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24 September 2008

The Great-Granddaddy of All Financial Scandals

In my native New York right now, an air of apocalypse reigns. I haven’t seen four horsemen galloping down Fifth Avenue yet, but on the bus the other day, I overheard someone moaning that if Goldman went down, we’d all be fighting over long-term leases on caves, having reverted to something akin to a state of nature. I do hope it’s a Lockean state of nature. A Hobbesian one would be no fun at all.

But before we start negotiating our cave leases, it seemed like a good moment for a little shot of historical perspective. It certainly won’t be the first time we’ve gone wild on unsound speculations and lost our shirts. Nope, I don’t mean the Great Depression. I give you… the South Sea Bubble, my very favorite financial meltdown.

It all began, as one might guess from the name, with a trading monopoly granted by the Crown. In 1711, the South Sea Company was granted the exclusive right to trade in Spanish South America. This was a little optimistic of them, as they were in the midst of the War of the Spanish Succession at the time, but, fortunately for the company, the Duke of Marlborough worked his usual military magic and the rich trade of the Spanish Americas lay open to the English merchant. Under the Treaty of Utrecht, the South Sea Company was granted the right to send one ship a year, as well as the lucrative “asiento,” the slave trade with the Spanish colonies.

All this is more than a little misleading. The South Sea Company, despite the glamorous images of pearls larger than your fist and spices untold conjured by its name, undertook its first voyage in 1717. That voyage was only marginally profitable. Despite its nominal guise as a trading company, the South Sea Company’s real money was to be had in ways that would be more familiar to us now: playing around with government debt.

Wars are expensive to run (also sound familiar?) and the War of the Spanish Succession was no exception. William and Mary had begun playing around with credit-floating and debt-financing during their reign, enabling England to hold out in the field against richer, larger but less financially creative France. Their successors, Queen Anne (who presided over the initial South Sea grant) and George I (who came to the throne in 1714) continued the experiment. A deal was struck. In exchange for taking on ten million pounds of short term government debt, the South Sea Company would be granted a perpetual annuity of nearly £600,000 a year. The debt holders would be granted shares in the South Sea Company, guaranteed against that government annuity. The government planned to raise the money for the promised annuity with a tariff on goods to be brought in from the South Seas (see only one marginally profitable voyage, above).

The real crisis arose in 1720. In France, John Law was making waves with his daring new finance schemes (the short version is that he issued paper money through the Banque Royale based on shares in his Mississippi Company, which held the monopoly on French overseas trade). Rumors abounded that he was turning France into the financial powerhouse of Europe. From the English point of view, this was very, very bad. (Anything good for France is always very, very bad for England. It’s just one of those laws of nature). England wanted in on the act. In 1719, the South Sea Company took over three-fifths of the English national debt, something in the order of thirty million pounds, a mind-staggeringly huge sum at the time. Under the South Sea Act of 1720, the holders of government annuities were offered the option to exchange their irredeemable fixed term annuities for either cash or South Sea shares. In the space of six months in 1720, between January and July, the price of South Sea stock rose from £128 to £950 a share. London had gone speculation mad.

As a token of quite how speculation mad they had gone, all sorts of companies were mooted and solicited investments in shares, including one (my very favorite) for the manufacture of square—yes, square—cannon balls. Brilliant idea, that. Everyone was involved, from the high to the low. Both of the King’s mistresses were deeply implicated in South Sea speculation (the Company had given them cheap shares), and members of both houses of Parliament were in it up to the tops of their elaborately curled wigs.

We can all see where this was going, right? The bubble burst. The scramble to sell began in August 1720. By September, the price had dropped to £150 a share. Ruin rippled across England, triggering countless bankruptcies, suicides, disgrace, and a government investigation, run by the First Lord of the Treasury, Robert Walpole. The same was happening across the Channel in France, where John Law, once feted and lionized, had had to flee in disgrace.

According to John Brewer, it wasn’t all bad. In his seminal work, The Sinews of Power: War, Money and the English State, 1688-1783, he writes that although “[i]n the short term, the South Sea Bubble was a major disaster… [i]n the long run, its consequences were more beneficial… changing the structure of the national debt” and thus making England a stronger state in the long run. As a side note, the South Sea crisis also consolidated the career of Robert Walpole, commonly thought of as England’s first real Prime Minister.

Empty speculation, rising stock prices, dodgy financial deals, bankruptcy and ruin…. As they say, there really is nothing new under the sun.

11 Comments:

Blogger Amanda Elyot said...

Lauren, I love the South Sea Bubble, too (as far as financial scandals go), if only for its name, which conjures up a Tahitian spa.

In ROYAL AFFAIRS, I discussed it in my entry on George I and his 2 greedy mistresses, one of whom was instrumental in the collapse. All 3 of them profited handsomely by it

9:47 AM  
Blogger Elizabeth Kerri Mahon said...

Lauren, not having a head for business, i've always wondered about the South Sea Bubble. Thanks for explaining it so succinctly. And yes, South Sea Bubble is a great name, much better than Teapot Dome.

12:37 PM  
Blogger Pam Rosenthal said...

Great post, Lauren, and wonderful to have the South Sea Bubble finally explained so clearly -- even if it does bring to mind my own poor little 401(K), doing its best these days to imitate the polar ice cap... but then, both of disappearing acts were brought to us by the same crew, imo

1:14 PM  
Blogger Tracy Grant said...

Lauren, thanks for the wonderful explanation of the South Sea Bubble! I love financial intrigue in books. My mom and I wrote a traditional Regency in which the villains (or antagonists, going back to my post from Monday :-) were involved in a financial scam, part of which hinged on maneuvering in Parliament.

11:22 PM  
Blogger Linda Banche said...

Good post. I like a complex story, and finance is always good for some complexity. Especially, since a romance has a happy ending, the villain get punished. At least I hope he does. I don't like ones where the villain gets away or suffers only a token punishment.

6:41 AM  
Blogger Kalen Hughes said...

Ooooooo, I've always wanted to somehow work this into the plot of a book (though now might not be the best time for such a theme, ACK!).

8:08 AM  
Blogger Lauren Willig said...

One book that does a brilliant job of working the South Sea Bubble into the plot is Karleen Koen's "Through a Glass Darkly." She does such a good job of capturing that sense of speculation fever and then the bewilderment and blinding despair when the bubble burst.

11:51 AM  
Blogger Maya Rodale said...

So I started reading this post, and had to go to class before I could finish it and then, of course, this South Sea Bubble comes up. In a literature class. Perhaps I should have finished this post, arrived a few minutes late and regaled everyone with an explanation. Maybe next time. Thanks, Lauren, for summing this up so clearly.

1:29 PM  
Blogger Louisa Cornell said...

Through a Glass Darkly is a great book! I agree with Kalen this piece of history is rife with story possibilities! Although, perhaps not at this time!

Yes, Pam, the crew of the haves wanting to have more and building it on the backs of the have nots! Or perhaps even the barely haves!

I thank God every day that my late DH insisted that we pay this piece of land off. I own it free and clear as long as I can come up with the taxes every year! And only one more payment on this piece of junk mobile home on it. Then I can start putting money back for my little English style cottage. It is GOOD to have brothers who have done every conceivable construction job!

As for my 401 K. Its with Wal-Mart, one of the few greedy behemoths who may survive this latest debacle.

Goes to show you that greed and the exponential growth of stupidity are with us always. Just like the poor!

7:08 PM  
Blogger Amanda Elyot said...

I'm currently researching Napoleon and his 2 wives for my wip on Notorious Royal Marriages, and came across this parargaph in Carolly Erickson's bio of Josephine. The year referred to is 1784, and we're in Paris.

"Underlying much else that was talked of was the precariousness of the financial system. Personal and national debt were increasing exponentially. Everyone was borrowing, no one was paying anything back--except by borrowing more. The shortage of money faced by Rose [It was Napoleon who named her Josephine] and her in-laws [her first husband's parents] was symptomatic of a wider malaise, a spendthrift mentality, an uncontrolled acquisitiveness that disregarded limits and denied the inevitable coming of a day of reckoning. . . . Bankruptcies were increasing in number . . . it was said, not entirely facetiously, that the measure of a nobleman's wealth was the value of his unpaid bills."

Sound familiar? Of course we all know that if one doesn't learn from history it is doomed to repeat itself.

6:23 AM  
Blogger Kathrynn Dennis said...

Fascinating stuff. After going the dot.com bubble here in the valley, I can only say...the old cliche "history repeats itself" comes shining thru!

8:01 AM  

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