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Old Money: Tossing a drachma — referendums and repudiation

The Greek Prime Minister’s decision to provide voters with an opportunity to reject the country’s bailout conditions in a referendum is an unusual move, but not without precedent.

by Professor Richard Roberts, King's College London

The State of Mississippi is the most notable instance of sovereign debt repudiation through a referendum. 

The saga began in the 1830s, with the issuance of $17m of state backed bonds to capitalise a couple of banks to serve local farmers. 

Mississippi’s state backed banks failed in a downturn in 1841, lumbering taxpayers with the burden of servicing their bonds. The securities were mostly owned by European investors, making foreigners the beneficiaries of Mississippi austerity. 

Repudiation of Mississippi’s bonds, justified by alleged sales irregularities, became a heated political issue; it was endorsed by a referendum in November 1852.

Payments ceased and protests by bondholders proliferated. Repudiation was entrenched by an amendment to the State’s constitution in 1875 to stop any further consideration of bondholders’ claims. The amendment was ratified in a further referendum by 129,000 votes to 27,000. 

Other US states also defaulted in the mid-nineteenth century; one of the nightmares inflicted by Charles Dickens on Ebenezer Scrooge was that his sound British Consols (perpetual Gilts) were transformed into US state bonds. But while other US state defaulters eventually settled with creditors, Mississippi was locked in by its referendums.

The outstanding claims of British bondholders even soured Anglo-American relations on occasion. 

US insistence after the First World War on the full payment of war debts by its former Allies was contrasted with Mississippi’s repudiations. 

Private bondholders were unable to sue a sovereign government for payment of their claims, but another state could do so.

So in 1933, a group of British bondholders managed to persuade the Principality of Monaco to sue the State of Mississippi in the US Supreme Court; the action was unsuccessful. 

Mississippi’s repudiation made it the pariah of the capital markets for 80 years, and the matter rumbled on into the 1990s when the claims of bondholders were deemed to have expired under the statute of limitations.

In recent times, Iceland has held two referendums on the payment of debts to foreign creditors. The financial crisis of 2008 led to public rescues of Iceland’s three major commercial banks. Landsbanki, the largest, had an online subsidiary, Icesave, with 400,000 British and Dutch depositors. Their claims were met by the British and Dutch deposit compensation schemes to the combined tune of €4bn. Iceland undertook to honour its international obligations and the creditors agreed to defer final payment until 2023.

But, once again, payments to foreigners stemming from the failures of bankers were deeply unpopular; a quarter of Iceland’s voters signed a petition urging the president to veto the Icesave deal. 

He put it to a referendum in March 2010. The issue became confused because in meantime the creditors made concessions that made a ‘no’ vote in the referendum the logical step for both supporters and opponents. Many voters appear to have thought that they were voting for outright repudiation, but in fact it was a vote on the terms of repayment. 

In the event, 98% voted for rejection, but it was unclear what was being rejected. The Financial Times called the referendum a “farcical piece of political theatre”.

A second act ensued in April 2011 following the president’s referral of a renegotiated Icesave deal — with full settlement deferred till 2046 — to a further referendum. This was also rejected — by a margin of 60% to 40%. The matter then headed for the courts. 

But the lawyers were overtaken by Landsbanki’s receivers, with recoveries from liquidations sufficient to repay the British and Dutch governments ahead of expectations. The experiences of Mississippi and Iceland suggest that a referendum can complicate the resolution of international debt problems, to say the least.

Recent decades have also seen another flavour of financial referendum, which built up the tottering edifice of European currency union.

In 1994, in the shadow of the Exchange Rate Mechanism crisis of 1992-93 (when the UK crashed out on "Black Wednesday"), Swedes and Finns supported EU membership while Norwegians rejected it. In 2000 and 2003, respectively, voters in Denmark and Sweden rejected joining the euro. And in 2012, Irish voters gave a lukewarm endorsement to the European fiscal compact. 

Overall, the recommendations of governments were endorsed on half these occasions — the same odds as tossing a drachma coin.

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