The man who knocks on the door is polished and friendly. His suit is fashionable, his briefcase looks important. And the things he pulls out of it are impressive: large sheets of bonds and coupons to be redeemed, signed by the heads of important banking houses and credit institutions.
The contracts are in clear terms and, he assures you, guaranteed by the government. They are secured by land, the safest asset in the world. Best of all, several times a year, the bond gives you a chance of winning a huge cash prize. How can you afford not to buy?
Conversations like this were commonplace in late 19th-century France, when novel financial instruments known as lottery bonds were in high demand among the middle classes. Some of the most popular were those deemed safest for their underlying security: bundled mortgages available through the Credit Foncier, a national mortgage bank founded in 1852.
Although the bonds may have lacked a AAA rating (credit-rating companies weren’t in operation yet), the government promoted them as gilt-edged securities, or “placements de pere de famille.” These instruments combined a reasonable investment (bonds) with hopes of irrational gain (lotteries). The combination was irresistible, and when stock-and-bond salesmen - - known in France as “demarcheurs” -- zoomed into towns and villages, they brokered a dream of ownership that often blinded their clients to the risks and onerous terms they were accepting.
In combining noxious sales pitches with novel financial instruments, innovative contracts, and ultimately exploitative payment schedules, the demarcheurs were a precursor to the unsavory mortgage practices that helped lead to the 2008 financial crisis.
The Credit Foncier, a semipublic joint-stock bank, was the envy of foreign mortgage reformers, who saw both its ability to pool mortgages and its loan terms -- long-term credit with annual amortization -- as the cutting edge in agricultural lending. (Most mortgages in the U.S. at the time were shorter-term “balloon loans” that imposed burdensome payment conditions on borrowers.) Authorized by, and accountable to, the state, the Credit Foncier enjoyed the singular privilege of issuing bonds to fund its loans. By the late 1870s, the bank had sold 1.5 billion francs’ worth of debt to hundreds of thousands of bondholders. Those sales doubled by 1890.
The success of these bonds was due in no small part to another privilege the company enjoyed: an exemption from an 1836 law prohibiting lotteries in France. This allowed the bank to issue bonds that came with rights to attend annual drawings for the lifetime of the loan. These drawings randomly selected bonds that the company would reimburse, as well as some that would be rewarded with cash prizes.
Drawings were highly orchestrated public events, attended by hundreds of hopeful investors. Special drums -- fantastic creations of glass and iron more than 6 feet tall -- were filled with thousands of brass cases, themselves filled with papers featuring hundreds of bond numbers. By the 1920s, the number of eligible bonds meant that the public drawing took as long as an hour, while processing the results took three days and required a staff of 70. The thousands of winning bonds were then listed in the company’s official publications and in national journals. Provided the installment payments on a bond were up to date -- the Credit Foncier’s archives are filled with letters from “winners” who were not so diligent -- the lucky bondholders stood to win as much as 200,000 francs.
Investors paid handsomely for the right to participate in these drawings. Bonds issued with a lottery option cost more than those issued without, and paid a lower annual interest rate. They were thus a lucrative way for the Credit Foncier to obtain loans, despite the outlandish sums the company spent on publicity. Just one of the many reasons these investments were criticized by contemporaries was that they were less productive vehicles for the modest class of buyers to whom they appealed.
Critics also noted the multiple schemes to which the securities gave birth. Bonds were sold on option, giving their temporary owners the right to the bond before a drawing but allowing them to decline to purchase it afterward. They were broken into portions as small as 50ths, with the intention of sharing any winnings between all the “owners,” a practice that seemed more like gambling than investing. They were sold on credit for installment payments over several years that amounted to more than the bond was worth. When the government sought to regulate such sales in the 1890s, legislators estimated that as much as 12 million francs in annual payments flowed through the offices of fly-by-night brokerage houses.
The purest example of the victory of chance over investment occurred in the new economic climate of the 1930s, when a devalued franc helped promote the sale of these titles globally as simple lottery tickets.
But the anxiety the bonds produced was outweighed by their real utility to financial institutions and public bodies, as well as their imagined utility to the investing public. The Credit Foncier was convinced that such instruments were the only way to create a consumer marketplace for its debt, and used them until the 1970s. In the 1880s, the economist Paul Leroy-Beaulieu, an ardent supporter of the bonds, reminded critics that they were to the urban citizen what land was to the peasant: an investment that appealed to the heart and the head. Today, the U.K.’s Premium Bonds are perhaps the best-known example of a lottery-based investment instrument.
The Credit Foncier’s lottery bonds combined land and financial markets in a manner calculated to enhance their persuasiveness to novice investors. Their popularity reminds us of something the political and cultural weight placed on property ownership has often hidden: that investment in land is always a gamble.
(Alexia Yates is a Prize Fellow in economics, history, and politics at the Center for History and Economics at Harvard University. The opinions expressed are her own.)
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