Archive Article: Corporate Crashes: Nothing New Under The Sun. 5 Dec 03.
December 23, 2008

The only thing we seem to learn from history is that we never learn. The current spate of corporate crashes are in many respects similar to previous ones.

One of the biggest in British history was the 1720 South Sea Bubble. This scandal was derived from a company that was supposed to do overseas trade (but had only a few ships), it was chaired by the King, had half of the MPs in the House of Commons as investors, and in which the Chancellor of the Exchequer invested a small fortune and had the wisdom to sell out once he got inside information on the company’s problems. Some people made great fortunes from the scandal but most people lost a great deal. The South Sea Company was formed in 1711. Its purpose was to supply 4,800 slaves each year for 30 years to the Spanish plantations in Central and South America. Britain had imposed the right to supply slaves to Spanish America on Spain in a 1713 peace treaty. Slave-trading seemed a smart way to earn money.

This was an era of great optimism and a sense of progress. People had a passion for business and followed commercial developments through a rapidly expanding new medium: newspapers.

The company knew the value of publicity. Suddenly it became very fashionable to own shares in the company. Owning shares in a company was then quite a new idea and people had little experience of what to look for (or to avoid). Word got around that share-owning was the smart thing to do.

As the price of the shares increased, so the directors issued more shares to keep up with demand. Shareholders were permitted to buy shares on the payment of some of their cost in the expectation that they could pay the rest of the amount by selling off some of the shares when their price had increased still more. Other Europeans heard about this boom and so they too bought some shares, thereby driving up the price still more.

By September 1720 the directors realized that the share price bore no relationship at all to the value of the company itself and so they began to sell their own shares. When this became public knowledge, it sparked a wave of panic selling. The company collapsed and many investors lost all their money.

A parliamentary investigation in 1721 uncovered widespread corruption among the directors, company officials and their political friends. Unfortunately some of the key players had already fled the country with the incriminating records.

Notice the similarities between 1720 and today. First, a sensible business venture (a trading company with a few assets) was taken to excess, especially because of unrealistic expectations of what it could do. Second, there was a herd instinct: people were buying shares not because they knew anything about the business but simply because others were doing so and they did not want to miss out. Third, there were warning voices about the risks of speculation but they were ignored. People were greedy enough to be blinded to commonsense by the promise of wealth. Fourth, some of the money was recovered but generally the main ringleaders in the crash escaped punishment.

Incidentally, Thomas Guy was one trader who did very well out of the South Sea Bubble. He had a troubled conscience and so left his money to fund what is one of Britain’s best hospitals: Guy’s Hospital in London.

Broadcast Friday 5th December 2003 on Radio 2GB’s “Brian Wilshire Programme” at 9pm.