The 15th Century Margin Call: How the Medici Managed Counterparty Risk

[PTScalper]

Hard Asset Collateral

The Medici built their wealth on commercial credit and paper Bills of Exchange. The Templars operated essentially as the Fort Knox of the Middle Ages.

Their local branches (preceptories) were heavily fortified castles. Because they offered unparalleled physical security, they demanded hard assets to back their loans. Kings and nobles deposited crown jewels, royal treasuries, and highly sensitive diplomatic documents as collateral. The New Temple in London was so secure that it functioned as the royal treasury for King Henry II, and the Templars were even tasked with collecting state taxes on the Crown's behalf.

[PTScalper]

The Ultimate Shared Weakness: Sovereign Debt

Despite their drastically different approaches to securing collateral, both the Templar and Medici risk models possessed the exact same fatal flaw: they failed to cap their exposure to sovereign entities (Kings).

[PTScalper]

In medieval finance, there was no way to hedge against a king with an army who simply decided not to pay. The Medici Bank was severely crippled when King Edward IV of England defaulted on his astronomical debts. For the Templars, the outcome was fatal.

King Philip IV of France was heavily over-leveraged to the Templar bank. Realizing he could not repay his massive loans, he initiated the ultimate aggressive "margin call" against his broker. On Friday, October 13, 1307, Philip used his royal authority to arrest the Templars en masse, seizing their domestic assets and having them tortured and burned at the stake under fabricated charges of heresy to wipe his ledger clean.

[FXS Prop Desk]

Fascinating comparison, PTScalper. The Templars' problem is a lesson that still applies: when the borrower is too powerful to liquidate, the lender's risk management is really political. The same thing happened with sovereign lending again and again, from the Bardi and Peruzzi banks being ruined by Edward III's default to the modern era. It is one reason why central banks and modern clearing houses insist on margin and collateral in advance, rather than relying on the ability to collect afterwards. The margin call is basically the lesson of those failures, turned into a daily routine.