Credible commitments and constitutional constraints: State debt repudiation and default in nineteenth century America

Abstract

Between 1839 and 1842 the United States suffered through an acute debt crisis. Over this period, eight states and one territory defaulted, five of which outright repudiated all or parts of their outstanding debts. However, for many of those same states, reentry into capital markets occurred relatively rapidly and at rather favorable terms. The question then arises, how and why was this possible? This work attempts to explain this phenomenon by suggesting that soon after default or repudiation many states enacted constitutional amendments meant to significantly constrain and credibly commit future governments from overextending credit and simultaneously to pursue time-consistent public policy. I explore this by examining the impact that these newly imposed constitutional amendments, which limited both the type and amount of debt and created stronger procedural safeguards for issuing debt, had on average bond prices, gathered from New York market data. Overall, my results show that newly constrained states had higher average bond prices than states that did not impose constitutional limits on debt financing, suggesting that markets did, in fact, perceive these constitutional changes to be binding and credible. © 2011 Springer Science + Business Media, LLC.