In 1840, the state of Mississippi defaulted on interest payments on $2 million of Planters Bank bonds and $5 million of Mississippi Union Bank bonds. At about the same time, seven other states and one territory subsequently granted statehood defaulted on their debts (McGrane 1935; Ratchford 1941; English 1996; Wallis, Sylla, and Grinath 2004), as did the Republic of Texas, later annexed as a state (Pecquet and Thies 2006, 2007, 2009). Most of the states subsequently reconciled with their creditors--for instance, by resuming interest payments and funding interest arrears--and furthermore adopted constitutional restrictions on indebtedness (Thies 2002, 248-50; Dove 2012). Mississippi, however, proceeded to repudiate both issues of bonds and to undermine the private debts due to its banks. With respect to state bonds, why did Mississippi not reconcile with its creditors? With respect to private debts, Mississippi was apparently prohibited by the U.S. Constitution from interfering with these contracts, so how was it able to nullify them? Examining this episode of repudiation exemplifies the importance of institutional arrangements for the protection of debt.
An early literature argued that the value of continued access to foreign capital might be sufficient to motivate sovereigns to repay debt (e.g., Eaton and Gersowitz 1981). Jeremy Bulow and Kenneth Rogoff (1989a, 1989b) challenged this view, arguing that, under very general conditions, reputation alone is not sufficient, so that some form of sanction might be necessary to induce repayment. Douglass North and Barry Weingast (1989; see also Weingast 1997) explore the development of institutional arrangements to assure creditors of repayment and thereby to enhance the ability of sovereigns and private parties to borrow, given that reputation alone might not be sufficient to motivate repayment. Among the institutional arrangements they discuss is an independent judiciary.
William English (1996), examining the experience of the American states that defaulted during the early 1840s, found that those with lower per capita debt burdens tended to resume debt payments and fund interest arrears, whereas those with higher debt burdens tended to settle with creditors at less than the face value of their debt or repudiate. Curiously, Mississippi had a relatively light debt burden, yet it repudiated its debt. These findings might be taken to indicate that reputation may usually be sufficient to induce sovereign debt repayment if the debt burden is relatively small and to highlight the exceptional characteristic of repudiation in the case of Mississippi.
In 1841, soon after Mississippi defaulted, the state legislature passed an antirepudiation resolution. But in the next election the composition of the state legislature was dramatically changed, and a pro-repudiation resolution was supported by large majorities in both chambers (Brough 1900, 336-37). As developed in this essay, the executive and legislative branches of the state government then engaged in a war against the state's banks. Against the popular sentiment, the judiciary proved insufficient. Significantly, by reason of the Constitution of 1832, judicial offices were made elective. No longer would jurists enjoy lifetime appointments, but circuit court judges would be elected to four-year terms, and the three justices of the state's supreme court (the High Court of Errors and Appeals) would be elected to overlapping six-year terms.
During the nineteenth century, nations that defaulted on their international debts put themselves at the risk of invasion. Such an invasion and threats of the same are referred to as "gunboat diplomacy" (Mitchener and Weidenmier 2005; Weidenmier 2005). Michael Tomz (2007), examining three centuries of sovereign-debt repayment, finds that reputation as opposed to sanctions better explains why some nations repay. Ugo Panizza, Federico Sturzenegger, and Jeromin Zettelmeyer (2009) review the literature on sovereign debt and default, concluding that we have not yet satisfactorily resolved the issues involved.
J. F. H. Claiborne tells of a debate between a pro-default Mississippi Democrat and an antidefault Democrat in 1843. The antidefault Democrat spoke of British cruisers off the shores of the state. At this point, a member of the audience spoke. "Sir, in that event I join my countryman who opposes the payment of the bonds. My sword ... sir, the last drop of my blood, shall be spent in resisting the demand. My state, sir, may she be always right, but, right or wrong, the state, sacred, intangible and profane, forever" (1860, 208). In the U.S. Congress in 1843, former president John Quincy Adams, a Whig, offered a resolution that would deny to Mississippi the protection of the federal government in the event the state was invaded by its creditors: "[I]n the event of such a war, the State involving herself therein will cease thereby to be a State of this Union, and will have no right to aid in her defense from the United States, or any one of them" (qtd. in Scott 1893, 243-44).
Whether to preserve the peace or to maintain the credit of the United States, some advocated a federal assumption of state debts. In 1841, U.S. senator Henry Clay of Kentucky, also a Whig, who described a federal assumption of state debts as "wicked," nevertheless proposed that the federal government use the distribution of funds from land sales and from taxes on the importation of luxuries to help states reconcile with their creditors (Seager 1988, 491-92). At a later time, Clay included a scheme to resolve the debt of Texas as part of his proposed Compromise of 1850. Mississippi, like Texas, might have required special consideration. And because Mississippi seemed special, some thought that were the other states to reconcile with their creditors, the state of Mississippi might be treated as a pariah within an otherwise creditworthy United States and so would not be invaded (Austin 1842). Looking back, we know that invasion by creditors was not used to induce Mississippi to reconcile with its creditors. Nevertheless, the question remains: Why were institutional arrangements not sufficient to guarantee repayment?
The rest of this article is organized as follows: the next two sections detail the events concerning the repudiation of the Mississippi Union Bank bonds. The third section places Mississippi's problems into the context of the Panic of 1839. The fourth section examines the undermining of the private debts owed to the state's banks. Finally, the article turns its attention to the depressed economic conditions that followed Mississippi's bank war and the broader implications of these events.
Mississippi's Banking Orgy
During the early to mid-1830s, the states, in particular Mississippi, were increasing the number and authorized capital of their banks in conjunction with the expiration of the charter of the (Second) Bank of the United States. Mississippi entered the 1830s with one bank. By 1837, it had fourteen, six of which were to use their banking powers to promote railroad construction. During 1838, another nine banks were organized, four of the new banks being railroad banks and one a waterworks bank (Weber 2006). From numismatic sources, it is known that at least a half-dozen note-issuing unincorporated banks, such as the Real Estate Bank of Hinds County, sprang up (Leggett 1975).
During this time, prices of cotton, commodities in general, land, and slaves were rising. Because banks were specie paying through early 1837, this rise of prices was befuddling. "Everyone is at loss to account for the high prices of ordinary articles of living" (Natchez Free Trader, hereafter FT, November 17, 1836). "Why is it, said a planter to his friend not long since, that every species of commodities has risen to double its former value; that now I cannot buy land, or Negroes or provisions, or indeed anything else without paying double the sum that I did three years ago?" (FT, February 2, 1837). Then in May 1837, all the banks in Mississippi suspended specie payments (FT, May 23, 1837).
For a long time, the accepted explanation of the inflationary boom of the 1830s was the state banks' easy-money policies. In real time, the New York Journal of Commerce (May 3, 1837) blamed the gathering panic on speculation in land along with actions of the Bank of England, state indebtedness for public works, the distribution of the surplus revenue by the federal government, the prohibition of small bills by New York and several other states, the weakened condition of the financial institutions of New York due to the fire of 1835, and the winding up of the Bank of the United States. President Andrew Jackson's specie circular (which required that federal land purchases be paid in gold or silver) or his distribution of the federal surplus or both then served as the precipitating cause or causes that pricked the speculative bubble and ushered in the ensuing hard times (see, e.g., McGrane 1924; Hammond 1957; Timberlake 1960). Following Peter Temin (1969), we should consider the possibility that international developments were the root causes of the inflationary boom. More recently, Peter Rousseau (2002) has argued that the specie circular and the distribution of the surplus were crucial insofar as certain transfers of funds were the proximate cause of the suspension. Whatever the root causes of the inflationary boom or the precipitating cause or causes of the bust, the suspension of specie payments was accompanied by deflation and a suddenly increased burden of debt repayment.
Figure 1 presents an index of commodity prices in Mississippi during the period of this study. It shows the run-up in prices that preceded the Crash of 1837 and the fall in prices that occurred in conjunction with that crash. Relief from this deflation in Mississippi and in several other states was to be provided by the chartering of additional and much...