South Sea Bubble (1720): Lessons from Britain’s Historic Financial Crash
The Dividend Hall of South Sea House (1810). Public domain, via Wikimedia Commons.
🚢 The Promise That Fooled a Nation
Imagine a company whose shares skyrocket from £128 to over £1,000 in just six months. Everyone starts buying: the shopkeepers, the politicians, and, heck, even the servants. People are taking out loans, selling their homes, and cashing out their savings just to get in on the action.
This is a picture of Britain in 1720, and the company just mentioned is the South Sea Company. It promised to make the nation and its citizens rich via trade with the Spanish colonies in South America. For a few months, the company seemed unstoppable. And only a few months later, investors’ fortunes were wiped out, shaking the nation’s faith in its government and its money.
Welcome to the South Sea Bubble: a tale of ambition, corruption, and danger in mixing government promises with public greed.
Photo Credit: MostEpic, Arms of the South Sea Company, CC BY-SA 4.0, via Wikimedia Commons.
📜 How It All Began
In the early 1700s, Britain had a big problem: debt. Britain was at war for nearly every year for the first twenty years of the 1700s with only a few periods of peace, fighting the War of the Spanish Succession from 1701 to 1714, the Jacobite Rising from 1715 to 1716, and the War of the Quadruple Alliance from 1718 to 1720. All this fighting had drained the treasury, and the government needed creative ways to raise money.
During this time period, forming a corporation meant getting approval from Parliament. And, in exchange for receiving special trading rights, companies could either give the government cash or take over parts of its debt.
The Birth of the South Sea Company
In 1711, the government granted a charter (i.e. it gave official permission for an entity to exist) to the newly formed South Sea Company. And the idea was simple:
The company would take on part of Britain’s war debt.
In exchange, the company would get a monopoly on trade with South America, including the right to sell goods and enslaved people to the Spanish colonies.
Both parties saw it as a win: The government reduced its debt, and investors who were betting on the company’s monopoly to make it extremely profitable got a chance at huge profits.
There was only one issue: It was 1711, and Britain was at war with Spain fighting the War of the Spanish Succession—fighting the very nation whose colonies the South Sea Company was supposed to trade with, thereby making trade almost impossible. The only thing the company had going for it was the fact that it had connections to powerful politicians to make it look legitimate; and that was enough to attract investors.
African slaves taken aboard a slave ship (1800s). Public domain, via Wikimedia Commons.
💡 Turning Debt into Profit—At Least on Paper
When the war ended in 1713 with the signing of the Treaty of Utrecht, the South Sea Company benefited because Britain had finally gained limited permission to trade with the Spanish colonies. And the South Sea Company’s leaders used this victory to sell an exaggerated promise: one of global trade, easy riches, and endless growth.
And though the company had a few slave-trading voyages after 1713, it was far less than promised. So instead of profiting primarily through trade, the company found a different way to make money: turning government debt into company shares.
For context: The British government had borrowed money from the public to fight its wars, and, in return, the public received IOUs (also known as annuities) that paid them regular interest.
So, the company hatched the following plan:
They would take over part of the government’s debt by paying a modest lump sum to the government, with the rest of the money coming from the issuance of new shares to the public.
The company would now collect the interest from the government on the debt it now owned.
Investors who held government IOUs could now exchange them for South Sea stock.
Investors received shares that were now, supposedly, paying dividends and could be traded freely in London.
And thus, everyone appeared to be winning: The government had simplified its debt problem. Investors now had new stock that was more convenient to buy and sell, was rising in price, and paid dividends. Meanwhile, the South Sea Company was earning interest from the government and was successful in getting people to exchange their IOUs for company stock, thereby driving up their share price.
But there was a deep flaw: the South Sea Company’s real line of business, i.e. trade, barely existed. So where was its supposed dividend money coming from? Well, it often came from the money made from issuing shares to the public as opposed to where they should have been coming from—the company’s profits from trade.
Photo Credit: Osama Shukir Muhammed Amin FRCP(Glasg), South Sea Annuities share certificate, issued November 13, 1784. On display at the British Museum in London, CC BY-SA 4.0, via Wikimedia Commons.
🧍♂️ The Man Behind the Mania
And now we come to John Blunt: a clever and persuasive businessman who rose to become the leading director of the company and, most importantly for the story, convinced Parliament to let the Company take over around £30 million worth of Britain’s roughly £50 million of remaining debt.
So, here was the newly revised plan:
The company would take over more of the government’s debt by paying a lump sum of around £7.5 million, while the rest would come from issuing more new shares at inflated prices.
This, in effect, relied on the bet that investors would be willing to pay more for these newly issued shares even though the company’s trading operations in South America were far less profitable than promised. (When I first studied this bubble, I realized that few people, if any, grasped the concept of share dilution back then. But in an era of minimal financial regulation, investors simply interpreted new share offerings as a bullish signal.)
If people believed in the company’s promises, then South Sea share prices would continue rising.
As long as the prices kept rising, the company would use that momentum to fund itself.
Once again, the company’s real product wasn’t found in its goods; rather, its product was the perception that the stock was worth buying because its shares would keep rising in value and that this perception would continue because of the company’s close connection to the government despite the fact that their trade business was minimal.
Photo Credit: Printed by John Simon After D. Stevens, John Blunt (Financier), CC BY-SA 4.0, via Wikimedia Commons.
💰 The Mania Spreads
In early 1720, the South Sea Company began to sell its new shares to the public for £300 each; buyers only had to pay 20% upfront with the option to pay the rest later; the result was that the offer sold out.
London was abuzz: Coffeehouses, which were the stock markets of the day, filled the air with the talk of fortunes being made.
The company then launched another round of shares, followed by another, each time raising its price and lowering its down payment. And within a short period of time, people started to borrow to buy shares that had already doubled or tripled.
By June, South Sea stock had hit a whopping £1,000 per share, an unrealized return of 233% (i.e. profit on paper without cashing out) for those getting in at £300, the whole time the company making little profit from its trading operations. But the company’s leaders fueled the excitement even further by lending money to those investors who wanted to buy shares but had no cash upfront. In other words:
The company loaned people money.
The people used that money to buy more shares (and these shares were used as collateral in case the buyer couldn’t pay back the loan).
This extra buying of shares inflated prices further upwards.
The higher stock price made everyone wealthier (or so they thought), allowing the company to justify further lending.
Soon enough, over 100 other companies joined the fray: they took advantage of the hype surrounding the South Sea Company, promising wild ideas of their own—ideas that ranged from reclaiming sunken treasure to extracting silver from lead.
But like the South Sea Company, these businesses sold shares to speculators with no assets, no operations, and had no real financing model. One company founder, who was looking to raise capital from investors at the time, said his business model was “for carrying on an undertaking of great advantage, but nobody to know what it is.” He promised a 100% annual return and took £500,000 worth of deposits in just six hours, after which he fled the country and was never heard from again. (As popular as this story is, it’s probably an exaggerated tale.)
The South Sea Bubble by Edward Matthew Ward (1847). Public domain, via Wikimedia Commons.
⚖️ The Bubble Act and the Beginning of the End
By mid-June, the government became uneasy, so Parliament passed a new law: the Bubble Act, banning unapproved companies and thereby halting the wild speculation taking place. The Act was also meant to protect the South Sea Company from competition, but the irony was that it brought the whole scheme down.
Investors who had put money into speculative companies needed cash to cover their losses. So what did they sell? They sold their shares in South Sea. And soon, prices began to fall.
In an attempt to stop the fall, John Blunt offered one more batch of shares at £1,000, implying that management really believed the shares were worth that much. To sweeten the deal, the company promised an unsustainable level of dividends: as high as 30 to 50%
But instead of restoring confidence, Blunt’s actions exposed the lie: It was obvious that there was no way the company could actually deliver those payouts. And within days, the panic set in:
On September 1: shares traded around £770.
A few days later, they fell to £370.
By September 10, they had crashed to £180.
Back when the stock price was soaring, many South Sea investors had taken their shares to the banks and to the moneylenders who were willing to accept their shares as collateral so that they could borrow their money. People used these borrowed funds to buy houses, jewelry, and some even bought land with the assumption that their shares would stay valuable.
But when the value of the shares collapsed, their collateral was now worth far less than their outstanding loan balance. And when the lenders came knocking for their payment, the borrowers, of course, didn’t have the cash.
They instead had to sell their possessions, often at fire-sale prices, and even after selling everything, many still couldn’t pay back their loans, leaving them deeply in debt and, in some cases, bankrupt.
A chart of the stock price of the South Sea Company, showing the South Sea Bubble. Public domain, by S. Kitahashi, via Wikimedia Commons.
💣 The Aftermath
The public’s outrage was enormous to say the least. Parliament launched an official investigation, and company records revealed everything from bribes to insider trading. Robert Knight, treasurer of the company, fled the nation, and company directors were arrested.
Even after the government had confiscated the directors’ wealth to repay investors, only a fraction of this money was recovered. And the Bank of England had to step in to steady the financial system by:
Agreeing to buy South Sea Company shares at a fixed (i.e. stabilized) price to prevent a complete collapse.
Offering loans to struggling individuals or businesses affected by the collapse and injecting liquidity into the market.
In effect, this was one of the first major financial bailouts in history, and the earliest example of a central bank (or proto-central bank) intervening to prevent a wider collapse.
The South Sea Company survived in name, but its reputation was permanently destroyed, continuing for a little over a century longer as nothing more than an entity that managed government debt (of all things) and finally closing in 1854. It left behind nothing more than deep scars on Britain’s financial culture.
The South-Sea House in Bishopsgate Street (1754) by Thomas Bowles. Public domain, via Wikimedia Commons.
🔮 Echoes in Today’s Markets
This event happened more than 300 years ago, but we see these historical patterns repeated into in the 21st century:
The Subprime Mortgage Crisis (2007–2010): Government-backed mortgage giants Fannie Mae and Freddie Mac fueled a housing bubble by guaranteeing risky subprime loans that inflated prices. When real estate collapsed, their downfall triggered a $200 billion bailout and the worst financial crisis since the Great Depression.
The SPAC Boom (2020-2021): Companies with no profits had raised billions based simply on promises of future deals. As a result, their stock prices soared because investors didn’t want to miss out on the fun.
The methods may change, but human emotions—hope, fear, and especially greed—will always remain the same.
A bubble-era stock promoter, caricatured as a “night wind hawker” (1720). Public domain, via Wikimedia Commons.
🧠 The Lessons
The South Sea Bubble offers us investors, and investors of any era for that matter, timeless lessons:
Easy credit can create dangerous overconfidence. If money is cheap and easy to borrow, prices can, and sometimes do, rise for all the wrong reasons.
Real profits matter. When investing in individual stocks, always look at a company’s business segments of revenue to understand how they make their money.
Big promises are warning signs. If dividends or returns sound too good to be true, they probably are.
Government partnerships don’t make an investment safe. Just because a company is doing official business with government doesn’t necessarily mean it’s a solid investment.
The South Sea Scheme (1721) by William Hogarth. Public domain, via Wikimedia Commons.
💬 Investor Takeaway
In sum, the South Sea Bubble illustrates how fast we forget reality when stock prices are climbing and hope takes over. Investors really believed they had a surefire asset backed by the government, when in reality they were buying into a narrative with a false promise.
Before you invest in anything that seems “guaranteed,” ask yourself three simple questions:
Would I still buy this asset if it didn’t have the backing of a big name or a big institution?
Is this company’s line of business profitable today or is the profit being promised at a later date?
If the price fell by half, would I still believe in its long-term value?
If you hesitate to answer, then you might just be chasing the crowds as opposed to building wealth.
The South Sea Bubble is a tale of old, but its lesson is fresh: no matter how impressive the promise of an asset, always go back to the fundamentals and never trade your reason for excitement.
📚 Attribution: Adapted from Lecture 5: “The South Sea Bubble,” taught by Professor Connel Fullenkamp in Crashes and Crises: Lessons from a History of Financial Disasters (The Great Courses, Duke University).
