The financial news has recently been dominated by the scandal over the London interbank offered rate (known as Libor), with allegations that leading banks have manipulated a financial benchmark determining the interest rates charged to millions of borrowers and used in derivatives contracts worth hundreds of trillions of dollars.
A new study of the foreign-exchange market in the Middle Ages, conducted by the University of Reading’s ICMA Centre, has documented a medieval system of exchange-rate manipulation similar to today’s.
That system also led to public outcry, a parliamentary investigation and the impeachment of a famous financier.
A major aim of financial innovation throughout history has been to circumvent regulations and restrictions placed on the industry. In the Middle Ages, an important obstacle was the religious disapproval of usury -- the charging of interest or “making money from money.” Dante condemned the usurer to the lowest level of the seventh circle of Hell. To avoid the “taint of usury,” medieval financiers developed various methods of disguising interest within other transactions.
The simplest method was for the borrower to recognize a debt of 15 pounds when he had borrowed only 10, the 5 pound difference being the lender’s profit. Or the borrower could pay the lender a “voluntary” gift on top of the principal. Alternatively, the lender could impose a penalty in case of “late” repayment, where the loan was deliberately intended to be repaid late.
Another medieval practice that might resonate today was “chevisance,” or in modern parlance, a repurchase arrangement. Here, a borrower would sell goods to the lender at one price with the understanding that the borrower would buy them back at a higher price. This is similar to our contemporary repo market, which underpins the shadow banking system.
Perhaps the most sophisticated method of disguising usury involved foreign-exchange transactions. The pound sterling, for example, was always valued higher in Venice than in London. These differentials (or spreads) enabled bankers to profit by moving money from one place to another and back.
To produce and maintain these spreads, however, required systematic “rigging” of exchange rates across Europe. In essence, banks and currency brokers in London always had to deduct a few pence from the rate with Venice, and their counterparts in Venice had to add a few pence.
But was this wrong? Without these exchange-rate adjustments, it would have been much more difficult to profit from foreign-exchange transactions. There would have been no incentive for medieval bankers to engage in the foreign-exchange market, which would have reduced the ability of merchants to fund their trading ventures or to transfer money internationally. Similarly, without the methods described above to disguise interest payments, there could have been no credit market. Although such techniques may have been essential for the functioning of medieval finance, and perhaps came to be viewed as normal business practice to those involved, the wider public was less understanding.
During the “Good Parliament” of 1376, public discontent over such perceived financial abuses came to a head. The Commons, represented by the speaker, Peter de la Mare, accused leading members of the royal court of abusing their position to profit from public funds.
A particular target was the London financier Richard Lyons, an immigrant from Flanders who had risen to become one of the wealthiest and most influential citizens, partly through his own talents as a merchant but also by capitalizing on his personal connections to members of the court. Among other crimes, Lyons was suspected of imposing an unauthorized tax on foreign-exchange transactions and overcharging the king for loans. On one occasion, he and William Lord Latimer were said to have arranged a loan of 20,000 marks for the king but charged him 30,000 marks, a usurious rate of interest.
Initially the government bowed to public pressure. Lyons was imprisoned in the Tower of London and his properties and wealth were confiscated. Other leading courtiers implicated in these abuses, such as Latimer and the king’s mistress, Alice Perrers, were banished from court.
Once parliament had dissolved and the public outcry had died down, however, the king’s eldest son, John of Gaunt, acted to reverse the verdicts of the Good Parliament. Latimer and Perrers soon reappeared at the king’s side and Lyons was released from the Tower and recovered his wealth, while the “whistleblower” de la Mare was thrown in jail. The government also sought to appease the wealthy knights and merchants that dominated parliament by imposing a new, regressive form of taxation, a poll tax paid by everyone rather than a tax levied on goods. This effectively passed the burden of royal finance down to the peasantry.
It seemed as though everything had returned to business as normal and Lyons appeared to have gotten away with it. In 1381, however, simmering discontent over continuing suspicions of government corruption and the poll tax contributed to a massive popular uprising, the Peasants’ Revolt, during which leading government ministers, including Simon of Sudbury (the chancellor and archbishop of Canterbury) and Robert Hales (the treasurer) were executed by the rebels. This time, Lyons did not escape; he was singled out, dragged from his house and beheaded in the street.
Although certain forms of financial engineering play a vital role within the economic system, when viewed from outside, they may seem amoral or even illegal. In this way, revelations about the hiding of usury in the Middle Ages or the fixing of Libor both reflect and contribute to a wider public suspicion of finance. It is particularly dangerous when such financial scandals coincide with periods of wider economic and political uncertainty, as in the 1370s and today.
The question now is whether public outrage at the Libor scandal and other financial misdeeds will lead to fundamental reforms of the financial sector -- such as the separation of retail and investment banking or legislation to regulate the “bonus culture” -- or just more cosmetic changes that fail to address the structural issues.
Will we have to wait for a 21st century peasants’ revolt before seeing any real change?
(Adrian R. Bell is a professor of the history of finance, Chris Brooks is a professor of finance and Tony K. Moore is a research assistant at the ICMA Centre, Henley Business School, University of Reading.)
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