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Saturday, 21 November 2009

Famous Scams: The South Sea Bubble

The South Sea Bubble was one of the earliest British stock market bubbles. But it was more than just a bubble, like the dot com bubble of recent years -- it was an example of a scam of massive proportions, with the snouts of businessmen, management, and government firmly in the trough.
The South Sea Company

With the rise of British Imperial power in the early eighteenth century, the huge wealth generated by its vast overseas businesses was creating a growing wealthy middle class. But it was well nigh impossible for anyone new to invest directly in the companies controlling the trade. For example, the East India Company, which enjoyed a monopoly on trade with India, had fewer than 500 shareholders to whom its handsome (and tax-free) dividends were distributed.

Enter the South Sea Company. Following the War of Spanish Succession, Britain was left with a national debt of around £10m (which was a considerable sum at the time). The South Sea Company was established in 1711 and raised capital from the investment-hungry wealthy to buy that government debt in return for 6% a year in interest. In addition, the company was granted a monopoly on trade with South America, upon which the government hoped to levy taxes that would, in turn, fund the 6% interest owed to the company. It was an incestuous web right from the start.
Naïve investors

The company's first issue of stock was snapped up by eager investors, who believed South American gold would be handed over in shiploads in return for English wool and other such finery. Sadly for investors, the managers weren't really much good at trade (though they were good at looking slick and talking smoothly), and with growing hostility between England and Spain, the company barely made any money from trade at all. Instead, further financial finagling followed, with new South Sea company shares being offered to the gullible public to finance new deals over national debt. Many insiders, in both the company and government, took advantage to gain huge wealth, with the share price rising nearly tenfold in little more than six months in 1720.

That year, in full knowledge that the company’s actual business was worth a meager fraction of the current market value of their shares, the management sold out, and panic selling ensued when people heard the news. In the carnage, such notables as Sir Isaac Newton (who was said to have commented "I can calculate the motions of the heavenly bodies, but not the madness of people."), Alexander Pope, and even the king himself, lost large amounts. It wasn’t just the uneducated masses who were fleeced.
Other scams

Seeing how easy it was to separate gullible punters from their money, during the bubble in South Sea stock a whole raft of even less reputable con artists got in on the act, offering stock in companies allegedly engaging in all manner of ludicrous ventures. One venture promised to reclaim sunshine from vegetables, while another was floated in order to buy the Irish bogs. It is even said that a company was formed with the stated aim of manufacturing a cannon to fire square balls. But perhaps the most ridiculous was the flotation of a company "for carrying on an undertaking of great advantage, but no-one to know what it is". Amazingly, even that one succeeded in conning the gullible out of £2,000.
The lessons?

The whole sorry episode saw all manner of scams that are, sadly, still around today -- insider dealing, pumping and dumping, cold selling, fraudulent reporting, and plain simple lies. And it was compounded by all manner of investment pits that people are still falling into today, from simple gullibility amongst people who really didn't know any better to the large scale switching off of the brains of people who really should have. People lost everything they owned and more, with many having borrowed the money to buy their stock.

But at least today nobody would fall for the "undertaking of great advantage" one, would they? Well, I can still remember people snapping up shares of companies simply because they had the word "Internet" in their name, without the merest inkling of what the companies did.


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