Wednesday, October 5, 2011

The South Sea Company

Big corporations these days have, to put it mildly, a poor reputation. They stand accused of such crimes as buying elections, corrupting government to the point of making constituents irrelevant to the process, severe exploitation of workers, disregard for communities, and using every trick in the book- including ones they make up as they go- in order to take everything of value that they can from everyone that is not running a big corporation, nearly to the point of confiscation, and then hoarding it so that money, once in the hands of the super-rich, never leaves it.

What if I told you that corporations have been, historically, even worse than that? They could just take over the world outright, with guns.

In the Age of Exploration, the kind of company most influential to world events- and almost certainly the most influential of all time- was the chartered company. A chartered company was what you made when you needed to raise money to fund an expedition overseas for the purpose of exploring, trading, and often conquering and colonizing whatever happens to be over there. By funding the expedition, you got to share in the spoils, whatever they were, however much they were. The companies were always named after wherever it was the expedition was headed. The American settlements at Jamestown, Virginia and Plymouth, Massachusetts were separate parts of one such company, the Virginia Company.

Probably the most notable of the others from the era were:

*The Hudson's Bay Company, set up to capitalize on Canadian fur trade and which is actually still around, headquartered in Toronto and currently in ownership of several Canadian retail chains.
*The Dutch East India Company, whose land holdings after dissolution effectively became Indonesia.
*The British East India Company, which ruled India for an entire century until the Sepoy Rebellion of 1857. That rebellion was brought on when Hindu and Muslim sepoys (local term for soldier) were made to use ammunition that required them to bite the end of the cartridge before loading into the gun. The cartridge had been coated in animal fat, very likely beef or pork. When the soldiers refused, citing religious sensibilities, they were punished by Company soldiers, who didn't see what the big deal was. They soon found out; while the rebellion was eventually squashed, the Company ended up handing control over to the British crown.

These were the successful ones.

Then there was the South Sea Company.

When someone says "South Sea" today, they probably are talking about the South Pacific, places like Fiji and Tahiti and Samoa. In 1711, though, when the South Sea Company was founded, "South Sea" referred to South America and the surrounding maritime area. In that year, Robert Harley- a British politician mainly notable today for his influence in literature- established the company alongside a man named John Blunt. The aim: exclusive rights of trade in South and Latin America, which when set up would help pay off 10 million pounds worth of government war debt. That all seemed like a great deal and a surefire winner. After all, Latin America was so rich in resources, and gold and silver.

There was just one problem, though as told in Charles Mackay's book Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, and again in the Guinness Book of Historical Blunders by Geoffrey Regan (you can see where this is headed just from the titles of those books): none of this land actually belonged to England. Locals notwithstanding, it belonged to Spain and Portugal, though as far as we're concerned here, really just Spain. And Spain wasn't really keen to allow England to horn in on its market, though after the War of Spanish Succession in 1713, they did allow one British ship a year to trade with Chile, Mexico or Peru. And even then, then-Spanish king Philip V got to tax that ship's cargo at 5%, and take a quarter of the profits.

Not that anyone cared. Gold! There's gold in them thar hills! The gold tells us to disregard reality! (No! It will do us harm!) We must obtain it! (But we cannot have it!) WE WANT IT!

While the public worked itself into a frenzy, 1717 arrived, where England and Spain went to war after England, getting presumptuous, announced that Spain would expand trade rights without the part where you inform Spain about these things. More debt was incurred, the British government became concerned about paying down the national debt, and the South Sea Company- which now had even less cooperation from Spain than the scrap they had when they started- offered to take on some of that debt, and allow the public to invest in the company to help get the money back.

Basically, they were now making a company centered around getting the general public to reimburse the directors after they had helped pay down the national debt, and dressing it up by invoking images of Spanish gold that stood a snowball's chance in hell of coming to fruition.

One man in Parliament, Robert Walpole, made a warning about just how thoroughly the public was about to get fleeced and how unethical it was to do it. Nobody listened. In fact, the rest of Parliament went out of their way to not listen. Whenever he was getting ready to speak on the topic, members of Parliament fled the chamber. Needless to say, in 1720, they approved everything by comfortable margins. In the meantime, the directors of the Company talked up predictions that Spain, who was actually still at war with England, was suddenly going to just hand over a Peruvian silver mine in Potosi. (Spain did lose that war in 1720, but didn't hand over the mine and would continue to be to odds with England for most of the rest of the century.)

The public's reaction: GOOOOOLLLLLD! WE WANT GOLD!

The second the South Sea Company made the 1720 England equivalent of an initial public offering in February, the stock price took off like a rocket, tripling in value on Day One. So many people arrived at the London exchange to buy stock that they shut down traffic. More rumors of inexplicable Spanish generosity came from the South Sea directors to drive it up even higher.

In the meantime, a whole range of people who weren't taken in decided to get in on the act themselves, creating short-lived scam companies on similarly ridiculous claims. Their short-lived nature and their tendency to pop out of existence without warning led them to be referred to as "bubbles".

Thus coining the term.

How ridiculous were the bubbles? One sought to trade in hair. Another asked for money to make a perpetual-motion machine. A third asked for money "for extracting silver from lead." Yet another asked people to invest in square cannonballs. Just about everybody's favorite when they examine the topic, though, was "a company for carrying on an undertaking of great advantage but nobody to know what it is." It was created in the morning, drew in 2,000 pounds, and the director fled the country five hours later, the second he had hands on the money.

In June 1720, Parliament, for whom Walpole's warnings would have rung in their ears had they allowed themselves to listen to them in the first place, bravely went on recess. The king, somewhat more sensible, declared the bubbles a public nuisance on June 11, and formally dissolved them the next day.

Too late for the South Sea Company investors. Which wasn't shut down anyway.

The South Sea stock price started to get shaky around May, when some investors, no longer caring about South America, started to take their profits and get out, figuring whatever was in Peru wasn't really worth hanging onto the stock much longer. On June 3rd, the stock, now at 890 pounds a share (they had been at 130 pounds on February 1), started to crash for lack of buyers, stopped at 640 pounds only through the directors performing a buyback and getting it back up to 750 pounds, and 1,000 by August through some feverish manipulation.

Then, one day, word got started, whether true or not, that John Blunt, one of the original directors, had cashed out. Game over. The stock cratered despite all efforts by the directors to ensure the people that the nation had actually been enriched, never mind the fact that the very name of the company implied that this was not how the people were supposed to be enriched. And the stock had a big crater to make before it even got back to its original price. Every day saw the stock going further and further down, drawing increasing fear and anger from investors who saw themselves flung closer and closer to begging in the streets. By mid-late September, the directors couldn't go out in public without risking assault.

Finally, people thought to listen to Robert Walpole. But by now there was little he could do. Walpole tried, employing various methods- most notably issuing bonds- but it was simply too late. Panic had gripped the nation and, by the end of September, the stock had come all the way back down to 135 pounds. Eventually, the banks refused to let things carry on any longer.

Curiously, from birth to death, the South Sea Company's stock price never once dipped below that of its IPO, as viewable on the logarithmic scale shown as Figure 1 of this PDF file.

Under Walpole's advice, Parliament set about punishing those they deemed most responsible in December. They managed to convict five people, and John Aislabie, a member of Parliament who was given 20,000 pounds to promote the company, wound up being sent to the Tower of London. The treasurer, Robert Knight, was highly sought, but managed to skip the border in time. He was picked up in Belgium, but insisted to be tried in the nation where he was captured, citing local law. He got his way, and then escaped again while awaiting trial. John Blunt was eventually stripped of all but 5,000 pounds of his 183,000-pound estate; other directors met similar fates as their assets were confiscated for reparations. (No word on what became of Robert Harley.)

One would like to think we've gotten smarter over the years- though there is always someone- but even so, smarts are a relative thing in this case. As investors step up their intelligence, those who look to fleece them step up their game, requiring people to be smarter and smarter in order to avoid getting taken, and eventually trying to seal off the exits entirely.

And once they consider those exits sealed, intelligence becomes irrelevant, any mask maintained can drop, and those who end up with the money feel comfortable doing this...

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