life. This was done on the premise that the beneficiary wouldn’t need to prove the continued survival of someone everyone knew to be alive. Those in line for royal succession were often chosen for this purpose. Indeed, many annuities were said to have been extinguished when King Louis XVI was beheaded in 1793. Regardless though, it was estimated that only one-third of the state annuities sold in this period were actually bought by ordinary pension seekers. The vast majority referenced lives other than that of the purchaser, as one would expect considering the financial incentives involved.
Among the larger purchasers of the French state annuities were the banks of Geneva. In the late 18th century, the Swiss city was one of Europe’s premier financial centers. The firms there benefited from the friendlier banking laws in Protestant Switzerland than could be found in Catholic France. Indeed, the city’s government even enacted the first Swiss bank secrecy laws in 1713.
Although, it could not have hurt that Geneva’s bankers had earned a reputation for their own wealth, sobriety, and financial acumen. When it came to calculating the value of life annuities, the Swiss could also leverage the work of their own Daniel Bernoulli. The Swiss mathematician, scientist, and statistician had collected lifespan data in the 1760s to prove the effectiveness of the smallpox vaccine. This work came just in time. In 1763, a Swiss banker named Jacob Bouthillier Beaumont came up with the idea of buying annuities contingent on the lifespans of children, pooling them, and then selling tradable shares against them.
The Thirty Maidens
This approach to capitalizing off French profligacy took off in the 1770s. Of course, any investment linked to the life of one person is bound to be risky. So, to diversify this risk away, Genevan bankers bought annuities contingent on the lives of several children, mostly young girls. High infant mortality meant that girls between the ages of five and ten were the best bet. They would be further screened for good family histories of longevity. The bankers then selected girls who had already survived smallpox or who, after the smallpox vaccine was introduced, had been vaccinated against it. Life annuities were then purchased against their lives.
To achieve diversification, these annuities were packaged into pools of roughly thirty, giving these schemes the name ‘Thirty Maidens of Geneva’ (trente demoiselles de Geneve). Thus, if one referenced person died, just 1/30th of the income to the pool was lost. The bankers figured that thirty was a large enough number to provide diversification without making the transaction’s costs uneconomically high; recall that each person’s survival had to be documented in order to receive the annuity payments. In a further innovation, these pools were divided into pieces and sold to investors. This transformed the annuities into negotiable securities, tradable on a secondary market, overcoming the liquidity constraints of ordinary annuities. When it came to maximizing the longevity of the referenced lives, the schemes worked; one pool achieved an average lifespan of 63 years, greater than lifespans of the era would have predicted.
In fact, so great was the financial interests at stake that these children’s healthcare expenses were paid for and investors even followed reports of their health in newspapers. When one of these girls, Elizabeth Pernette Martin, died at the age of eight, over 200,000 livres in income tied to her life was extinguished. Consider that an individual income of a thousand livres would have already been above average for the time.
These annuity securitizations were not niche financial products. In the 1770s and 1780s, the Genevan annuity pools were buying up as much as 30% of some state annuity offerings, though they almost certainly bought less than a quarter of the offered annuities on average. Nonetheless, considering that annuities made up 30% of the sovereign debt at the time, these early securitizations were an important part of French public finances in the late 18th century. As such, they were particularly exposed during the tumultuous French Revolution, brought on in large part by over-indebtedness. On the eve of the Revolution, debt service made up 65% of the state budget. Thus, France was poised for another sovereign default as the century came to a close. First, the annuities were redenominated into increasingly worthless money. This was followed by missed payments and, in 1797, the French state’s cancellation of two-thirds of its debt. With that, this chapter in the history of financial innovation came to a close.
Lesson
Though they came to an abrupt end with the last French sovereign default of the 18th century, annuity securitizations still had a good thirty year run up until then. Of course, no financial derivative can completely detach itself from the credit risk of the underlying asset it tracks and given its propensity to default, the French sovereign was hardly a good credit. Performance aside though, the Genevan annuity pools are a surprising example of what financiers were capable of in supposedly simpler times. Bankers in 18th century Geneva had to manage without the efficiencies of modern finance. However, opportunities to execute complex deals still abounded where investment opportunities were enticing enough. Imprudent and peculiar borrowing practices created an obvious opening for creative financiers to structure products that both earned high yields and diversified out the idiosyncratic risk tied to individual lifespans. Those bankers’ innovations really were ahead of their time.
Further Reading
1. “Dowry Funds and the ‘Trente Demoiselles De Geneve.’” Securitization and the Global Economy: History and Prospects for the Future, by Bonnie Buchanan, Palgrave Macmillan, 2017, pp. 55–56.
2. “Handmaid to History.” Smart Money: How High-Stakes Financial Innovation Is Reshaping Our World–For the Better, by Andrew Palmer, Basic Books, 2015, pp. 20–22.
3. Hassan, Fabien. “Lessons from History II: The ‘Thirty Maidens of Geneva’ and the French Revolution.” Finance Watch, 10 Aug. 2018.
4. “The Dilemma.” A Free Nation Deep in Debt: the Financial Roots of Democracy, by James Macdonald, Princeton University Press, 2006, pp. 239–251.
5. Velde, François R. “Macroeconomic Features of the French Revolution.” Princeton University Press, 2017.
6. Velde, François R., and David R. Weir. “The Financial Market and Government Debt Policy in France, 1746–1793.” The Journal of Economic History, vol. 52, no. 1, 1992, pp. 1–39.
