UK: BUSINESS LEGENDS - SPECULATORS TAKE A BUBBLE BATH.

UK: BUSINESS LEGENDS - SPECULATORS TAKE A BUBBLE BATH. - From its early slave-trade links to its spectacular demise, the South Sea was an unsavoury outfit. Rhymer Rigby charts its history and the events that led up to the world's biggest financial scanda

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Last Updated: 31 Aug 2010

From its early slave-trade links to its spectacular demise, the South Sea was an unsavoury outfit. Rhymer Rigby charts its history and the events that led up to the world's biggest financial scandal

'The Company of Merchants of Great Britain Trading to the South Seas' was no such thing. It is better described as a finance company with a sideline in slave-trading. Set up in 1710 by the Earl of Oxford, it incorporated some £10 million worth of Government debt into its foundation, with the Government's creditors receiving equity in exchange for their securities. In return for this, the South Sea Company received certain trading concessions in South America and the 5% interest paid on the debt.

For the next seven years, the company did very little: the trading concessions were something of a sham and the only real income was the interest it received.

This sleepy state of affairs was not to last: in 1717, King George I accepted the company's offer of the governorship, enhancing its status considerably. The next year, England went to war with Spain, resulting in the cessation of what little trade it had. Thus, in 1719, the company assumed a further £1.5 million of Government debt. Again it paid the creditors off with equity and, using the ruse that would later lead to the South Sea Bubble, it made a quick £70,000.

The deal's architect, John Blunt - who was something of a wideboy - was a major player on the South Sea board. The nation was groaning under huge Government debt, and Blunt proposed to take over the lot - some £50 million.

The final figure was actually only £30 million as the remainder was owed to the powerful East India Company and the Bank of England; for the privilege of taking on more debt, South Sea would pay the Government £7.5 million.

Unsurprisingly, everyone wondered how it was possible to make money from a huge debt. The company's plans were as follows. For every £100 of debt it took over it could issue one share, worth £100 at par value (the nominal value assigned to stocks), which would then go to the creditors in place of their securities. The market value of the stock was, at the time, £128 but what if it rose to, say, £400? South Sea could then take over £1,200 worth of debt and issue 12 shares, worth £4,800. It could pay off the creditor with three shares and sell the remaining nine to the public for a profit of £3,600.

Blunt's scheme was based on the recognition that the debt was split equally into two types - redeemable and irredeemable. South Sea would first exchange the redeemable debts for equity then, once the speculation had driven up the price of the stock, he would convert the irredeemable debt at a hefty premium. Blunt's proposal went before the Houses of Parliament. Opposition, led by the Whig Robert Walpole, was fierce, but the bill was eventually passed.

In the exchange alley coffee houses, the company's stock shot up in reaction to this news and Blunt began selling shares, which, as no conversion of the irredeemable debt had yet taken place, were hostages to continued high prices. But the concepts of buying and selling on margin, credit and the like were new and ill-understood and the stock continued to rise.

Having long traded at between at £100 and £150, it rose to a heady £700, on the back of speculation and rumour. However, as investors had been allowed to buy in instalments with deposits as low as 1%, the company had a cash shortfall and yet more shares needed to be sold at yet higher prices.

South Sea hatched another plan; it would lend up to £5,000 to shareholders, who would hopefully buy more stock. This was initially successful, and, when the annuities were converted into equity, accelerated lending carried the stock through a wave of early profit-taking. But by this stage, South Sea was out of control: shares were changing hands at over £1,000 and the cash-strapped company was owed £60 million in instalments.

The main threat to South Sea's fortunes was its imitators or 'baby bubbles' which were attracting funds that should be going into South Sea stock.

Writs were issued against many of these concerns and, unsurprisingly, their shares collapsed. Unfortunately, so did public confidence, and with it South Sea stock, which crashed from £1,200 in August, 1720, to £200 by late September of the same year. Bar the peasantry, most people had some stake in the company, and suicide notices appeared daily. As one contemporary wit noted: 'It is almost unfashionable not to be a bankrupt'.

When Parliament reconvened, Walpole led the enquiry and prevented the scandal from bringing down the Government. After asset-stripping the directors, the shareholders received about £33 for every £100 invested with the share price reckoned at £400. The company itself continued to exist, largely because nobody could fathom its web of loans, lies and liabilities. It issued a few annuities, was half-heartedly involved in whaling off Greenland and, a century after ruining thousands, was wound up quietly in 1854.

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