Credible Commitments and Constitutional Constraints : State Debt Repudiation and Default in 19th Century America

Between 1839 and 1842 the United States suffered through an acute debt crisis. Over this period eight states and one territory defaulted, five of which outright repudiated all or parts of their debts outstanding. However, for many of those same states reentry into capital markets occurred relatively rapidly and at rather favorable terms. The question then remains, how and why was this possible? This current work attempts to explain this phenomena by suggesting that soon after default or repudiation many states enacted constitutional amendments meant to significantly constrain and credibly commit future governments from overextending credit and simultaneously to pursue time consistent public policy. I explore this by examining the impact that these newly imposed constitutional amendments, which limited both the type and amount of debt as well as created stronger procedural safeguards for issuing debt, had on average bond prices from New York market data. Overall, my results show that newly constrained states had higher average bond prices than states that did not impose constitutional limits on debt financing, thus suggesting that markets did in fact perceive these constitutional changes to be binding and credible. These results are robust to a number of specifications