Saturday, December 3, 2011

The South Sea Bubble

A company known under name “The South Sea Bubble” started its activity in 1711, when Earl of Oxford founded “The South Sea Company” financed by many traders of that time (the company` s full name was "Manager and Company of Traders of Great Britain for Support of Fishing in the South Seas and Other American Parts”). The company acquired almost 10 million pounds of the state debt with guaranteed annual rent of 6 % and monopoly for the whole trade with Latin America.

After a small time period there appeared rumours about the company` s incredible profits of the trade in Latin America, where English goods could be changed for gold and silver for “inexhaustive” fields of Peru and Mexico. Actually Spanish colony authorities admitted only one English ship per year and received one quarter of the whole profit and 5% of the turnover. The “South Sea” shares quietly existed on the stock exchange, the price moved only within two or three points per month.

In 1717 English king proposed to “re-privatize” the state debt. Two large financial agencies of the country, Bank of England and “The South Sea Company” presented their projects, and after heated parliamentary debates “the South Sea” was allowed to take one more debt commitment with the interest rate of 5% per year.

But in 1719 an event of great importance for the English colony took place in France. An outstanding person called John Law founded a company "Compagnie d'Occident" in Paris for trade and participation in colonization of the American state of Mississippi. An enormous wave of the company shares increased their prices from 466 francs on August 9 up to 1705 francs on December 2, 1719. The buyers were both the French and the foreigners. It was the reason for the British ambassador asking the government of His English Majesty to do something in order to stop the English capital runoff into “the Mississippi Bubble”. The bubble burst on December 2, 1719. After the crash followed it the capital returned from France to England in continuous search of new opportunities for investment.

This gave interesting opportunities to the main share-holders of British “The South Sea Company” offered to take the whole debt of the English state. On January 22, 1720 the House of Commons appointed a council for the proposal consideration. In spite of many warnings, on February 2 the decision to present a project to the Parliament was taken. Investors were excited with the outlook of the company` s further capitalization. In some days the price of the company` s shares, supported with inflow of funds from France rose up to 176 British pounds for a share. During the project further consideration there emerged new rumours about incredible profits which could be allegedly made, so the share price grew up to 317 British pounds. In the last Act on April 7, 1720, the wave of the profit acquired (i.e. sells) pushed the price back down to 307 British pounds already next day.

Even at such prices the company initiators and managers could take some profit of the capital growth, and the profit was just enormous according to the standards of that time and realized from a company that actually did not work.. This excited their appetites more and more. On April 12 there emerged new positive rumours, and new stock subscription was undertaken for 1 million pounds at the price of 300 pounds for a share. The share subscription exceeded the originally declared volume twice, and in several days the shares were bought and sold by 340 pounds. Then the company declared that dividends of 10% for new and old shares would be paid. After that new subscription for 1 million pounds at the price of 400 pounds was proposed. It was exceeded as well. The company was still almost out of work.

New bubbles

All this inspired many people for business activity, and in 1717—1720s a new phenomenon appeared in the stock market: more and more proposals of shares in new “blind securities”. These companies, like “Compagnie d'Occident” and “The South Sea Company”, sold nothing but plans, ideas and expectations. They were entirely out of work by the date of subscription and were managed by management beginners. The shares were bought with great enthusiasm and their price grew rapidly. The stock speculation was nothing more than rich people` s game: everyone and their brother, men and women here and there participated in it. Those companies were called ‘bubbles” thanks to their founders, who frequently sold their own shares, took the profit just in some days or weeks after a new issue, and left other investors alone with an out-of-work company and inflated prices of its securities.

On June, 1720 the King announced some of those companies “danger sources for all surrounding people”, and forbade trading their shares with a penalty for violation of the statement. The list of 104 forbidden companies included the following fancied activities:

improvement of soap making;

silver extraction out of lead;

buying and equipment of ships for pirates suppressing;

mercury conversion into a ductile refined metal.

In spite of all efforts of the government, there emerged more and more bubbles every day, and the speculation fever still aggravated. The first and the largest bubble of the action – “The South Sea Company” had its share price of 550 pounds on May 28, 1720 (Fig. 2). In June the impressive price level exceeded 700 pounds. In this period the price movements were extremely jerky, with enormous periodic movements. For only one day, June 3, the price fell down to 650 pounds before afternoon, to grow up to 750 pounds in the afternoon. Many large investors used high summer level in order to realize their profit which was then invested in something else, from land and goods to real estate and other shares. However, others continued buying the shares of “The South Sea Company”, physicist Isaac Newton was among the latter ones. During the early rises of the price he sold all his shares of “The South Sea Company”, with taking the profit of 7000 pounds. In the middle of the summer he bought them again, and the bargain cost him 20,000 pounds.

In early June “The South Sea” shares grew again, within a short magic period they were traded by 1,050 pounds for a share. Only very few were aware that the time for investors was finishing. Among those who knew it were the original founders of the company and the Board of Managers. They used the high summer price level in order to get rid of their own shares. In early August ominous facts started penetrating into masses, and slow and stable share price fall began.

On August 31 the company management announced that the annual dividend of 50% would be paid during the next twelve years. This would exhaust the company entirely, and such a piece of news did not stop the investors` increasing concern. On September 1 the shares continued falling and, when the price reached 725 pounds in two days, panic arose. In the rest of the month the shares reached minimum price level and, when on September 24 the company bank was announced to be bankrupt, the falling rate increased. In the last day of the month the shares could be bought by 150 pounds per share. Only for three months their price fell by 85%.

In anticipation of “The South Sea Company” death, banks and brokers found themselves in siege. Many exceeded the portfolio loan values, consisting of shares of “The South Sea Company”, and a wave of bankruptcies ran through the whole financial world. The company was finally wound up in 1855, and its shares converted into bonds. For 140 years of the company existence it never managed to trade in the South Seas to any attention deserving extent.,sampleanalitika/

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