Cases of a sovereign government being called upon to pay claims against an insolvent state-sponsored guaranty agency are few. The principal historical examples involve China. In 2008, Chinese institutions, as creditors, used peaceful suasion to persuade the United States government to make good on its implicit guarantee of the debts of mortgage insurers Fannie Mae and Freddie Mac. In 1839-1842, Great Britain used military violence to force the Chinese government to pay the claims of private British creditors against an insolvent state-sponsored guaranty fund, the Consoo Fund. Those debts were paid in a single lump sum cash payment of $3 million that was delivered to the British consul at Canton on 23 July 1843. These examples of resort to the sovereign state after the insolvency of a state-sponsored guarantor -- one case peaceful and the other case involving violence – deserve examination.

As the result of a crisis arising from subprime mortgage loans, U.S. mortgage insurers Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Association) were placed in federal receivership on 6 September 2008. These agencies either owned or guaranteed a large proportion of all home mortgage loans in the United States. As “quasi-governmental” organizations, each had long been believed to enjoy the implicit guaranty of the United States Treasury. Chinese holders of their debt, in particular, expressed concern that the United States must honor its implicit sovereign guaranty of these insolvent state-sponsored agencies. In conservatorship, claims of bondholders including financial institutions worldwide were honored with full payment due to United States government concern about potential risks to the global financial system posed by their threatened default. “Thus,” in the view of Robert Pozen and many other seasoned observers, “the bailout vindicated the widely held perception that the bonds of Fannie Mae and Freddie Mac were indeed the moral obligations of the federal government.” Resolution was peaceful. Chinese interests were protected.

When the Consoo Fund, the Chinese state-sponsored guaranty fund that inspired bank deposit insurance in the United States, was found insolvent Chinese interests fared very differently. From the beginning of the fund in 1780, through to its demise in 1842, some British creditors believed that the fund enjoyed the Chinese government’s implicit backing. Charles Elliot, the infamous British Superintendent of Trade at Canton, stated in a February 1838 letter to Lord Palmerston that the Chinese government had in effect guaranteed payment of the hong merchant foreign debts as the quid pro quo for the privations the foreigners were forced to suffer in abiding by the restrictive rules of the Canton System. The Consoo fund was insolvent in 1838, and its constituents the hong merchants were seeking to pay the debts it guaranteed over as much as twenty years without interest. All it took was a war, commenced by Britain the next year, to force China to pay these private debts immediately. That the Opium War involved a financial crime ($3 million extorted to pay guaranteed debt), as well as a drug crime ($6 million extorted to pay for opium seized by Lin Zexu), has been largely forgotten.

Chinese history thus offers striking examples of the risk involved in the implicit guaranty of a sovereign government. When a state-sponsored private insurer is found to be insolvent, it may be natural for creditors to look to the state to pay the shortfall. When government is seen to be acting as mother bountiful, using state resources to subsidize against or to ameliorate insured risk in various ways, the belief may arise that the state will forever stand in the middle of the marketplace acting as yang ma (big mama). Such belief may prove dangerous indeed. These violent and peaceful examples, found in the Chinese history of successful calls on governments to make good as implicit guarantor, do not speak to China alone. They are packed with lessons about risk and financial limits that speak to the United States, to the sovereign states of the European Union, and to nations worldwide which find themselves ever more closely and rapidly connected by ties of trade and finance.

1 Robert Pozen, Too Big to Save? How to Fix the U.S. Financial System (Hoboken, N.J.: John Wiley & Sons, Inc., 2010), p. 38.

2 Jessica Hanser, Mr. Smith Goes to China: British Private Traders and the Interlinking of the British Empire with China, 1757-1793 (Ph.D. dissertation, Yale University, 2012), p. 37.

3 R. Randle Edwards, Ch'ing Legal Jurisdiction Over Foreigners, pp. 222-269 in Cohen, Jerome A., Edwards, R. Randle, and Chang Chen, Fu-mei, eds., Essays on China's Legal Tradition (Princeton: Princeton Univ. Press, 1980), pp. 237-238.