Despite ongoing geopolitical tensions, higher borrowing costs, and persistent supply disruptions, global stock markets remain surprisingly buoyant. Many major equity indices are trading at or close to record highs. This can feel reassuring, but as economist Hyman Minsky famously observed, long periods of market calm can encourage complacency. When stability appears guaranteed, investors tend to take on more risk, often by piling into the latest financial innovation that seems too good to fail. History offers a warning: these periods of confidence can precede painful corrections.
To explore that dynamic, we look at two very different but surprisingly connected events: the Global Financial Crisis of 2008 and the Stop of the Exchequer in 1672. This is the first in a two-part series; in our next piece, we turn to the Dutch Tulip Mania to further explore the relationship between speculative assets, ‘bull runs’ and risk.
Sovereign Spending and Private Credit
After the monarchy was restored in 1660, Charles II returned to power with grand ambitions – a luxurious court, expansive naval projects, and costly wars with the Dutch. Charles II’s revenue was, however, restricted by Parliament, which controlled taxation. With tax income insufficient and Parliament hesitant to give additional support to fund military adventures, the King turned to private lenders.
Charles II turned to goldsmith bankers, the City of London’s earliest financial intermediaries. These men, whose vaults held gold and issued notes, soon evolved into the king’s de facto financiers. They lent to the Crown in exchange for Treasury Orders. These Treasury Orders functioned as proto-government bonds. Goldsmith bankers would purchase Treasury Orders, injecting the royal coffers with liquidity, on the promise that they would be repaid from future tax revenues.
The yields on these Treasury Orders were huge, ranging from 10%-30%, and for the bankers, who were paying only 6% interest to depositors, the gap between what they earned and what they paid out represented an undeniably attractive profit margin. So, the bankers, taking full advantage of fractional reserve banking, poured in their depositors’ money to buy Treasury Orders, collecting the surplus yield as pure profit.
Charles II’s sovereign debt was also readily transferable and so relatively liquid. Goldsmith bankers could trade these Treasury Orders between themselves or onward down the chain to other investors, who were happy to purchase what was viewed as a high yielding, liquid, and low risk asset.
Packaging Risk
This 17th-century network of financial obligations shares similarities with the mortgage-backed securities—Collateralised Debt Obligations (CDOs)—that played a central role in the 2008 Global Financial Crisis. At the heart of both systems was the practice of pooling future income streams to raise capital upfront. In the 1600s, these income streams were future tax revenues collected by the King, bundled into what one commentator, Professor Moshe Milevsky, has helpfully referred to as “Collateralised Treasury Obligations” (CTOs). In 2008, the bundled payments came from homeowners’ mortgages, packaged into CDOs.
In both cases, these financial instruments were seen as safe and highly attractive: they offered steady returns, were widely traded, and appeared to be backed by dependable income sources. But this perception masked the true vulnerability in the system. Investors failed to fully account for the systemic risk: that the ultimate payer (the Crown or homeowners) might default.
Collapse & Contagion
By 1671, the goldsmith bankers became weary of funding the King’s spending and refused to purchase further issues. Faced with no increase in revenues from Parliament or cash injections via bankers, the King had to find a way to either raise more capital or cut costs. The King chose the latter. In 1672, Charles II announced that he would stop payments on Treasury Orders for one year. In essence, the King chose to default on his debts. The consequences were swift and brutal for the bankers.
The yields promised to the bankers disappeared and with it the easy means to meet their 6% interest payments to depositors. In the secondary market, the value of Treasury Orders collapsed and so the goldsmith bankers and investors were left holding worthless assets. Depositors rushed to withdraw their funds, but the banks, fearful of a run, froze deposits igniting public anger. King Charles threatened the bankers with prison if they did not return depositors’ funds immediately.
Ruin & Reform
Many prominent bankers ended up in debtor’s prison, and most of the goldsmith bankers went bankrupt, acting as the precedents for Lehman Brothers and Bear Stearns. The crash of 1672 did, however, leave a legacy in the form of the Bank of England. Twenty-One years later William III, trying to raise money for his wars against France, once again went to the goldsmith bankers who, unsurprisingly cautious of sovereign debt, denied his request. In 1694, William Paterson, a Scottish merchant, proposed a bold solution to the crown’s financial woes: members of the public could lend £1.2 million to the state in return for 8% interest. To further attract investment, the new ‘National Bank’ offered something uniquely appealing: assurance that deposits held within its vaults would be protected from royal interference. While the bankers of the 2008 crisis were bailed out, the credit crunch prompted reform of the financial system that similarly promoted increased safeguards and transparency.
The Stop of the Exchequer isn’t just a quirky episode of 17th-century finance. It reveals enduring truths: leverage magnifies risk, political defaults destroy trust, and without institutional safeguards, booms centred around the popular financial instrument of the day can spiral into systemic busts. From Charles II’s default to the crash of 2008, the lessons remain familiar.