Showing posts with label South Sea bubble. Show all posts
Showing posts with label South Sea bubble. Show all posts

Thursday 24 December 2020

A 300-year bubble worth remembering: South Sea Bubble

By Edward Chancellor
LONDON (Reuters Breakingviews) - 

Next year marks the 300th anniversary of England’s most notorious speculative mania. The South Sea Company owned the monopoly rights to trade with South America but never made much from those activities. It was the Company’s offer in 1720 to acquire 32 million pounds of Britain’s national debt, in exchange for its own shares, that juiced its returns. Between January and August of that year, the price of South Sea stock traded in London rose sevenfold. At its peak, the Company’s market worth was around twice the total value of land in all of England. The South Sea bubble contains lessons for contemporary investors - even if many of the tales told about the affair are the stuff of legend. 


Sir Isaac Newton, when asked about South Sea stock in the spring of 1720, famously declared that he “could calculate the motions of the heavenly stars, but not the madness of people”. The trouble with the great mathematician’s comment is that it was first recorded, in slightly different form, three decades after his death in 1727. Newton did, however, lose a great deal of money in the bubble – possibly as much as $20 million in current terms - having sold his South Sea stock at an early stage, later re-entering the market and investing his entire fortune in the Company. Although Newton died a rich man, his niece said that he hated being reminded of these losses. 


It’s possible to calculate precisely how irrational Newton and his contemporaries became during 1720. Since England was then at war with Spain, the Company’s South American trading monopoly was basically worthless. Its entire income derived from the fixed interest payments it was set to receive from holding government debt. A highly numerate parliamentarian, Archibald Hutcheson, published a pamphlet in June 1720 arguing that the stock could not possibly be worth more than 200 pounds – just one-fifth of its peak value and roughly the level to which the shares subsequently fell. Some shrewd investors didn’t lose their heads. Bookseller Thomas Guy sold his entire South Sea holding at an average price of 416, and later used his enormous profits to establish the London hospital that still bears his name. Guy also shorted South Sea stock. 



During the early months of 1720, dozens of new companies were floated on London’s Exchange Alley. The most commonly cited of these ventures - a “company for carrying an undertaking of great advantage, but nobody to know what it is” – never actually existed. This mythical venture was merely a satire on the crazy schemes that abounded at the time. Nearly 200 “bubble companies” were launched at the time. Not all of them were scams: of the four survivors, two insurers, the Royal Exchange and London Assurance, later enjoyed great success. 



The companies, the startups of their day, were deeply unpopular with the directors of the South Sea Company, who wanted all the speculators’ capital for themselves. The directors persuaded Parliament to pass a law banning the trade in unauthorised shares. This backfired. After writs were issued in August against several illegal companies, a panic appeared in Exchange Alley; the collapse of market confidence doomed both the mini-bubbles and the South Sea Company itself. By early autumn, its stock was down 80%. Several banks failed, including the Sword Blade Bank which had provided loans against South Sea shares. Distressed speculators took their lives, leading to a large rise in the number of reported suicides. Writing in February 1721, the Earl of Oxford reported that “all credit in trade is stopped”. 



The collapse of the bubble is widely believed to have produced a severe economic downturn. Yet records show only a small increase in bankruptcies and a slight decline in overseas trade. The collapse of the South Sea stock caused a public uproar, however. The directors of the Company, led by former lottery promoter Sir John Blunt, had used numerous tricks to boost the shares. Their main sleight of hand was not to specify the number of shares to be issued for the conversion of the government debt. What this meant was that the higher the South Sea stock climbed, the fewer shares needed to be issued in exchange for the debt and the greater the Company’s profit. To this end, the Company provided loans to speculators, issued partly paid shares with only 10% down payments, secretly repurchased its own shares and promised impossibly large dividends. 



The connection between the Company and the ruling class was close - King George I served as its Governor-General and several directors held government offices. It was later discovered that the Company had spent vast sums bribing members of the establishment. King George, his mistresses, several ministers and dozens of lawmakers were allocated shares at low prices for which they paid nothing. During the bubble months, insiders including the king, Chancellor of the Exchequer Sir John Aislabie and the nefarious Blunt cashed out large fortunes. A House of Commons investigation concluded that the Company’s directors had engaged in “the raising and supporting of the imaginary value of the stock at an extravagant and high price, for the benefit of themselves, and those who were in secret with them”. After the collapse, the directors were forced to disgorge their profits and several ministers lost their jobs. 



In 1720, the word “bubble” didn’t refer to an overpriced asset but to a confidence trick. The South Sea swindle was the greatest of them all. Yet financial practices haven’t improved much over the past three centuries. Bubbles arguably proliferate among the unicorns of Silicon Valley and in the murky world of cryptocurrencies. A revolving door whirrs between Wall Street and Washington. Companies are floated which don’t reveal their ultimate purpose – today they’re called SPACs. Directors still use company funds to boost their stock price and enrich themselves. Thomas Guy’s intellectual heirs, now styled value investors, continue to avoid bubbles and lose money shorting them. But when markets crash, the cries of outrage from those who’ve been “bubbled” will be as loud as in Newton’s day. 

From Reuters

Thursday 4 August 2016

A Random Walk Down Wall Street - Part One 3: Stocks and Their Value

Chapter 2. The Madness of Crowds

The psychology of speculation is a veritable theater of the absurd. Although the castle-in-the-air theory can well explain such speculative binges, outguessing the reactions of a fickle crowd is a most dangerous game. Unsustainable prices may persist for years, but eventually they reverse themselves.

I. the Tulip-Bulb Craze

1. In the early 17th century, tulip became a popular but expensive item in Dutch gardens. Many flowers succumbed to a nonfatal virus known as mosaic. It was this mosaic that helped to trigger the wild speculation in tulip bulbs. The virus caused the tulip petals to develop contrasting colored stripes or “flames”. The Dutch valued highly these infected bulbs, called bizarres. In a short time, popular taste dictated that the more bizarre a bulb, the greater the cost of owning it.

2. Slowly, tulipmania set in. At first, bulb merchants simply tried to predict the most popular variegated style for the coming year. Then they would buy an extra large stockpile to anticipate a rise in price. Tulip bulb prices began to rise wildly. The more expensive the bulbs became, the more people viewed them as smart investments.

3. People who said the prices could not possibly go higher watched with chagrin as their friends and relatives made enormous profits. The temptation to join them was hard to resist; few Dutchmen did. In the last years of the tulip spree, which lasted approximately from 1634 to early 1637, people started to barter their personal belongings, such as land, jewels, and furniture, to obtain the bulbs that would make them even wealthier. Bulb prices reached astronomical levels.

4. The tulip bulb prices during January of 1637 increased 20 fold. But they declined more than that in February. Apparently, as happens in all speculative crazes, prices eventually got so high that some people decided they would be prudent and sell their bulbs. Soon others followed suit. Like a snowball rolling downhill, bulb deflation grew at an increasingly rapid pace, and in no time at all panic reigned.


II. The South Sea Bubble

1. The South Sea Company had been formed in 1711 to restore faith in the government’s ability to meet its obligations. The company took on a government IOU ( I owe you: debt) of almost 10 million pounds. As a reward, it was given a monopoly over all trade to the South Seas. The public believed immense riches were to be made in such trade, and regarded the stock with distinct favor.

2. In 1720, the directors decided to capitalize on their reputation by offering to fund the entire national debt, amounting to 31 million pounds. This was boldness indeed, and the public loved it. When a bill to that was introduced in Parliament, the stock promptly rose from £130 to £300. 3. On April 12, 1720, five days after the bill became law, the South Sea Company sold a new issue of stock at £300. The issue could be bought on the installment plan - £60 down and the rest in eight easy payments. Even the king could not resist; he subscribed for stock totaling £100,000. Fights broke out among other investors surging to buy. The price had to go up. It advanced to £340 within a few days. The ease the public appetite, the company announced another new issue – this one at £400. But the public was ravenous. Within a month the stock was £550, and it was still rising. Eventually, the price rose to £1,000.

4. Not even the South See was capable of handling the demands of all the fools who wanted to be parted from their money. Investors looked for the next South Sea. As the days passed, new financing proposals ranged from ingenious to absurd. Like bubbles, they popped quickly. The public, it seemed, would buy anything.

5. In the “greater fool” theory, most investors considered their actions the height of rationality as, at least for a while; they could sell their shares at a premium in the “after market”, that is, the trading market in the shares after their initial issue.

6. Realizing that the price of the shares in the market bore no relationship to the real prospects of the company, directors and officers of the South Sea sold out in the summer. The news leaked and the stock fell. Soon the price of the shares collapsed and panic reigned. Big losers in the South Sea Bubble included Isaac Newton, who exclaimed, “I can calculate the motions of heavenly bodies, but no the madness of people.”

III. Wall street lays an egg

1. From early March 1928 through early September 1929, the market’s percentage increase equaled that of the entire period from 1923 through early 1928.

2. Price manipulation by “investment pools”: The pool manager accumulated a large block of stock through inconspicuous buying over a period of weeks. Next he tried to enlist the stock’s specialist on the exchange floor as an ally. Through “wash-sales” (buy-sell-buy-sell between manager’s allies), the manager created the impression that something big was afoot. Now, tip-sheet writers and market commentators under the control of the pool manager would tell of exciting developments in the offing. The pool manager also tried to ensure that the flow of news from the company’s management was increasingly favorable – assuming the company management was involved in the operation. The combination of tape activity and managed news would bring the public in. Once the public came in, the free-for-all started and it was time discreetly to “pull the plug”. Because the public was doing the buying, the pool did the selling. The pool manager began feeding stock into the market, first slowly and then in larger and larger blocks before the public could collect its senses. At the end of the roller-coaster ride the pool members had netted large profits and the public was left holding the suddenly deflated stock.

3. On September 3, 1929, the market averages reached a peak that was not to be surpassed for a quarter of a century. The “endless chain of prosperity” was soon to break. On Oct 24 (“Black Thursday”), the market volume reached almost 13 million shares. Prices sometimes fell $5 and $10 on each trade. Tuesday, Oct 29, 1929, was among the most catastrophic days in the history of the NYSE. More than 16.4 million shares were traded on that day. Prices fell almost perpendicularly.

4. History teaches us that very sharp increases in stock prices are seldom followed by a gradual return to relative price stability.

5. It is not hard to make money in the market. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges.


A Random Walk Down Wall Street - The Get Rich Slowly but Surely Book Burton G. Malkiel
http://people.brandeis.edu/~yanzp/Study%20Notes/A%20Random%20Walk%20down%20Wall%20Street.pdf

Saturday 28 June 2014

How Britain’s greatest physicist lost a fortune

How (not) to invest like Sir Isaac Newton


“When I see a bubble forming I rush in to buy,” he said. In January 2010 he declared gold to be the “ultimate asset bubble” shortly after he built up a £400m stake in the metal.
He had sold most of it by March 2011, at a handsome profit – and comfortably before the bubble popped in September of that year.
Not everyone can pull off the same trick; some clever people have lost a lot of money by failing to get out before everyone else. Some very clever people indeed, actually: one investor who lost a fortune this way was Britain’s greatest physicist, Sir Isaac Newton.













Newton was a victim of the South Sea Bubble, one of the most famous boom-and-busts in history – in fact, it was the one that gave rise to the very term “bubble”.
As the graph above shows, he initially did just what Mr Soros would do centuries later – invest early and then sell after making excellent returns very quickly. But Newton made the mistake of re-entering the market much closer to the peak, and then hanging on even after the bubble had burst, selling only once the price had collapsed to well below his buying price.
Newton reportedly lost £20,000, equivalent to about £3m in today’s terms.
The South Sea Company was an unusual business. Founded in 1711, it was promised a monopoly on trade with Spanish South American colonies by the British government in exchange for taking over the national debt raised by the War of Spanish Succession. However, the trade concessions turned out to be less valuable than hoped.
In January 1720, when the company’s shares stood at £128, the directors circulated false claims of success and fanciful tales of South Sea riches and in February the shares rose to £175.
The following month the company convinced the government to allow it to assume more of the national debt in exchange for its shares, beating a rival proposal from the Bank of England. With investor confidence mounting, the share price had climbed to about £330 by the end of March.
The South Sea Company was part of a wider flurry of speculation on the stock market, however.
Newly floated firms were seen as appearing like bubbles; 1720 was sometimes known as the “bubble year”. In June, Parliament, at the behest of the South Sea Company, passed the Bubble Act, which required all shareholder-owned companies to receive a royal charter.
The South Sea Company received its charter, perceived as a vote of confidence in the company, and at the end of June its share price reached £1,050.
But investors started to lose confidence in early July and by September the shares had plummeted to £175, devastating investors.
How to avoid losing a fortune in bubbles
The simplest way to avoid losing money in a bubble is not to invest in any asset in which you suspect a bubble is forming. But as the example of Newton illustrates, this can be easier said than done. The temptation to join in, especially if you tell yourself that you will “sell before the bubble bursts”, can be irresistible.
If you do buy into the latest hot investment, one homespun piece of advice is to sell when even the taxi drivers are talking about it. 

http://www.telegraph.co.uk/finance/personalfinance/investing/10848995/How-not-to-invest-like-Sir-Isaac-Newton.html

Sunday 14 April 2013

Extraordinary Popular Delusions And The Madness Of Markets



The twin bubbles of today: Government bonds (which are set to burst) and gold (which is getting ready to enter the mania phase).

Sunday 11 April 2010

Isaac Newton loses his fortune


Isaac Newton loses his fortune

8.7.2007


There is an increasing amount of concern about the protracted bull market in world equity markets. Since March 2003, almost every stock market has increased in value (and on average, world markets have almost doubled).

Memories of the “Dotcom Wreck” starting in 2000 are still fresh. The Nasdaq index is a good proxy for this financial disaster:

Nasdaq

The graph shows the dramatic growth in share prices that started late in 1998. The hype about the potential of the Net was being pushed daily in all the media. “This time it’s different” was the mantra of the TV commentators.
  • If you had invested in 1998 (when the Nasdaq was around 1400), your money would have more than tripled by the time the Nasdaq peaked at over 5000 in March 2000.
  • Three years of misery followed where investors (those that hung on) lost 80% of their money (in October 2002 the Nasdaq was at around 1100.) 
  • In the following 5 years, the Nasdaq has more than doubled.

South Sea Bubble

Flashback to the early 1700s. England was in a spot of bother having sent itself broke fighting a war involving the French, Spanish and money. The government approached the South Sea Company to help them out, and put conditions in place to attract investors. People always want to make a quick buck, and the investors enthusiastically invested – in droves. From the story in stock market crash.net:

Speculation became rampant as the share price kept skyrocketing. It was thought that this company “could never fail”.

One of the main money-making ventures of the South Sea Company was trading African slaves for the Americans.


Isaac Newton

Even Isaac Newton got caught up in the South Sea mania and invested a big chunk of his fortune. Interestingly, he pulled out early (after making a respectable 7000 pounds) then went back in after the bubble continued to inflate. The inevitable bust happened and he lost 20,000 pounds – a considerable sum at the time.
As a result of this crisis, he stated “I can calculate the motions of heavenly bodies, but not the madness of people”.



Footnote 1: Some of the Dotcom mania was well founded. Google, YouTube, Yahoo and others have gone on to develop highly successful Web-based businesses, worth billions. The problem in the late 1990s was that investors were happy to fund companies with no business plan and no hope of profits. The “madness of people” indeed.

Footnote 2: I don’t wish to imply that investing in stocks is dangerous – quite the opposite. If you don’t invest, you are setting yourself up for later poverty. But what you need to do is be careful to avoid hype and to be able to spot a bubble.

Footnote 3: For another speculative bubble (involving Japanese real estate), see Math of House Buying.