“They had an immense capital dividend among an immense number of proprietors. It was naturally to be expected, therefore, that folly, negligence, and profusion should prevail in the whole management of their affairs.”
Adam Smith on the South Sea Bubble
The 1720 South Sea Bubble scandal serves as Britain’s first modern financial crash. At the height of the Empire, it was believed that no British venture could fail. Thus, in return for a £7 million loan to finance war against France, the House of Lords allowed the South Sea Company a monopoly in trade with South America. The company underwrote £30 million of English National Debt, on a promise of 5% interest from the Government. Shares artificially inflated 10 times their value as investor confidence resulted in wildspeculation. Soon it in no way reflected the actual worth of the company and the entire country suffered a catastrophic loss of money and property overnight.
This story is not unique. The fatal combination of negligent folly of financiers and aggressive speculation has been a recurring theme leading to the 1929 Wall Street Crash, the Dot.com Bubble of the 1990s and the recent global financial crisis of 2009. Notewhat a man who purchased £500 worth of South Sea stock said: “When the rest of the world are mad, we must imitate them in some measure”. Mob mentality and mass hysteria is no doubt a deviant from rational behaviour. However, this risk was not negated by those experts relied upon to manage financial affairs responsibly; moreover,as depicted so outrageously in the film Wolf of Wall Street, it was encouraged
Almost a decade since the Lehman’s Brothers collapse it is clear that lack of accountability dominated the packaging and re-packaging of subprime mortgages as bankers saw fit to banish risk once they had lost track of it. Just like the South Sea Company before them, banks considered themselves “too big to fail”. Nonetheless, the collapse of Northern Rock and the Royal Bank of Scotland led to radical government bail-out to salvage complete economic break-down, the cost being less than the cost of the failure to the economy.
Financial regulation is going through a period of significant reflection and change. In Britain, the Financial Conduct Authority has formulated ‘The Principles for Businesses’ with integrity at its core. Financial institutions have bought into conduct risk as the industry works to regain consumer confidence in responsible banking.
All the while, the European Debt Crisis is looming which begs the question: how serious does a crash have to be to effect lasting change? Certainly, as the financial industry becomes ever more complex to fit a global economy we must not fall foul of collective delusion.