History of the Bond Market

In ancient Sumer, temples functioned both as places of worship and as banks, under the oversight of the priests and the sovereign. Loans were made at a customary fixed 20% interest rate. This custom was continued in Babylon, Mesopotamia and written into the 6th Century BCE Code of Hammurabi.

The first known bond in history dates from circa 2400 BC in Nippur, Mesopotamia (modern-day Iraq). The bond guaranteed the payment of grain by the principal. The surety bond guaranteed reimbursement if the principal failed to make payment.

In these ancient times, loans were initially made in cattle or grain from which interest could be paid from growing the herd or crop and returning a portion to the lender. Silver became popular as it was less perishable and allowed large values to be transported more easily, but unlike cattle or grain, silver could not naturally produce interest. 

By the Plantagenet era (1154 -1485), the English crown had long-standing links with Italian financiers and merchants such as Ricciardi of Lucca in Tuscany. These trade links were based on loans, similar to modern-day bank loans. Other loans were linked to the need to finance the crusades and the city-states of Italy found themselves, uniquely, at the intersection of international trade, finance, and religion. The loans of the time were not yet securitized in the form of bonds. That innovation came from further north in Venice.

In 12th Century Venice, the city-state’s government began issuing war-bonds known as prestiti, (lending) perpetuities paying a fixed rate of 5%. These were initially regarded with suspicion but the ability to buy and sell them became regarded as valuable. Securities of this late Medieval period were priced with techniques similar to those used in modern day quantitative finance. The bond market had begun.

Following the Hundred Years’ War, monarchs of England and France defaulted on very large debts to Venetian bankers causing a collapse of the system of Lombard banking in 1345. This economic set-back hit every part of economic life, including clothing, food, and hygiene. During the ensuing Black Death, the European economy and bond market were depleted even further. Venice banned its bankers from trading government debt but the idea of debt as a tradable instrument was still attractive, and thus the bond market endued.

With their origins in antiquity, bonds are much older than the equity market which appeared with the first ever joint stock corporation, the Dutch East India Company in 1602 (although some scholars argue that something similar to the joint stock corporation existed in Ancient Rome).

The first ever sovereign bond was issued in 1693 by the newly formed Bank of England. This bond was used to fund conflict with France. Other European governments followed suit.

The U.S.A. first issued sovereign treasury bonds to finance the American Revolutionary War. Sovereign debt (“Liberty Bonds”) was again used to finance its World War I efforts and issued in 1917 shortly after the U.S. declared war on Germany. Each maturity of bond (one-year, two-year, five-year and so on) was thought of as a separate market until the mid-1970s when traders at Salomon Brothers began drawing a curve through their yields. This innovation, the yield curve, transformed the way bonds were both priced and traded and paved the way for quantitative finance to flourish.

Starting in the late 1970s, non-investment grade public companies were allowed to issue corporate debt.

The next innovation was the advent of Derivatives in the 1980s and onwards, which saw the creation of Collateralized Debt Obligations, residential mortgage-backed securities, and the advent of the structured products industry.