Budget & Tax

J. Rufus Fears | December 3, 2008

How the Founders Responded to a Debt and Mortgage Crisis

J. Rufus Fears

The year 2008 is not the first time our country has faced a debt and mortgage crisis with profound consequences for our freedom—our economic freedom, our political freedom, and even our national freedom.

In 1786, a severe debt and mortgage crisis threatened to bring down the fragile structure of republican freedom in our young nation. The wise heads of Europe believed that the financial crisis of the new United States was proof that democracy could never work.

The Founders of our country, men like George Washington, Alexander Hamilton, James Madison, and Robert Morris, responded to that financial crisis in such a way that they laid the foundation for the freedom we still cherish. The Founders did so because they learned from history. They thought historically. They used the lessons of the past as a means of making decisions in the present and planning for the future. They studied the history of the republics of classical Greece and Rome. They read Plutarch’s Lives of Solon and of Julius Caesar, and they learned how debt and mortgage crises led to the loss of political freedom in both ancient Athens and Rome.

Financial Crisis in Athens

Our current debt crisis has been brought on, in part, by the use of a most convenient medium of exchange: the credit card. So too, in Athens of the seventh century B.C., a debt crisis was brought on by a newly invented, convenient form of economic exchange: coinage.

Coinage was first invented around 640 B.C. in the kingdom of Lydia (Turkey), part of the trading network of the Greek world. It was under King Croesus, who had enormous reservoirs of gold and silver, that the coins were first struck.

The creation of coins provided a highly portable form of currency, and almost immediately it led to people going into debt. The Greeks very quickly changed from a cumbersome system of barter to the much more portable and convenient financial instrument of coins. In every Greek city-state, this transition precipitated a financial crisis. One of the sharpest of these was in Athens, and by 594 B.C. there were hundreds of Athenians who were enslaved because of their debts. First they lost property; then they put up one of their children as collateral; then a second one; then their wives; and finally themselves. And the creditors were quite rightly determined to get their debts paid.

The intense financial crisis almost led to a civil war in Athens. Instead, the Athenians stepped back and gave a mandate to one of their most highly distinguished citizens, Solon. He had traveled widely and had made a great deal of money in business, and the Athenians always thought business was a noble way to earn money (unlike some other Greek city-states, such as Sparta, which despised commerce). Solon was the great mediator. The Athenians said, “We will make you a dictator.” But Solon said, “No, I don’t want to be a dictator, but I will take broad sweeping executive powers to end this debt crisis.”

What Solon did was essentially cancel all debts and liberate all the Athenians who had been sold into slavery for their debts. Then, he went on to establish a balanced constitution which rested upon the idea that citizens voted and held office dependent upon the amount of money they had. The Athenians were divided into four economic groups. Those at the very top could hold office as well as vote, and those at the very bottom could only vote. He hoped this radical solution would bring peace to Athens; but it didn’t, because the people who had lost enormous amounts of money through the cancellations of debt formed their own political party, and, within a generation, Athens had a dictatorship that lasted for 60 years.

Financial Crisis in Rome

The second great financial debacle was in Rome at the time of Julius Caesar. This tremendous debt crisis was brought about by a global economy and the formation, starting as early as 100 B.C., of stock corporations. The Roman government farmed out the collection of taxes in their various provinces to stock corporations. This led to enormous debts being incurred, and the situation reached its breaking point in 63 B.C.

The notorious Roman nobleman Lucius Sergius Catilina was absolutely bankrupt, both morally and financially. He cooked up a scheme with a number of other debtors to start a civil war to get the intervention of a foreign power, the Gauls, to invade Italy, burn down the Senate house, and cancel all the debts. Word of this got to Cicero, who was consul that year, and it was immediately stopped. Catilina himself was put to death. But the debt crisis remained, and this led to Julius Caesar becoming dictator.

Caesar is remembered for having achieved military success over his enemies, but what gained him the confidence of the Roman people was the debt solution project he implemented in 49 B.C. It was his true stepping stone to the absolute power he sought. As part of his solution, he insisted on the repayment of debts at full value. However, the interest that had already been paid counted toward the full amount. This satisfied, in some general way, both the debtor as well as those who had loaned the money.

America’s Financial Crisis

America’s Founders were familiar with both Solon and Caesar’s stories. From these, the Founders understood that canceling debts leads to dictatorship. That’s why, in 1786, when the mortgage crisis got severe in this country, men like George Washington, Alexander Hamilton, James Madison, Benjamin Franklin, and Robert Morris all realized that the situation could lead to a dictatorship.

What caused America’s first financial crisis was that the country was enormously in debt when it signed the peace treaty with Britain in 1783. We had gained a vast territory all the way out to the Mississippi, but the question was: Could we keep it? We were trying to govern our country under the Articles of Confederation. Under the Articles, the government had the power to declare taxes, but no power to collect them. It also lacked the ability to keep up an army and could not regulate trade between the states. So, various states erected tariffs on goods from other states. Possibly most troubling was the fact that, under the Articles, we had run up enormous debts in funding the war for independence. The total debt in our country, in 1786, was around $72 million. Given inflation and the inability of a government in those days to raise money (there was no such thing as income tax), this was an outrageous amount of debt.

To make matters worse, our currency was worthless, and we had utterly no respect in economic circles in Europe, which led to no respect in political circles. Moreover, we were being pressured by France and Holland to pay the debts we owed them. Also, we weren’t fulfilling our guarantee to pay the debts of British merchants incurred during the war. It was then, in 1786, that the mortgage crisis began to spread from farms in western Pennsylvania and Virginia, to the banking houses of Boston, and to the banking houses of London and Amsterdam, creating a worldwide mortgage crisis.

In western Pennsylvania, it came about because Revolutionary War soldiers had borrowed money from the local banks or general stores just to keep their farms going while they served in the militia. They came back and wanted to pay the merchants in the scrip money they had been paid. But that scrip money, called Continental Congress money, was literally worth less than one cent on the dollar. Hence the saying “not worth a Continental.” Merchants refused to accept it as payment, so farms and homes were foreclosed on from Massachusetts to Georgia. State legislatures were gridlocked, because their constituencies included bankers, who said they wanted to be paid in gold or silver, and mortgagees, who insisted on paying with the worthless currency.

Outraged by foreclosures on the farms of men who had served bravely in the Revolutionary War, in 1786, farmers in western Massachusetts took matters into their own hands. With revolutionary war hero Daniel Shays as captain, they rose up. They marched upon the local courts, took them over, and declared their scrip money to be legal currency for paying off their debts. The rebellious farmers had planned to do what America had done to the British. They were marching to the armory in Springfield to get enough muskets and cannons and declare themselves an independent state in western Massachusetts. The rebellion was so strong that a militia had to be sent out from Boston to crush it. When word of this reached George Washington and other thoughtful Americans, they understood the desperation of these men. At the same time, they could not have the country brought into anarchy because of the debt situation. This was the impetus for the Constitutional Convention which, on May 25th, finally got started. It brought 55 delegates to Philadelphia to set up our Constitution.

Resolving the Financial Crisis

In writing the Constitution, the Founders wanted to ensure that the federal government was strong enough to enforce contracts, issue real money, prevent states from erecting tariffs against one another, and, above all, strong enough to enable a free-market economy to flourish. That Constitution, however, would have remained nothing but a historical footnote had the first Congress, elected under that Constitution, been as ineffectual as our Congresses are today.

The Congress that took its position in 1789, when George Washington was inaugurated, had to, first, draft a Bill of Rights and send it out to the states for ratification. Most of the states had ratified the Constitution only on the delegates’ word that they would establish a Bill of Rights. Then they had to draw up an ordinance for settlement of the Northwest Territory (which become states like Indiana, Ohio, Michigan, and Illinois) and the southwest territories (which would become the states of Kentucky, Tennessee, Alabama, and Mississippi). They had to provide a means for them to become states, and to do so in such a way that enabled ordinary Americans to have the equality of opportunity to own a farm if they could work it.

But the debt crisis still had to be solved. That task was taken over by the first Secretary of the Treasury, Alexander Hamilton, a man of enormous ability. He had studied at Kings College (now Columbia University). Like George Washington, he had a broad vision for this country and was a very astute financial expert, who drew heavily upon the advice of the financier and patriot Robert Morris.

Hamilton presented the following plan. First of all, the debts had to be taken care of. The U.S. owed money to foreign countries like France and Holland, as well as to merchants. Then, there were the debts acquired by the states, which were enormous.

There was general agreement that the debts owed to foreign countries were debts of honor and should be paid with gold and silver. However, leaders disagreed as to how to pay individual merchants. Most of these debts had been bought by speculators, and, if paid in full, the merchants would be getting a fortune. But Hamilton made the argument, which Washington supported and Congress accepted, that these debts should be paid at face value with gold and silver, in order to establish the government’s credit.

Finally, there was the matter of the states’ debts, and here again Congress was gridlocked. States like Virginia had paid off almost all their debts, whereas states like Massachusetts and South Carolina had paid off almost none of theirs. Again, Hamilton, supported by Washington, presented the argument that the debts must be paid at face value to establish credit and get America’s banking system working again and accepted at the highest levels of commerce in the world.

Thomas Jefferson, who represented Virginia, wanted to meet with Hamilton. They differed on many matters, but finally a deal was worked out. Jefferson agreed that Virginia would support Hamilton’s plan to fund the debts of the states at face value if he could swing enough votes from Pennsylvania for the new federal capital to be located on the banks of the Potomac River, rather than in Philadelphia where it had been proposed. And so it was done.

That one Congress had unfrozen the banking system, settled the debts of this country, and put the U.S. in a position, in terms of credit, such that during the French Revolution in 1789, hundreds of European investors poured millions of dollars into our banking system, laying the foundation for the Industrial Revolution.

Hamilton not only believed in the importance of sound credit, but he also believed in the importance of sound currency. Having provided for the funding of the debt, he recommended that the U.S. issue currency backed by silver, using the decimal system, rather than the inconvenient British system of shillings and pounds. The U.S. dollar was based on the quantity of silver in the Spanish dollar, which was the standard currency throughout much of the Western Hemisphere. The result was a sound currency based on real money.

Another part of Hamilton’s plan was the formation of a national bank. The implementation of this was very difficult, but Hamilton’s idea was backed by Robert Morris, who had enormous influence with George Washington. The plan was to raise ten million dollars to fund a bank, two million of which would be put up by the federal government in gold. The rest would be raised by selling bonds that would pay a 6 percent interest to the bondholder. So, in a way, they used debt to fund the bank. The bank would then be able to issue notes, backed by silver and gold, which would serve as sound currency throughout the country. The bank would also facilitate commercial transactions at all levels, including those of the federal government. The bank also worked well for private investors, who ultimately made about 8 percent. This grand-scale plan to get the credit system working was all put into place in 1789 by the first Congress.


That is how our Founders responded to a credit crisis which, in the relative terms of their day, was as severe as what we are currently experiencing. The role of the government, as I see it, is to provide a sound currency as well as an atmosphere in which contracts can be made and enforced and in which the ordinary investor can understand that his investments will be safe and that the credit market will serve not to punish the economy, but facilitate economic growth with a minimum of government interference.

How did this infant republic produce a galaxy of statesmen unsurpassed in history and unequal to any power in Europe at the time? The older I get, and the more I study history, the more I wonder if these things just happened by chance or whether there was a greater hand guiding it. What separated them from men and woman of today is (1) they were all patriots; (2) they were people who understood the teachings of Adam Smith in the Wealth of Nations; (3) Congress was willing to listen to experts like Robert Morris and Alexander Hamilton who were not theoretical economists, but practical men of business; and (4) they had honor and believed that repaying debt was a matter of honor.

This last principle, which states that the person who loans us money is owed an obligation of full repayment, has fled from our political scene. We have no sense that there is any such thing as honor or obligations with regard to finances. It would have been very easy for the Founders to do what the French Republic did in that same situation: repudiate all their debts. No, that would not be the course of honor, and in our course of honor, we found economic salvation.

What our leadership lacks today is patriotism; a broad national sense (instead of partisan politics); a true trust in the free-market economy, based on the teachings of Adam Smith; a sense of obligation; and a sense of history. In other words, the crisis of the debt situation was more real for the Founders of our country because they looked backed at what had happened to Athens and Rome, and realized that the situation was so serious that, if they didn’t act quickly, they would end up with a dictator. We don’t have that sense of history. If we did, we wouldn’t be in our current credit crisis. How insidious a debtor economy can be!

There is one final point that makes us different: The Founders believed that there were real fundamental values that both a person’s and nation’s life was built upon. These were honesty, trust, and frugality. In many of the state constitutions written at the time of the Revolution, frugality was put in as one of the virtues they wanted their citizens to cultivate. Washington believed it was immoral to be in debt, and that a government’s encouragement of debt and punishment of saving (as our government does today) is immoral. So they lived within their means, both as individuals and as a country.

Ultimately, what it comes down to is a question of values, and we have lost the values the Founders had.

Dr. Fears (Ph.D., Harvard University) holds the G.T. and Libby Blankenship Chair in the History of Liberty at the University of Oklahoma and is Dr. David and Ann Brown Distinguished Fellow for Freedom Enhancement at OCPA.

J. Rufus Fears

J. Rufus Fears (Ph.D., Harvard University) is a classics professor at the University of Oklahoma. He serves as the Dr. David and Ann Brown Distinguished Fellow for Freedom Enhancement at OCPA.

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