We start a new three part series this month looking at Failed Investment Schemes, and the factors that are involved in their creation, growth and eventual demise.
There is a saying about history repeating itself and this applies to these types of investments as much as it does to anything else. So we begin this series with some history, actually 300 year old history.
The South Sea Bubble is the name given to the collapse of the South Sea Company (SSC) in the first part of the 1700’s. The background is pretty basic. In 1711 the company was given a Royal Charter and a monopoly over other British companies to trade with Spanish South America. The fact that relations between England and Spain were not great at that time meant that trade was non-existent.
Part of the deal was that SSC would take over a significant amount of government debt, the Treasury converting government bonds to SSC bonds, and the Treasury would pay SSC an annuity for doing so. Shares in the company were then sold to the public.
Finally, in 1717, company ships set sail for Spanish South America, but this venture proved a failure and ran at a loss. By 1718 relations had again deteriorated between the countries and no further trade was possible. In 1719 SSC took over one-half of the current government debt (some 30 million pounds) and received another annuity.
In 8 years of existence the company only attempted to trade once – and lost money – and had taken over large amounts of debt at a rate that it could not support. It should have been considered a bad investment, but in 1720 the shares started to be talked up by some members of London society. Shares were also sold to a number of prominent people (they were never asked for payment) and their names were used to give the company some credibility. The 100 pound shares went to 890 pounds, based purely on hype. Clearly ‘spin’ is not a new phenomenon.
Profit takers started selling, but the company countered by buying its own shares, pushing the price over 1000 pounds. Eventually and inevitably the market acted rationally and the share price collapsed, ruining many fortunes.
Interestingly, at about the same time, a Mr John Laws formed a company in Paris that was set up to trade with the New World, effectively the colony in Mississippi. The story of that company is very similar to SSC. That failure became known as the Mississippi Bubble.
Why the history lesson? There are a number of common factors to failed investment schemes, and they applied as much in the 1700’s as they do today. Next month we explore some recent examples. In the meantime we leave you with the following relevant quote from perhaps the preeminent scientist of all time.
“I can calculate the movement of stars, but not the madness of men”
Sir Isaac Newton – after losing 20,000 pounds in the South Sea Bubble