First Government Bonds (12th Century Republic of Venice)

Venice, 1171-2, was a city in financial strife. Within what’s terms the Medieval Era by historians it was certainty the dark ages for finance. The Republic of Venice had lost a war to the Byzantine Empire, causing significant damage to their fleet, embarrassing the city. The leader at the time, the Doge of Venice Michiel (a modern-day Chief Magistrate/Duke) was murdered by a fellow Venetian upon return from the war. 

Venice went about restoring public finances in a uniquely roundabout form of taxation, in doing so they invented the first government bonds. 

Rather than tax citizens directly, Venice imposes loans on their wealthy citizens, recapitalising the city, decapitalising individuals. These wealthy citizens owned a security entitling them to future repayment, albeit the initial terms were obscure. These loans did not pay interest for more than three decades and the rates not based on fundamental credit risk. 

Genoa Follows Suit

Genoa issued similar bonds, eight years earlier in 1164. The Bank of St. George helping intermediate the transaction. The Genoese and Venetian bonds did not trade and provided no liquidity to investors, yet. 

In 1214, a notarial deed documents the sale of Genoese bonds highlighting important advancements in the creditworthiness and marketability of these instruments. Genoa developed a toll specifically to help repay their debts. The deed shows how these loans (luoghi)) were divided by 100 lire (local currency at the time) to create a unit called loca. These loca could be bought and sold by private individuals via a notary public.

The standardisation of lire to luoghi of 100:1, became the convention in the quotation of these government bonds. While an arbitrary ratio, the elegance of the solution has withstood the test of time and continues to this day on a wide array of financial assets. 

Secondary Market Develops

In 1262, the Venetian Grand Council, consolidated a disparate collection of these forced loans into a single prestiti which would have a 5% semi-annual coupon. Prestiti were perpetual securities with no fixed maturity date. The Council declared several excise taxes would be earmarked for the repayment of these bonds. The combination of these features created the first notion of a risk-free asset.

Genoa and Florence consolidated their debts both in the 1340s, solidifying the structure initiated by Venice and fuelling the growth in the secondary markets for government securities. 

Such securities, from Northern and Central Italian city-states Venice, Genoa, Pisa, Verona and Florence, were popular investments. Bonds were often bought by fathers as part of a dowry for the future marriage of his daughter. Foreign investors such as the Portuguese King and Knights Hospitallers in Jerusalem were attracted to these interest-bearing securities which were diversified in risk from their own domestic operations. 

We can thank the Italians for the development of two major financial milestones; the creation of a risk-free asset as well as the creation of a secondary market to trade such securities.