The South Sea Company was formed in 1711 by Robert Harley, British politician who wished to create further political allies. He was the leader of the Tory party and soon to be lord treasurer. The company was organized under the new joint-stock principle, as a corporation with transferable shares.
Holders of the national debt were obliged to exchange their government securities for shares at par in the company. The company was promised a monopoly of all trade to the colonies in South America in exchange for taking over and consolidating the national British debt created by the War of Spanish Succession.
While the war effectively ended in 1713, the international treaties included the scope of trade opportunities for the South Sea Company by confirming Spain's sovereignty over its new world colonies. The South Sea Company was left with limited options in the slave trade and narrowing trade opportunities in the Spanish colonies in South America. In addition to its trade monopoly, the company would get an annual payment from the Exchequer of £568,279, or 6 percent of the debt taken over.
Stockholders had no promise that they would see any of this as dividends, but who could blame them for thinking that massive capital gains based on trade would come quickly. It's interesting that the South Sea Company did not even conduct its first trade voyage until 1717 and the potential for South Sea fortune actually slipped further from grasp when the fragile relationship between Spain and Britain deteriorated in 1718.
Speculation and greed
It didn't matter to investors that the company wasn't headed by experienced management. After all, as long as they owned a monopoly that would bring them vast fortunes, greed was dominating factor. Those who lead the company were born public relations directors, setting up offices furnished with luxurious items in the most extravagant quarters. Ordinary people, investors and speculators upon seeing the wealth the South Sea Company seemed quite content and eager to invest their money in company shares without much thought.
In 1719 the government again found itself awkwardly in debt. John Blunt, top director and his fellows again proposed the same solution a few years before. The debt in the amount of £30,981,712 should be voluntarily converted to company stock, at terms to be named later, saving the government much in annual interest and bringing it a fee from South Sea of £7,500,000 potentially for the privilege of making the conversion. Just to put these sums in perspective, some historians claim that a middle-class family of the period could live quite comfortably on £200 a year.
As some doubted the attractiveness of the scheme, the company distributed £1,259,325 of fictitious company stock, in reality bribes, later to be paid in cash with the public's money to 40 or 50 members of Parliament, first lord of the treasury and secretary to the treasury. Even Duchess of Kendal, the king's mistress at the time was on the list. Sounds crazy right? But it happened all the same.
South Sea Company stock price skyrockets
In January of 1720, South Sea Company stock was trading at a modest £128. In an effort to boost popular interest in the company's stock, the directors used the newspapers to circulate false claims of success in trading made in the South Sea. Public believed, so the share price rose to £175 in February. Interest in the company was additionally increased in March when the government endorsed a proposal from the company to assume yet more of the national debt in exchange for shares of South Sea Company stock.
The South Sea Company's proposal was chosen over that of its chief competitor, the Bank of England. With investor confidence mounting, the share price climbed to approximately £330 by the end of March. Speculative frenzy mounted as South Sea Company stock benefited from the high demand making the price in May around £550. The government passed The Bubble Act in June, requiring all joint-stock companies to receive a royal charter.
This legislation had been introduced by the South Sea Company, presumably as a means of controlling competition in the burgeoning market. When the company received its charter, which investors view as a vote of confidence in the company, and by the end of June share price had reached a peak of £1050. At the time, first major doubts arose and investor confidence began to wane.
The collapse occurred in early July. By the end of August stock was valued at less than £800. A fall of 20% seemed like a breeze as the investors started to panic. In the September the share price had plummeted to £175, devastating institutions and individuals alike. In 1721 the government opened a series of formal investigations which exposed all the deceit, corruption and bribery.