Formed in 1711 by Robert Harley, the South Sea Company was created to convert £10 million of government war debt (incurred during the War of Spanish Succession) into its own shares.
In exchange, the company would receive annual interest payments from the government and a monopoly on trade with the South Seas and South America.
The exchange was successful and although the expected trade riches never materialized, the company continued with several other debt conversions.
In 1720 the company proposed to take over the entire British national debt.
As soon as the plan was announced to Parliament, the company’s share prices began to rise as speculators gambled on the conversion plan.
The House of Lords approved the plan on April 7, 1720, after government officials had been bribed with secret allocations of shares. In order to make the deal more attractive, the company inflated the value of its stock.
On April 14, £2 million of South Sea Company stock was offered to the public at £300 per share and the subscription sold out within an hour.
The company made several more stock offerings, all of which sold out, with the subscribers representing all social classes.
The apparent success of the South Sea Company’s scheme led to the appearance of many new joint-stock companies, which became known as “bubble” companies.
One of them was for a wheel for perpetual motion — capital one million; another was “for encouraging the breed of horses in England, and improving of glebe and church lands, and repairing and rebuilding parsonage and vicarage houses.”
But the most absurd and preposterous of all, and which shewed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled:
“A company for carrying on an undertaking of great advantage, but nobody to know what it is.”
Were not the fact stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project!
The subscription for this final company sold out, and the satisfied entrepreneur promptly disappeared to the Continent!
Worried about the competition from the bubble companies and in an attempt to sustain their share price, the South Sea Company convinced the government to pass the Bubble Act in June 1720.
The act prevented the establishment of new companies without government permission, and allowed existing companies only to carry out those activities that were prescribed by their charters.
The price of South Sea stock peaked at £1050 in late June of 1720, before the scheme began to fall apart.
The first large drop in the market occurred in August, as foreigners and other investors began to withdraw from the market.
British domestic credit was stretched to its limit and the scheme finally collapsed at the beginning of September, with the stock having fallen by 75 percent in four weeks.
Parliament conducted an investigation, corrupt politicians and businessmen were imprisoned, and over £2 million was confiscated from South Sea Company directors.