Governments are usually able to borrow on terms at least as favorable as any available to individuals or companies. So long as they are not too indebted, their ability to tax subjects is something creditors are quite often happy to lend against. In the 19th century, numerous countries began to issue longer-term debts in bond form for the first time. However, not all governments had it so easy. Those whose very sovereignty was in question rarely found an abundance of eager creditors. This was precisely the tepid response the Republic of Texas encountered in credit markets soon after its independence. The new country had a rocky fiscal start.
Slow Beginnings
The Republic of Texas declared its independence from Mexico in 1836, after a brief war of independence, and just a year before the Panic of 1837 began in the United States. The financial panic that coincided with the birth of the new country made the already difficult task of finding lenders for the new government even more arduous. In the mid-1830s, the country had virtually no revenues at its disposal and so was in arrears on its debt payments almost as soon as it declared independence.
While its tax system was being implemented, the Texan government relied on patronage from locals and supporters in the United States. In 1839 and 1840, to complement what little it could raise in loans, the government increased its issuance of Treasury Notes, a form of banknote also known as ‘red-backs’, first issued in 1837. The notes helped fund a government deficit but, overprinted, they eventually became close to worthless. Indeed, the government soon after abandoned its own currency. The notes’ legal tender status for payment of certain taxes was revoked after January 1841 and they traded at between eight and eleven cents on the dollar by January 1842.
Local Borrowing
In search of more formal financing arrangements, the Texans looked locally and to the United States for willing lenders but like most new ventures found relatively few. The Congress in Texas approved a 10% interest bond secured by public lands and certain tax revenues but found no bank willing to place the loan. That loan would have even allowed bondholders to convert their securities for land at a fixed rate but even that inducement was not enough to sell the issue.
In one of their few successes, just over $450,000 was raised in a loan from the Bank of the United States in Philadelphia in 1839. Where there were lenders, their pricing demands were exorbitant. A bond offering in 1840 saw an issue with an 8% interest rate sell at a 75% to 85% discount, meaning the Texan government received just twenty cents or so on a promise to repay a dollar with interest.
Despite the very poor terms, and perhaps because of them, the government of Texas continued to borrow at a fast pace to finance rising administrative and military expenses. Though the country was mostly at peace, Mexico had not yet recognized its rouge territory’s independence, distracted at the moment by its other wars and rebellions then underway, including against France and other breakaway regions.
Texan public debt rose from $1.25 million in 1836 to almost $7.5 million in 1841, most of this accumulated during the administration of independent Texas’s second president Mirabeau Lamar, successor to Sam Houston, from 1839 through 1841. In addition, there were in 1841, almost $3 million in non-interest-bearing red-backs outstanding.
The low prices at which bonds were issued helped increase the debt faster than expenses alone could have explained but there were other ways in which the poor credit of the Republic made its situation worse. As just one example, in 1838, a contract was made with a Baltimore firm for the purchase of two ships for $280,000, payable in one year. The contract stipulated that if the payment was not made in time, the price of the ships would double. Sure enough, the payment was missed and two 10% bonds of $280,000 each that were offered as security were forfeited.
Foreign Borrowing
Unable to raise substantial loans on reasonable terms in America, the Republic turned to Europe. Demand in Europe for American securities had been high but times had changed. Appetite for American bonds in Britain dwindled in the aftermath of the 1837 financial crisis. The state of Pennsylvania had defaulted on its bonds in London and the bonds of other states were selling at steep discounts. Several other American states would default on their debts between 1841 and 1842.
Recognizing the unfavorable environment in Britain, General James Hamilton, a former Governor of the state of South Carolina, was tasked with raising a $5 million loan for Texas in France. To help sell the deal, Hamilton was also given authority to grant some tariff concessions to the French, perhaps with an eye for encouraging the French government to purchase the entire issue. In the end, the French bank of Messrs. J. Lafitte & Co. agreed to sell the bonds, with French government approval, but at just 50% of face value. Nonetheless, the Republic of Texas had gotten used to terms even worse than these.
Everything looked set but the bank and the French government reversed course, partially because of a negative report provided by the representative of the French government in Texas. The offering was halted and the effort to raise a loan in Europe was abandoned.
In the early 1840s, whether because of a scarcity of willing lenders or the return of the more conservative administration of Sam Houston, the Texan government began to cut spending and the debt grew more slowly thereafter. In any case, by 1845, the Texan 8% bonds, long since in default, were trading at as low as three cents on the dollar. During the mid-1840s, ownership of these defaulted bonds and red-backs shifted from the hands of locals towards speculators, especially in the eastern cities. Reflecting this transition, the center for trading in Texas bonds moved from the relatively nearby New Orleans to distant Philadelphia and New York.
Annexation and Settlement
The speculators buying up the Texan securities were looking for a rescuer and that rescuer came in the form of the United States government. The annexation of Texas by the United States in 1845 ended Texan independence but supported the prices of Texan bonds. Annexation made far less likely any reconquest by Mexico. Nevertheless, repayment of the bonds at face value, or anything close to face value, was still uncertain. The American federal government did not guarantee the debts of its states.
In a larger legislative arrangement known as the ‘Compromise of 1850’, the state of Texas received a $10 million payment in exchange for adjusting its claimed state boundaries to a less westward reaching line. However, half of this sum would be withheld until the state made progress towards repaying its old debts. This legislation continued the sharp recovery in bond prices, taking Republic of Texas bonds from four to five cents on the dollar to fifty cents. Prices rose still higher from there when a final settlement of the defaulted bonds drew closer.
In the meantime, any settlement needed to be approved by the Texan state government. Many in the state, including its governor, Peter Hansborough Bell, argued against a redemption at face value of the bonds the formerly independent country had issued at far lower prices. Local politicians knew that by now, most of the debts were owned by distant speculators and not their original holders. ‘Foreign’ speculators, as the new eastern holders of the bonds were known, were not particularly popular with the locals who saw a settlement of the debt at par value as too generous. James Hamilton, previously hired to raise loan for the Texans abroad, was now employed as a lobbyist for the ‘foreign’ creditors.
The state legislature was also keen on simply writing off large parts of its debts, especially those issues held mostly by non-locals. The legislature approved a scheme in 1852 whereby debts were to be repaid at a rate that mirrored the depreciation of the local currency, so that earlier issues, more likely to still be held by locals, would receive a larger repayment than later issues preferred by speculators.
The discord between bondholders and the state of Texas continued. Creditors tried to block the state from granting land to railroad developers, arguing that the land formed part of the security for their bonds. Creditors were also accused of bribing American congressmen to vote for a bailout, offering them at low prices Texas bonds and scrip that would appreciate considerably if redeemed.
Perhaps with the aid of this inducement, in 1855, an act passed by the American Congress appropriated $7.75 million to repay bondholders. The bailout by the federal government was, unsurprisingly, approved by the Texas legislature the following year. Like the bonds, the red-backs also benefited from the debt settlement. Holders were repaid at 76.9 cents on the dollar, prices for the red-backs that were six or seven times greater than the nadir of their valuation over a decade earlier. By the time of the bailout, Texan debt was held by very few investors. Only 647 parties received redemption payments, with most of this distributed to just sixteen entities which held most of the bonds. The redemption of 1856 brought an end to the story of the independent Republic of Texas’s public debt.
Lesson
Texas was bankrupt when it was incorporated into the United States. It was not the only American state to have encountered financial difficulties in the 1840s though its story is, of course, unique among them. The eventual repayment of Texan debts is a case study in the political complexities of sovereign debt settlement. Despite being a somewhat creditworthy country, it was not a given that the United States would repay Texan debt, as individual American states have largely been regarded as responsible for managing their own indebtedness. The Texans themselves viewed the debt as being issued on unconscionably onerous terms and repayment as a boon to undeserving speculators. Nonetheless, the debt was voluntarily settled on terms relatively friendly to bondholders, evidence of the power of threatened reputations, and perhaps effective lobbying, to make creditors whole.
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Further Reading
1. Brown, Charles W. “Funds for the Republic, A Saga of Wine and Swine.” East Texas Historical Journal, vol. 4, no. 2, 1966, pp. 107–115.
2. Burdekin, Richard C.K. “Bondholder Gains from the Annexation of Texas and Implications of the US Bailout.” Explorations in Economic History, vol. 43, no. 4, Feb. 2006, pp. 646–666.
3. Miller, Edmund Thornton. A Financial History of Texas. University of Texas, 1916.
4. Pecquet, Gary M., and Clifford F. Thies. “Texas Treasury Notes after the Compromise of 1850.” The Independent Review, vol. 13, no. 3, 2009, pp. 411–429.
