In late 1671, King Charles II of England—also known to history as the Merry Monarch—was preparing to wage yet another war against the Dutch, then the financial and commercial center of continental Europe. The sentiment in the English street was that the Dutch were getting the better of the English in international trade deals and they wagered that a good war would help resolve commercial matters in their favor. The problem was that the perennially short of money King Charles II didn’t have the funds required to outfit and provision his navy. What to do?

Well, in the fall of 1671 he called in the major goldsmith bankers of the day and asked them for a very big loan to outfit a fleet of 60 ships. But, these influential and wealthy bankers flat-out refused to give him a single shilling. Strutting their financial muscles, they claimed that they had already extended the king enough credit via the collateralized treasury orders (CTOs) they held – which could be described as one of the earliest forms of long-term government bond.

Under CTOs -- anticipated tax revenues were used as collateral. Think of modern mortgage backed securities for comparison, except that instead of mortgage payments by homeowners backing the loan, it was various tax payments due to the government. And, as the tax revenues from the customs, excise and hearth taxes were received at the Exchequer they would be redirected to the bankers who had fronted the money and held the securities. They were quite popular bonds and handful of goldsmith bankers held most of the outstanding supply. In the fall of 1671 decided that enough was enough. They wouldn’t extend anymore credit. They wouldn’t buy any more of these bonds.

Well, to make a long and messy story short, the king decided to extract his revenge and decided to default. In fact, this was the last time the English formally and officially announced a suspension of payments on their fixed income obligations. On January 2^nd, 1672 they proclaimed that the tax revenues that had been promised or assigned to the holders of these securities would instead be redirected to pay other required expenses, such as outfitting the mentioned 60 ships. Quite clever when you think about it. The bankers would lend anymore, so he yanked the rug (tax revenues) from under their feet. The amount of debt on which England defaulted was approximately one year’s worth of government tax revenues, which at the time was slightly over £1 million.

Technically this was called the Stop of the Exchequer, well known to financial historians and relished by professional politicians who had little love for the Stuarts. Essentially, interest payments on the treasury orders held by the goldsmith bankers were suspended and principal would no longer be redeemed. Needless to say, the market value of these early-modern bonds plunged overnight and the bankers were plunged into financial distress.

But, it got even more dicey. The goldsmith bankers who had purchased most of the outstanding supply of what was then the closest thing to government bonds were outraged and demanded repayment. When the King and his council didn’t budge they retaliated against ordinary Englishmen. At the time, bankers were taking deposits from ordinary English savers and paying them 6% -- which was the legal maximum rate – while using the funds to invest in the bonds which had been purchased at a discount and were implicitly paying 10% to 30% interest. A nice spread which didn’t endear them with the masses.

Well, the bankers’ response to the crisis – when the assets plummeted in value – was to freeze deposits and not allow withdrawals from their banks until they themselves were paid back and the Exchequer resumed redemption.

Alas, the king would have none of it and promptly warned them to immediately return the non-interest-bearing accounts, or else face prison time!

As for the bonds, the government didn’t budge. For the first few years they received no interest, then a token year or two’s worth. Then, sometime in early April 1677 the Exchequer was reopened and only interest (but not principal) payments were resumed. Now, I don’t want to make this process sound easy or painless. It actually took over three decades of litigation until the creditors finally got the matter resolved.

And the goldsmith bankers? Well, most of them went bankrupt – that is what happens when the ancient concept of financial leverage is allowed in the absence of modern limited liability -- and many of the prominent bankers of the Restoration era ended up in debtor’s prison. In fact, some committed suicide and others escaped the country. This was a tragedy (for them) of Shakespearean proportions, but with little sympathy from the English masses.

For once in history, the market got the better of the bankers – and not the other way around.

Moshe A. Milevsky is the author of the recently published book: The Day the King Defaulted: Financial Lessons from the Stop of the Exchequer in 1672 (Palgrave Macmillan, 2017), from which this article was excerpted.