Cartoon by Thomas Nast depicting the Tweed Ring in Harper’s Weekly, Aug. 19, 1871. Source: Library of Congress.

A hearty thanks to the Bloomberg “Echoes” financial history blog for running this item first on May 9, 2012.  Check them out for a great daily history fix.

How can excessive debt sink a government? Look no further than New York — in 1871, under the leadership of the eminently corrupt William M. Tweed.

Today, the U.S. government owes some $15.2 trillion. Its largest group of public creditors comprises foreigners and foreign governments, led by China and Japan. Overseas creditorshold $5.1 trillion in U.S. paper and continue to be big buyers at Treasury auctions. What would happen in the (still unlikely) event they stopped buying?

Take a look at “Boss” Tweed’s New York. Tweed, the legendary Grand Sachem of Tammany Hall and a renowned political fixer, was easily the most corrupt politician in American history. He and his cronies stole a remarkable amount of money during their brief reign from 1868 to 1871: Estimates range from $60 million to $100 million in 1871 dollars, worth many billions today.

Tweed himself ultimately was convicted on 204 counts of fraud and died behind bars in New York’s Ludlow Street jail as a disgraced man.

Still, while in power, Tweed ran a happy city. Everyone made money under his system. Real estate boomed and business prospered. He financed his corrupt regime on low taxes while providing good service and plenty of graft for friends. To pay the tab, he borrowed.

Debt, Debt, Debt

Under Tweed, the city treasury issued oceans of debt: Croton Aqueduct Bonds, Central Park Improvements Bonds, four classes of County Court House stock, Bonds for Repayment of Taxes, Assessment Fund Stock, Park Improvement Bonds, Street Improvement Bonds. New York’s city and county debt swelled to more than $97 million by mid-1871 from $36.3 million in January 1869, with interest payments approaching $10 million a year.

Local banks and brokers snapped up these bonds and sold them to investors in Europe, mostly British and German, who didn’t know any better and considered them safe.

But that changed in July 1871, when the New York Times (NYT)received a stolen copy of the Tweed Ring’s secret accounts and published it on its front pages — disclosing all manner of fraud and theft, including embezzlement and bill padding on construction of the Tweed Courthouse in lower Manhattan. City leaders read with disbelief.

Thomas Nast’s clever cartoons of the time depicted Tweed as a laughable crook. But one group that found no humor in the situation was the bondholders. In late July, they cut off credit. The city put $40,000 in bonds up at auction one day and failed to receive a single bid. A few days later, the Commercial and Financial Chronicle warned of a panic. In Europe, the Berlin Stock Exchange banned New York’s city and county bonds from its official trading list.

The city had a looming interest payment of $2.7 million due Nov. 1, and its agents could no longer raise money in world markets. “They distrust our securities in London,” an unnamed broker told the New-York Tribune.

If credit dried up and the city defaulted on its debt, the impact on New York’s wealthy would be devastating, wiping out their bulging bond portfolios and crippling their standing in Europe, which was still a principal source of capital for American finance.

An “insurrection of the capitalists” quickly organized itself in lower Manhattan. Some 1,000 merchants rushed to sign a petition refusing to pay any more property taxes until city officials gave a full account of their spending. Another group filed a lawsuit to block a city construction project on Broadway. Calls went out for city leaders to convene publicly on Sept. 4 — when wealthy men had returned from their summer holidays.

The Fall

After that, the fall came quickly. In early September, reformers won a court injunction demanding an accounting and blocking any more spending by Tweed’s City Hall. By October, Tweed had been indicted, and would soon begin his long journey through the city and state prison system. The flow of credit only resumed after the entire Tweed system had been dismantled.

America’s current mountain of debt wasn’t built on fraud like Tweed’s. Nor did the European bondholders in Tweed’s day worry that stopping the money flow to one city government would hurt their larger investments portfolios in the long term, as U.S. creditors today surely would. They demanded regime change – – replacement of the Tweed Ring with an honest government — and they got it.

But there are lessons for modern American politicians here. First, don’t steal. (Hopefully they know that one already.) Second, it’s not just in Europe where debt can topple governments — in a pinch, creditors always call the tune.

(Kenneth D. Ackerman is the author of four books, including“Boss Tweed: The Corrupt Pol Who Conceived the Soul of Modern New York.” The opinions expressed are his own.)