THE CON: A company formed by a group of London merchants took on Britain's huge national debt in exchange for monopoly on trade with South America. They lied about the amount of stock available, hyped its worth and cashed out before the gigantic investment bubble burst.
THE DAMAGE: MISC
THE OUTCOME: Thousands of people, and several banks, faced complete ruin. Britain learned – like France before it with the Mississippi Scheme – that a credit-based plan is a dangerous and ineffective way to deal with national debt.
Formed by a group of London merchants in 1711, the premise of the South Sea Company was simple: take on Britain's national debt in exchange for a monopoly on trade with South America. Struck with visions of gold mines of Chile and Peru, people snapped up the stock and created an enormous credit bubble. When it burst in 1720, hundreds of people and several banks faced financial ruin.
Though John Law's failed Mississippi scheme in France loomed in the not too distant past, the brains behind the South Sea Company were sure they could make a credit-based plan work in their favor. The South-Sea Act passed through Parliament in 1717, at which time the company made an advance of $2 million to pay off the principal and interest on the national debt.
Almost overnight, the stock doubled. London was abuzz with excitement; the narrow Exchange Alley where deals were made was mobbed at all hours with people desperate for South Sea stock. Within just a few hours, more than a million and a half shares were sold. Within weeks, dozens of little joint-stock companies (or “bubbles”) were created to raise the price of stock – at which time the stockholders cashed out. Their stated purpose sometimes veered on the side of the absurd. In fact, when the king issued a proclamation, among the list of companies deemed illegal were ones set up “for trading in hair” and “for carrying on an undertaking of great advantage; but nobody to know what it is.”
Still, the South Sea Company stock continued to rise. By 1720, nearly two-thirds of the British government was in stock. At one point, people worried that it could rise no more. The stock began to plummet before it shot up 1,000 percent. Finally, the bubble burst and the bottom dropped out. Most of the directors, who saw which way the wind blew, had sold out early and held onto their wealth. The average investor was not so lucky.
After the company that served as primary cashier folded, there was a run on the Bank of England: everyone hurried to cash in. The bank – under pressure from the South Sea Company to circulate bonds – pulled out of the deal and the financial disaster struck. As a solution, or at least a means of easing the pressure of the crisis, the Bank of England agreed to circulate a limited number of South-Sea bonds.
Hundreds of people lost their savings in the bubble, which turned out to be the result of more than just the misguided expectations of the company's directors. Prior to the passage of the South-Sea Act, they lied about the amount of stock that was available – and what had already been sold. Those directors, and their co-conspirators who helped pass the bill, sold out early and were thus spared the financial ruin of so many ordinary Londoners.
Con Timeline: 1717-1720
