NY Fed Compares The Current Reach-For-Yield To South Sea Bubble Of 1720

Tyler Durden's picture

When a tin-foil-hat-wearing digital dickweed points to record volumes of cov-lite loans, insatiable demand for Ugandan bonds, and the disconcerting disconnect between record-high median leverage and almost-record-low credit spreads, the mainstream can scoff at their obsessions... but when the NY Fed - once again - highlights the potential froth in credit markets and compares it to the South Sea Bubble of 1720... maybe it's time to get the hint...


Via The NY Fed Liberty Street Economics blog,

In 1720, the South Sea Company offered to pay the British government for the right to buy the national debt from debtholders in exchange for shares backed by dividends to be paid from the company’s debt holdings and South Sea trade profits. The Bank of England countered the proposal and the two then competed for the right to buy the debt, with South Sea ultimately winning through bribes to the government. Later that year, the government moved to divert more capital to South Sea shares by hampering investment opportunities for rival companies in what became known as the Bubble Act, and public confidence was shaken. In this edition of the Crisis Chronicles, we explore the rise and fall of the South Sea Company and offer a cautionary look at the current reach for yield.

A Rogue’s Guide to Repackaging Debt: Start with Insider Trading . . .
Two key events predate the South Sea Bubble. First, around 1710, the Sword Blade Bank offered to exchange unsecured government debt issued by army paymasters for Sword Blade shares. But it did so only after having secretly amassed large holdings of the debt, which traded at a deep discount given investor uncertainty that Britain could pay its debts. Knowing the price of the debt would rise with the announcement of the debt-to-shares exchange, the Sword Blade Bank made a significant profit on its debt holdings in what would today be called insider trading.

The second key event was the formation of the South Sea Company in 1711, for the purpose of rivaling the East India Company in trade. But a unique feature included in the formation of the company was the exchange of shares for government debt, no doubt influenced by the prior Sword Blade Bank deal; five of the directors of the South Sea Company were from the Sword Blade Bank. By 1713, the peace treaty at Utrecht brought an end to war with Spain, but the British gained only limited access to trading stations in the Americas. Consequently, the trading operations never proved profitable and the South Sea Company became a financial enterprise by default. In 1715, and then again in 1719, the South Sea Company was allowed to convert additional government debt into shares. In April 1720, South Sea won approval to buy the remaining government debt and to issue stock in exchange. The once-burdensome debt had been cleverly repackaged into a valuable commodity.

Then Pay Bribes . . .
Investors in South Sea shares now anticipated both a 5 percent annual dividend payment in addition to the hope of lucrative profits from trade with the Americas. But on the announcement of approval to buy the remaining government debt on April 7, 1720, the South Sea share price fell from £310 to £290 overnight. South Sea directors were eager to pump up the stock price and spread rumors of even greater riches to be earned from South Sea trade. Later that month, South Sea offered to new investors its First Money Subscription of £2 million in stock at £300 a share with 20 percent down and the remaining payments to be made every two months. So successful was the first offer that a Second Money Subscription followed later that same April with equally generous terms that allowed participants to borrow up to £3,000 each. Nearly 200 new ventures were launched that year under similar schemes, increasing the competition for investor capital. In the short term, shares soared across most companies. But South Sea stock sale proceeds were needed to pay dividends and bribes to the government for favorable treatment, as well as to buy its own shares to support its stock price. Consequently, a Third Money Subscription was launched later that year with even more generous terms at just 10 percent down with installment payments over four years and the second payment not due for a year.

. . . And Ban Rivals
Later that summer, the government moved to ban the new ventures—South Sea’s rivals for investor capital—in passing the “so-called” Bubble Act, which jolted public confidence. Companies impacted by the ban saw their stock prices plummet and leveraged investors were forced to sell South Sea shares to pay off debts, which put downward pressure on South Sea’s stock price as well. To prop up the company, South Sea launched the Fourth Money Subscription in August with a promise of a 30 percent year-end dividend and an annual dividend of 50 percent for ten years. But the market didn’t view the offer as credible and the South Sea share price continued to fall through mid-September. Liquidity constraints in London were further compounded by the concurrent Mississippi Bubble and bust in Paris, which we’ll cover in our next post. The South Sea Company was forced to turn to the Bank of England for help with the Bank ultimately agreeing to support the company but not its banker, the Sword Blade Bank.

Recall from our last post on the “not so great” re-coinage of 1696 that after the re-coinage, silver continued to flow out of Britain to Amsterdam, where bankers and merchants exchanged the silver coin in the commodity markets, issuing promissory notes in return. The promissory notes in effect served as a form of paper currency and paved the way for banknotes to circulate widely in Britain. So when panicked depositors flocked to exchange banknotes for gold coin from the Sword Blade Bank (the South Sea Company’s bank), the bank was unable to meet demand and closed its doors on September 24. The panic turned to contagion and spread to other banks, many of which also failed.

The Return of Repackaged Debt
As we’ll see in upcoming posts, financial innovation—in this case the repackaging of debt—is a recurring theme in our review of historic crises. In this case, the South Sea Company structured the national debt in a way that was initially attractive to investors, but the scheme to finance the debt-for-equity swap ultimately proved to be noncredible and the market collapsed. Now fast-forward to 2013 and the five-year anniversary in September of Lehman Brothers’ failure. As Fed Governor Jeremy Stein pointed out in a recent speech, a combination of factors such as financial innovation, regulation, and a change in the economic environment, can sometimes contribute to an overheating of credit markets. Asset-backed securitization and collateralized debt obligations have returned with a bang—or perhaps a boom—and are on pace to exceed pre-crisis levels, perhaps fueled by investors’ reach for yield. And remember from our introduction to the Crisis Chronicles series that “lessons learned often last only a lifetime and are easily forgotten.” So, will the current reach for yield lead to ever more complex, leveraged investments and the next credit market bubble? Or will the lessons from the Great Recession last at least a lifetime?

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Exponere Mendaces's picture

Pay attention to the chart. Nowhere does it rally up again to challenge its old high. Memorize that and recall if you feel compelled to make "bubble" comparisons to Bitcoin.

bunzbunzbunz's picture

Bubbles...bitcoin has a market cap of 8.8 Billion USD. TWTR has a market cap of 23.2 Billion USD. They both simply produce ad revenue through promotion. Wait, is that like Facebook? 118 Billion/!??@#? 

Gosh, ideas that create revenue through public interest, advertising, transaction fees seem to be viable. So I would say Bitcoin isn't quite that much of a bubble yet.

Right now I'm desperately wishing I had taken the chance and bought a few bucks worth 3 years ago when I learned about them. And yet, I'm still scared shitless to buy some. Stupid brain.

TheFourthStooge-ing's picture

Rest assured that the lessons learned from the Great Recession will indeed last at least a lifetime.

Kirk2NCC1701's picture

I had considered buying $50k in BTC when it was less than a buck. Then, in winter 2011/12 I had a chance to buy $200k for my parents, when it was around $6.

In the first instance I opted for rental property (barely breaking even, even with no mortgage), and in the latter instance I went for PM. Cause I was full of ZH piss & vinegar.

Don't I look like a fucking idiot now? Especially if you do the math... It's enough to make you wanna throw up.

Looks like I/they will now be looking at the "long run". The problem with the "long run" in their case is...

walküre's picture

I will pay attention when the first BTC mogul comes out richer than Warren Buffet.

saveandsound's picture

@Kirk: Bitcoin is a small market. Since the FBI has "seized" about 600.000 Bitcoins belonging to Dread Pirate Roberts, it has become even tighter. It's a risky bet, but if you dare give it a shot. $200k is quite a chunk - at least in my eyes.

We will see what happens, when Dread Pirate Roberts is forced to reveal his passwords and the authorities convert the seized Bitcoins into Dollars. If I knew the future I would participate every once in a while in the national lottery.

Dr. Engali's picture

Lessons learned? Hah we have people making peer to peer loans out of their 401ks..... So the answer is a resounding no. We will never learn.

kaiserhoff's picture

Thanks for the chuckle, Doc.  I hadn't seen that.

A good ten years ago, I saw a display in a convenience store in Baltimore, or as the locals call it, Balmur, Murilan.

Anyway, for five bucks, based on your birth date, they would sell you a list of lucky lottery numbers to play.

And I was fucking working for a living.   What's wrong with this picture?

bunzbunzbunz's picture

They also probably sold cigarettes and alcohol. Are those somehow more reputable products?

Dr Benway's picture

No lessons have been learned since then, quite the contrary. The English parliament had the right idea in 1721, when they proposed a resolution that the bankers responsible for the scam "be tied up in sacks with snakes and thrown into the Thames". Today we worship the criminals instead.


My blog on current financial fraud in Australia has examples of every single one of the criminal acts mentioned in this article, check it out:


aVileRat's picture

Yup. Well past the point of no return for Hawkish tapering without a massive and permant reversal in 'animal spirit' confidence. You think corporate CAPEX is bad now ? Wait until they see a 30% plunge in B2B sales orders when the whole system (REITS included) take a 40% equity haircut. The collateral hikes on trade credit will be awesome, unless your LIFO inventory accounting prevents you from actually trade dumping.


spanish inquisition's picture

Didn't get through the whole article, but the South Sea Company looks like it has some legs. Anyone know the ticker so I can get some cash into it tomorrow?

worldofdebt's picture

Crazy World of Debt!!! And the cycle goes round and round.

It's all OK though,  because JIM CRAMER'S TERRIBLE STOCK PICKS will save you (Hilarious Video Below):



Deo vindice's picture

For those who haven't clued in ... worldofdebt pretty much only posts a link to that silly video.

Does he have anything else to say?

Flammonde's picture


An enterprising and wealthy businessman called William Patterson (1658-1719), founded the Bank of England in 1694 following his award of a Royal Charter to establish the Bank, granted by William III (1650-1702) following Patterson's rendering considerable funds to help finance William's war against France. The need for such a thing appeared simple: the government required money, and Britain, rapidly increasing in wealth, required a prestigious, powerful bank – a central bank. Thus, as was the case of some of the earlier European banks, a loan to the government was the origin of its establishment. The loan, which was £1,200,000, was raised through subscription between Thursday, 21st June, and noon of Monday, 2nd July 1694 and on Tuesday, 10th July, the subscribers appointed Sir John Houblon the governor, and Michael Godfrey deputy-governor. Joining these two men were the first twenty-four appointed directors, all men of high mercantile standing, elected on Wednesday, 11th July 1694. The bank was moved to its permanent location on Threadneedle Street, London, in the 1730s.

The important point to understand here is that the management of the British national debt has been confided to the Bank of England from the date of its foundation, and this private corporation has remained the preferred banker of the British government ever since. That is, from the date of its foundation a private corporation calling itself the "Bank of England" assumed total the control of the credit of the British nation and it has remained the banker of the British government ever since. The"Bank of England" therefore became the pre-eminent bank –the Central Bank- of the British Empire.

olto's picture

Interesting that the Fed would highlight the 1720 bubble that destroyed the financial worlds of that time.

Now it points out that there is another bubble 'reaching for' the yield that the very same mouth has taken off the table!

Are they just stupid---my preference

or is there something else in the works?

I can barely wait for another very boring 'same, same' day in the markets tomorrow.

These Fed dudes keep me right on the edge of my seat---thanks to ZH


moneybots's picture

"Or will the lessons from the Great Recession last at least a lifetime?"


There aren't any lessons from the Great Recesssion.  The lessons were learned during the Great Depression.  They weren't forgotten 80 years later.   There was HUGE  money to be made by a small group of .01%ers if the lessons learned were willfully and deliberately dismantled.  There is still HUGE money being made by a small group of .01%ers, as they are preventing any fixing of the problem, by buying off the representatives who would otherwise do something to re-fix what wasn't broken.

adr's picture

That chart is a direct result of people rushing into a market not really knowing why they are rushing into a market.

Stated reason: Cause people are making money, and I don't want to miss out on making money.

moneybots's picture

“lessons learned often last only a lifetime and are easily forgotten.”


Lessons are not forgotten.  Lessons are OVERTURNED by people when they can make HUGE money doing so. 

No one fogot the reason Glass Steagall existed.  The representatives sold out to the .01% moneyed interests and dismantled it for their benefit.  Wealth and income disparity is now greater than at any time since the 1920's

olto's picture


In 1987, I remember a long luncheon conversation with oldtimers who had been in the brokerage business since the thirties(one had been a bank analyst on Wall Street in 1929). I was just a baby of 46 and the youngest, by far, of all. So I just listened and kept quiet.

Glass-Steagall was admitted by each to be the only reason that the brokerage business had been relatively honest and functioned on participants word over a telephone line or a handshake in person.

At that time, our firm was being 'looked at' as a purchase by a large bank and, after the several "I'll never work for a bank." declarations, I had the pleasure of listening to these old men, honorable and well respected by their peers, each one----talk about how they feared the banks entry into the brokerage business would bring about the same idiotic, insane greed that brought us the 1929 crash.

I was pretty amazed at the stories about how dumb and careless the bankers had been throughout the twenties. The interesting thing is that, although the Birchers and the Galties were pretty prominent in our environment(mainly clients), no one mentioned anything about that, because the bankers were known to be so greedy and stupid, that for those two reasons alone, they could never be trusted to re-enter the brokerage business; that they had to be prohibited from from any potential conflict-of-interest because of their history.

The banks had begun, by 1987, to buy brokerage firms which was the reason the conversation began that afternoon---I'll never forget that they predicted accurately that if Glass-Steagall was ever repealed that another 1929 type crash would follow not long after.

Here we are in Happyville------------------ 

TheRideNeverEnds's picture

Well with that analogy we have several hundred more percent to go on the upside till we top out, this is supper bullish news.


I bought some 2000 strike leaps in the /ES in anticipation for when this market really starts getting its legs on the upside.


this bull run is just getting warmed up!  

Kirk2NCC1701's picture

History teaches us that in each "gold rush" (gold, dotcom stocks, real estate, etc) there is more money to be made by the purveyors selling picks & shovels (financial services, advice, etc) to the hope & greed-filled hordes, than in anything else.

Sheep never learn, and the packs of wolves are always ahead of the herd.

Hedge and DIVERSIFY accordingly.

AUD's picture

Yeah, well, when panicked depositors look to exchange their $ for gold coin the Fed won't be able to meet the demand either.

The Fed has been 'cleverly repackaging' the once-burdensome debt of the government into a valuable commodity, the $, for many years.