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.