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More well known than The South Sea Company is perhaps the "South Sea Bubble" (1711 - September 1720) which is the name given to the economic bubble that occurred through overheated speculation in the company shares during 1720. The price collapsed the same year after reaching a peak in September.

Initial stages

The company, formed in 1711 by Robert Harley, was granted exclusive trading rights in Spanish South America. The trading rights were pre-supposed on the successful conclusion of the War of the Spanish Succession, which did not end until 1713, and the actual granted treaty rights were not as comprehensive as Harley had originally hoped.

In return for these exclusive trading rights the government saw an opportunity for a profitable tradeoff. The government and the company convinced the holders of around £10 million of short-term government debt to exchange it with a new issue of stock in the company. To further spice up the transaction, the savvy dealers underwriting this transaction placed a perpetual annuity from the government paying 576,534 pounds annually on the company's books, or if you will, a perpetual loan of £10 m paying 6% to the company from the government. This guaranteed the new equity owners a steady stream of earnings to this new venture.

The company did not undertake a trading voyage to South America until 1717 and made little actual profit. Furthermore, when ties between Spain and Britain deteriorated in 1718 the short-term prospects of the company were very poor. Nonetheless, the company continued to argue that its longer-term future would be extremely profitable. In 1717 the company took on a further £2 million of public debt.

Debt for equity explained

The rationale in all these transactions was:

To the

  • government: lower interest rate on its debt
  • South Sea company (owners): a steady stream of earnings financed by equity dilution
  • government debt holder: upside potential in a promising enterprise

Trading more debt for equity

In 1719 the company proposed a scheme by which it would buy more than half the national debt of Britain (£30,981,712), again with new shares, and a promise to the government that the debt would be converted to a lower interest rate, 5% until 1727 and 4% per year thereafter.

The purpose of this conversion was similar to the old one, it would allow a conversion of high interest, but difficult to trade debt, into low interest, readily marketable debt/shares of the South Sea Company. All parties could gain.

For a clarification of the situation the total government debt in 1719 was £50 million:

  • £18.3m was held by 3 large corporations.
  • Privately held redeemable debt amounted to £16.5m.
  • £15m consisted of irredeemable annuities, long fixed-term annuities of 72-87 years and short annuities of 22 years remaining maturity.

The Bank of England proposed a similar competing offer, that didn't prevail when the South Sea raised its bid to 7.5 million pounds (plus approx 1.3 mln in bribes). The proposal was accepted in a slightly altered form in April, 1720. The Chancellor of the Exchequer, John Aislabie, was a strong supporter of the scheme.

Crucial in this conversion was the proportion of holders of irredeemable annuities that could be tempted to convert their securities at a high price for the new shares. (Holders of redeemable debt had effectively no other choice but to subscribe.) The South Sea Company could set the conversion price but could obviously not diverge a lot from the market price of its shares.

The company ultimately acquired 85% of the redeemables and 80% of the irredeemables.

Buoying the share price

The company then set to talking up its stock with "the most extravagant rumours" of the value of its potential trade in the New World which was followed by a wave of "speculating frenzy". The share price had risen from the time the scheme was proposed: from £128 in January 1720, to £175 in February, £330 in March and, following the scheme's acceptance, to £550 at the end of May.

What may have supported the company's high multiples (its P/E ratio) was a fund of credit (known to the market) of £70 million available for commercial expansion which had been made available through substantial support, apparently, by Parliament and the King.

Shares in the company were ‘sold’ to politicians at the current market price; however, rather than paying for the shares, these lucky recipients simply held on to what shares they had been offered, ‘sold’ them back to the company when and as they chose, and received as ‘profit’ the increase in market price. This method, while winning over the heads of government, the King’s mistress, etc., also had the advantage of binding their interests to the interests of the Company: in order to secure their own profits, they had to help drive up the stock. Meanwhile, by publicizing the names of their elite stockholders, the Company managed to clothe itself in an aura of legitimacy, which attracted and kept other buyers.

Bubble Act

A number of other joint-stock companies then joined the market, making usually fraudulent claims about other foreign ventures or bizarre schemes, and were nicknamed 'bubbles'.

In June, 1720, the Bubble Act (repealed in 1825) required all joint-stock companies to have a Royal Charter. The South Seas Company held a charter providing exclusive access to all of Middle and South America. However, the areas in question were Spanish colonies, and England was then at war with Spain. Even once a peace treaty had been signed, relations between the two countries were not good. The best terms that the South Sea Company was able to obtain allowed them to send only one ship per year to Spain’s American colonies (not one ship per colony; exactly one ship), carrying a cargo of not more than 500 tons. Additional wrangling won the company the right to transport slaves, although steep import duties made the slave trade entirely unprofitable.

The grant of a charter to the South Sea Company was an added boost, its shares leaping to £890 in early June. This peak encouraged people to start to sell; to counterbalance this the company's directors ordered their agents to buy, which succeeded in propping the price up at around £750.

Top reached

The price of the stock went up over the course of a single year from one hundred pounds a share to over one thousand pounds per share. Its success caused a country-wide frenzy as citizens of all stripes – from peasants to lords – developed a feverish interest in investing; in South Seas primarily, but in stocks generally. Among the many companies, more or less legitimate, to go public in 1720 is – famously – one that advertised itself as “a company for carrying out an undertaking of great advantage, but nobody to know what it is.”

The price finally reached £1,000 in early August and the level of selling was such that the price started to fall, dropping back to one hundred pounds per share before the year was out, and triggering bankruptcies amongst those who had bought on credit and increased selling, even "short selling" (selling borrowed shares for a profit if the price falls).

Also, in August 1720 the first of the installment payments of the first and second money subscriptions on new issues of South Sea stock were due. Earlier in the year Blunt had come up with a brilliant idea to prop up the share price, the company would lend people money to buy its shares. As a result a lot of shareholders couldn't pay for their shares other than by selling them.

Furthermore, the scramble for liquidity appeared internationally as "bubbles" were also ending in Amsterdam and Paris. The collapse coincided with the fall of the Mississippi Scheme of John Law in France. As a result, the price of South Sea shares began to decline.

By the end of September the stock had fallen to £150. The company failures now extended to banks and goldsmiths as they could not collect loans made on the stock, and thousands of individuals were ruined (including many members of the aristocracy). With investors outraged, Parliament was recalled in December and an investigation began. Reporting in 1721, it revealed widespread fraud amongst the company directors. The newly appointed First Lord of the Treasury Robert Walpole, who had argued against the scheme from the beginning, was forced to introduce a series of measures to restore public confidence.

Restructuring

The company continued its trade (when not interrupted by war) until the end of the Seven Years' War. However, its main function was always managing government debt, rather than trading with the Spanish colonies. The South Sea Company continued its management of the part of the National Debt until it was abolished in the 1850s.

Quotes on the bubble

  • "I can calculate the movement of the stars, but NOT the madness of men." - Sir Isaac Newton, after losing a fortune (£20,000) in the bubble.

Further reading

J. Carswell, The South Sea Bubble (Cresset Press, London 1960).

See also

External links

British political scandals | Defunct companies of the United Kingdom | Economic bubbles | History of banking | Georgian era | 1711 establishments

Südseeblase | Krach de 1720 | 南海会社 | South Sea Company | Компания Южных морей

 

This article is licensed under the GNU Free Documentation License. It uses material from the "The South Sea Company".

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