"Shooting turkey" or why a genius lost money in The South Sea Company ! There's a conciliation with today.
In brief :
The The South Sea Company, was established in 1711 by (among others) the Lord Treasurer Robert Harley and the previous director of the Sword Blade Company John Blunt, was granted exclusive trading rights in the Spanish South America area were coffee and spices had been discovered and were being shipped back to Europe.
Europeans traders applied the term "South Seas" only to South America were trading rights were presupposed on the South Sea Company a government backed company. This after the successful conclusion of the War with Spain 1713.
The government saw an opportunity for a profitable venture and preformed a trade-off. The government and the South Sea Company convinced the holders of around £10 million of short-term government debt to exchange it with a new issue of stock in the company. In exchange, the government granted the company a perpetual annuity from the government paying £576,534 annually on the company's books, or a perpetual loan of £10 million paying 6 percent, huge in that time.
This guaranteed the new equity owners a steady stream of earnings to this new venture or so they thought. The government thought it was in a win-win situation because it would fund the interest payment by placing a tariff on the goods brought from South America.
The company then set to talk up its stock with "the most extravagant rumors" of the value of its potential trade in the New World which was followed by a wave of "speculating frenzy" ( sound familiar ).
The share price had risen from the time the scheme was proposed: from £128 in January 1720, to £175 in February, £330 in March and, following the scheme's acceptance, to £550 at the end of May. ( oh my )
What may have supported the company's high P/E ratio was a fund of credit of £70 million available for commercial expansion ( CAPX ). Which had been made available through substantial support, apparently, by Parliament and the King.
Shares in the company were "sold" to politicians at the current market price, however, rather than paying for the shares, these recipients simply held on to what shares they had been offered, with the option of selling them back to the company when and as they chose, receiving as "profit" the increase in market price.
This method, while winning over the heads of government, the King's mistress, etc., also had the advantage of binding their interests to the interests of the Company. In order to secure their own profits, they had to help drive up the stock. Meanwhile, by publicizing the names of their elite stockholders, the Company managed to clothe itself in an aura of legitimacy, which attracted and kept other buyers coming on board.
Thus, Sir Isaac Newton, a gullible old fool as he described himself, was sucked in....more.
Some details derived from Wikipedia® & the Spice trade wars which included the coffee bean.
Part 2 A large number of other joint-stock companies were then floated on the stock market, making extravagant claims (sometimes fraudulent) about foreign or other ventures or bizarre schemes. These were nicknamed "Bubble stocks". Then, The Bubble Act of 1720 or the “prick” that did the trick! Various motivations have been suggested for the Act. The real reason was that Parliament who regulated the business wanted to maintain the monopoly of the South Sea Company, thus guarantying their cut. The Act was repealed in 1825 after a recession was in full bloom. To this day, it is said that bubbles precede recession or worst. Joseph Spence wrote that Lord Radnor reported to him, "When Sir Isaac Newton was asked about the continuance of the rising of South Sea stock… He answered 'that he could not calculate the madness of people'." He is also quoted as stating, "I can calculate the movement of the stars, but not the madness of men". Newton's niece Catherine Conduitt reported that he “had lost twenty thousand pounds. Of this, however, he never much liked to hear of it.” He attributed the event to the greediness of men and individuals in government. Newton' had a fortune at the time equivalent to about £3+ million in present day terms, so he just philosophized what ever was his loss. At the time it was not clear whether it was a monetary loss or an opportunity loss, why? Butt be assured that the king’s love of him was true and that every pence loss was returned to him interest, less you lose your head. ( LOL!) Never again did he invest in bubble companies. Especially in the South Sea Company’s which was in the slave trading business. Inflating the a share price…
Driving the price up required a sudo ponzi like scheme of it’s time. Using a recent example, Bernard L. Madoff, I will try to show how it was done then as now.
Madoff lived off the affections of his people thus gaining a confidence which would not have been possible other wise.
Religious intimacies was a chief tool of his, he always attended his place off worship were he would show a false pity. He donated just enough to keep him in the good graces of his religious leaders. He did pro bono work helping his organizations with his expertise help.
When with his religious people he kept asking questions while dining. Accordingly he would enter into deals powerful people known in the city. He would learn while he was reclining at a meal all about oil and what positions were being taken. You would think making would have been enough no, he wanted to become a legend not just rich. Also, he would tenderly kiss the cheeks of all that greased his palms. At the sight of him people would call him the prophet and the people would listen to what the “Teacher, said!”
His attitude was commendable, when some people did not have anything with which to him pay back, he freely forgave the debt, to a limit (15%). Therefore, people would love even more.
This allowed him to become a prominent member of the securities industry. He served as vice chairman of the NASD, a member of its board of governors, and chairman of its New York region. He was also a member of NASDAQ Stock Market’s board of governors and its executive committee and served as chairman of its trading committee.
Now Madoff founded his investment advisory firm in 1960 the “South Sea Company”. He had set the base for his greatest achievement the 60 billion dollar+ ponzi scheme of all times.