Lessons from history II: The “Thirty Maidens of Geneva” and the French Revolution

One of the main causes of the French Revolution was a crisis of public debt. Unlike England, 18th century France never managed to balance its budget, which led to several sovereign defaults. In 1789, Louis XVI, who had committed himself never to default, chose to summon the Estates General in order to find new resources. This was the beginning of the French Revolution.

The old way to fund a deficit

It is also where the small girls of the Swiss bourgeoisie come into play. How? The standard form of public debt at the time was the life annuity. The buyer, or annuitant, pays a lump sum to the State, and in exchange he receives a given percentage of that sum every year until he dies. You lend 100 to the State in 1700, and you receive 10 every year until death. Around 1690 already, the rate paid to the annuitant depends on his age. The older you are when you buy the annuity, the more you receive every year, in order to balance the income on a lifetime. For the State, the cost of the annuity is more or less the same, whatever the age of the buyer.

Around 1760, for several reasons which are still discussed in literature, the French government decided to come back to the more basic technique of “fixed-income” annuities. This means that whatever the age of the annuitant, they would receive the same amount until their demise. At the beginning, this was not a problem because most buyers were adults. Life expectancies were shorter than now and the fixed rate was calculated to correspond to the rate that was applied to a 50-year old buyer in the previous system.

Tricks and loopholes

But in 1771, Geneva banks realized that there was nothing preventing from buying annuities in other people’s names. In fact to receive annual payments, you had to prove that you were still alive. Life certificates were expensive, so a lot of people chose to buy annuities whose lifespan would correspond to that of a famous person. When he was executed in 1793, £400,000 of annuities relied on Louis XVI’s life. Banks exploited another loophole by involving young girls between 4 and 7 (most child diseases hit between 0 and 3 years old, so the life expectancy of a small child is superior to that of a newborn). Annuities were placed in their names. Banks even paid those girls follow-up care… Marc Cramer tells us that when boys were used, “it went as far as offering them small pensions, in exchange for a commitment not to leave the country and not to opt for dangerous careers, like military service abroad”. There is nothing like the quietness of Swiss mountains to keep you healthy…

Securitisation

Smart as they were, Swiss bankers pushed the mechanism even further. “To diminish the risks of losses by accident, the banker would choose a certain number of ‘heads’, 30, 40, 50, 60 (the most common was 30, hence the name of the ‘Thirty Geneva Heads Loan’)”. Annuities from several different people, or heads, were packaged into a single financial product, which was then divided into shares and offered to clients. Sound familiar? It is the same mechanism as mortgage securitisation**, the allegedly revolutionary technique that provided the raw material for the subprime crisis. The technique became ‘revolutionary’ in another way, as we shall see.

Annuities were put together into a single vehicle, and then shares of the vehicles were sold. If one child passed away, risk was limited because other annuities would still earn. Shareholders of the vehicle still got their money, and profit was certain, or so the theory went. In this case, the trick worked fine until 1797 when, exhausted by revolutionary wars, the French State eventually defaulted and wrote down two thirds of its debt. In the more peaceful 21st century version, it was the end of a housing bubble that broke the spell, when too many borrowers could not pay at once.

Lessons from history

Today, securitisation is back in the news as policymakers try to get more credit into the economy and banks try to re-open a profitable market; for example the securitisation of SME loans features heavily in the European Commission’s recent Green Paper on Long-term financing.

In Finance Watch’s view, any revival of this technique should keep the lessons of history in mind. The lesson from the subprime crisis is that securitisation should be done with very limited leverage, maturity transformation and no principal–agent problems. The lesson from the Geneva scheme is that securitisation can change the nature of an investment, inducing moral hazard. Instead of a personal bourgeois investment, annuities became a tool of massive institutionalized speculative investment, putting public finance at risk.

Back to 1782. Three quarters of the annuities issued then are estimated to have been placed in the name of small children. French banks (and possibly individuals) had massively imitated the Geneva scheme. The little trick thus contributed to the rise of the debt burden and indirectly to the fall of the Ancien Régime.

Today’s debt burden is less dramatic. But financial history is full of surprises. Who would have thought that the first revolutionaries were the small girls of the Swiss bourgeoisie?

Fabien Hassan