& nbsp & nbspΙωάννης Τελώνης & nbsp; & nbsp; The lessons that can be taught to Cyprus
The story of the South Sea Company – one of the first stock market bubbles – is not uncommon. It is a story full of misleading claims, false news and conflicting versions even today. Apart from the obvious – that is, the inflation and abrupt deflation in the share price of the company that took place between the years 1719 and 1722, its history contains elements, weaknesses and bad practices that are unfortunately familiar to us after 300 years. Therefore, a touch of this story and its lessons is helpful. This is because as a global society we have obviously not consolidated them in relation to the management of public money – in the broadest sense of the word. For our country, these courses are particularly relevant in view of the challenges we will face in managing the enormous resources that will be available to us through the EU restart program.
We are in 1710 in the aftermath of two wars in which Great Britain was involved. The first conflict was over the so-called war of the Spanish succession between Britain and France which in 1710 was coming to an end (it ended in 1713). The second involvement was in the Great Northern War, which challenged Swedish sovereignty in central and eastern Europe, where Britain entered the war on the side of Sweden – this war was to end in 1721.
The result of these wars was the creation of a huge and out of control public debt in England. The state was practically unable to control erratic borrowing from the various government departments. The Bank of England (TTA), which at the time was a privately owned bank entrusted with the management of state funding under a monopoly, did not have the best reputation for its capabilities or good conduct. So when in August 1710 Robert Harley was appointed Chancellor of the Exchequer he decided to solve the problem. He cleverly persuaded the new parliament to appoint a committee to look into the public debt issue. The scene of entanglement begins to set.
Setting the stage for entanglement
This is where the interests in the case begin. The commission of inquiry consisted of Harley himself, his brother, his sister's husband, two members of the Treasury and three others. Harley had to immediately raise ,000 300,000 to pay for the army fighting in mainland Europe. The traditional way of financing such expenses was through a state lottery managed by the TTA (I remind you of a private company at the time) by the government. The last two issues did not yield the required amounts, creating a problem for the Bank of England. Harley thus found the opportunity. Bypassing the TTA, he settled a loan from a private partnership to cover ,000 300,000. In addition, he instructed his friend John Blunt of the Hollow Sword Blade Company – which despite its name actually operated as an unofficial bank – to sell state lottery tickets. In just 3 days Blunt managed to dispose of all the lotteries. The success prompted Blunt – with the blessings of Harley of course – to announce a new 2 2m lottery. Of course, Blunt himself and his custodian received commissions for sales in excess of ,000 20,000 – an amount that today stands at 20 20 million!
But that was only the beginning. The famous debt investigation commission found after hard work that the state's liabilities amounted to more than nine and a half million pounds. To understand the magnitude in relation to Cyprus the debt was approximately equivalent to borrowing for 4 memoranda for the Cypriot economy.
And worst of all there was no provision or mechanism for repayment! This is where the jackals of financial engineering of that time took action.
The squaring of the circle
Harley, Blunt, and their collaborators devised a truly ingenious mechanism for solving the problem based on an earlier proposal by William Patterson, one of the founders of the Bank of England. Taking the example of the TTA's practice of merging previous debt issues – and although the TTA maintained a monopoly on debt management – he proposed the creation of a new company that would absorb all debt by issuing shares for the benefit of debt holders. . The government would pay 6% annual interest to the company (approximately 9 569,000) plus administrative expenses. The government contribution would be distributed to the shareholders.
In addition, and to motivate debt holders to exchange it, it was proposed that the company be given an exclusive privilege (monopoly) in trading the supply of African slaves in the Spanish markets of the South Seas (modern-day Latin America). This was suggested because Harley, as a member of the government, knew that the government had already begun to think of the terms of a treaty ending the Spanish succession (the later Treaty of Utrecht of 1713). One of the terms could also contain a provision for this.
Profits from the slave trade were particularly high, so Harley believed that with such a monopoly in his possession the new company would have significant profits from which he could repay part of the debt. And one last detail. Creating a company in the 1700s was not an easy task. Although the term company was used by various entities, a public limited liability company as we understand it today – in the terminology of the then joint stock company – traditionally sought the acquisition of a royal charter which was given only with prior parliamentary approval (royal charter), process very costly and time consuming.
Harley and his associates realized, however, that the law as such allowed the creation of joint stock companies without the need for royal approval. In addition, with the great growth of trade that the country was aware of, they realized that very soon many investors would not seek royal approval, which would mean competition in the market from new players. So, to prevent this competition, they passed a law in parliament (called the Bubble Act) that would ban the creation of joint stock companies without the royal charter – and which was approved in 1720 a few months before the collapse of the company!
< p>Thus was “born” in January 1711, the South Sea Company with the full name “The governor and Company of the merchants of Great Britain trading to the South Seas and other parts of America and for the encouragement of fishery” – a joint stock company by royal charter. For his efforts, Harley was rewarded in May 1711 with the title of Earl of Oxford and Lord Chancellor of the Exchequer. From this high position began secret negotiations with France that led to the Treaty of Utrecht in 1713, which, among other things, gave Britain a thirty-year monopoly on the supply of 4,800 slaves a year to the Spanish colonies in America! With this square of the circle, the stage was set for the frenzy that would follow.
A company that everyone wanted
And so began the story of the South Sea Company. Everyone seemed to have won. The state had ensured the consolidation of its finances, the debt holders saw a realistic possibility for gradual repayment of the debt at 100% of its value while until the establishment of the Company the maximum they expected was 50-55%. The government now had the opportunity to stop the increasingly inefficient practice of the state lottery to strengthen its funds.
The frenzy began when the English debt bonds that were supposed to be repaid to the company in exchange for its shares began to change hands and become traded themselves. The prospect of repaying them through their exchange of shares in the Company began to attract large investors such as Bateman and Janssen. The bubble began to form.
The bubble is growing despite the financial results
As soon as the Utrecht Treaty was signed, the company began transporting African slaves. From July 1713 until its collapse, the Society relocated more than 34,000 slaves to Latin America. be detrimental to the Company. Its continuation was obviously done to maintain the share price as it was the main component of the supposed super profits of the Company.
Meanwhile the frenzy continued. Famous names of the time such as Jonathan Swift (Gulliver's Travel Writer) and Sir Isaac Newton invested in the Company. The latter, in fact, while he had managed to liquidate his investment at the beginning of the inflation of the stock with good profits, being carried away by the frenzy that had flooded the market, re-invested, as a result of which he lost a huge amount for the time. In fact, after the experience, he said the following joke: “I could calculate the motions of the heavenly stars but not the madness of people!”.
The recipe for the exchange of government debt with company shares
The other great and fatal weakness of the Company was its political dependence on the respective government. Every change of government meant a change of administration.
For example, when in mid-1714 there was a controversy in the Conservative party, Harley found himself in the wrong camp, losing his position in government and his influence in the Society. His replacement broke his commitment to pay 6% interest for two years, causing the share price to plummet as the government owed more than ενός 1m. When in 1715 the Conservative government was replaced by the Liberals and George I ascended the English throne, the share price began to rise again after the new government agreed with the Company to write off the amount due in exchange for the loan to the company. license to issue new shares of equal value. Of course, it did not hurt that both the King and the Heir to the throne were big investors in the Company.
With a capital of more than εκατο 10 million, the Company's capital represented 50% of the share capital of all companies in the country! In 1718 Britain was again at war with Spain. As a result, all of the Company's assets in South America were confiscated by the Spaniards. In 1719 the ingenious mechanism of exchanging government debt for company shares was again used by the government (Lord Craggs) to tame state debts. The goal this time was to convert the bonds issued as payment of the prizes in the state lottery of 1710 into shares of the Company.
As soon as the new intention was made public, the Company's shares took off. The whole course of the share was “assisted” by rumors about the attempt of James Edward Stuart to claim the English crown. James landed in Scotland with a small number of troops and was eventually defeated at the Battle of Glen Shiel in June 1719. Our well-known Hollow Sword Blade Company spread various stories about the outcome of the battle, creating and fueling a constant euphoria that helped absorb new shares and the rise in the share price.
In this climate, the attempt to absorb the bonds was crowned with success since about 2/3 of the circulating bonds were exchanged for shares. The project was considered so successful that a new project was immediately hatched to exchange another, 30,981,712 in debt with the Company's shares!
The Company was overflowing absorbing government debt. Indicatively, in 1719 the state debt amounted to 50 million pounds. Of these, only 3.4 million were held by the Bank of England, 3.2 million by the East India Company, 11.7 million by the Company, 16.2 million by individuals and the remaining 15 million were long-term bonds.
The new plan was presented to the Society and Parliament on January 21, 1720. Members of Parliament demanded that, as requested, the Bank of England submit its own proposal on the plan. After hard negotiation the Company won, but with significant discounts to the government that undermined its viability. It was the beginning of the end.
The first signs that something was wrong were already present at Christmas 1719, when the Society announced the postponement of dividend payment for 12 months. The Company, meanwhile, began to make an effort to gain influence by selectively offering stakes to individuals with political involvement and large investors. Eventually he managed to get 85% of the government debt bonds of fixed term and 80% of bonds of indefinite duration. The next move of the Company was the attempt to influence its share, spreading non-existent positions for the value of its activities in America. The price started in January 1720 at 128 pounds. By May it had reached 50 550. The εμπο 70 million state-owned commercial development fund also contributed to the price increase, which, with the support of both the King and members of Parliament who held shares in the Company, bought shares. By promoting the distinguished members of society who owned its shares, the Company presented an image of honesty, stability and legitimacy.
In 1720, a large number of joint stock companies tried to persuade investors to invest in them with non-existent claims about the future returns of their activities. This resulted in the intervention of the parliament and the adoption of the Bubble Act of which, as I mentioned above, the Company and the then Minister of Finance Robert Harley were the first proposers!
With the passage of the Bubble Act the share price reached 890 pounds in June 1720. By the end of August the price had reached almost a thousand pounds tenfold in value in 12 months! People started selling wanting to cash in on their profits. The sale was generalized and by the end of the year the price had dropped to λ 100. The South Sea Company bubble deflated.
The & nbsp; epilogue
The furious public forced the Parliament to return to a session this Christmas. An Investigative Committee was appointed which in 1721 presented its report revealing the roles played by the various institutions, the entanglement and corruption that nurtured and destroyed the Company, dragging many investors into the disaster.
The Commission's findings do not remained blank paper. Finance ministers and prominent politicians were jailed for their omissions. The same goes for the executives of the legal service who contributed to the creation of the weak institutional framework.
The new Treasury Secretary Robert Walpole personally oversaw the prosecution of 33 of the Company's directors and the confiscation of an average of 82% of their assets distributed to fraudulent investors.
The Company was split between the Bank of England. and the East India Company ending its operation in 1722. Even today the English State pays interest on the securities arising from the liquidation of the Company by the method known to us as bail in.
The lessons that the history of the company teaches us
The first interesting fact is that despite the huge outcry caused by the scandal, its financial consequences did not have a serious impact on the economy. The bubble burst, the company disbanded but the British economy did not collapse. This is in contrast to similar events that led to major financial crises with the most recent crisis of 2013.
The reality with this Company was that its activities and financial relations were limited to a close circle of investors and creditors who absorbed (apparently due to their greed) all the risk and its consequences, reducing the extent of the crisis (contagion effect). Second, although the prevailing view is that thousands of investors were ruined, this does not seem to be true. Several large investors of the English aristocracy and ruling class lost a lot of money but the small investors seem to have been compensated to a large extent. The lesson here is to distinguish between exaggeration and reality. In the case of the company, the percentages of the shares that each investor had were available immediately, which allowed the government to focus on the satisfaction of the small investors, calming the popular reaction.
Third, the actions of the new Minister of Finance By administering justice, strengthening the institutional framework and compensating small investors, Walpole quickly restored confidence in both the institutional framework and the state's ability to enforce the rule of law.