New Evidence on the First
Financial Bubble
William Goetzmann
Edwin J. Beinecke Professor of Finance and Management Studies
Yale School of Management
November 13, 2009
Background
•
•
•
•
•
•
•
•
•
•
•
East Indies Company VOC, 1602
West Indies Company WIC, 1621
British East India Company EIC, 1600 –funding 1708
Royal Africa Company, 1660
Bank of England, 1694 funding of debt, paper money
Royal Exchange Company and the London Assurance ,
1719
John Law, Banque, Company Des Indes, 1719
1720’s New Issues in London
South Sea Company, 1711 Asiento, funding
Rotterdam Insurance Company, 1720
Crash in Fall 1720
Interpretations
• Bubble Drive by Government Debt Conversion
• Irrationality
• Mackay “Extraordinary Delusions…” 1863
• Kindleberger (1978)
• (Dale, Johnson, & Tang (2005)
• Velde (2009)
• Plausibility
• Scott (1912)
• Garber (1990)
• Neal (1990)
Our Approach
• Look at cross-section
• Did bubble hit some industries/companies not others?
• Look at timing
• Daily data and coincidence with events may help identify
source of expectations.
• Look at international evidence
• Holland’s Bubble – never before explored
• Data never found
Our Findings
• It was an Insurance Company Bubble
• It Was about America
• It was about Corporate Regulation
Data
•
•
•
•
•
•
Neal (1990)
Freke’s Price of Stocks
Castaing’s The Course of the Exchange
The Bubblers Mirror
Leydse Courant ( Hague)
Het Groot Tafereel
“Monument consacré à la posterité en memoire de la folie
incroyable de
la XX année du XVIII siècle”
Bernard Picart, 1720
The Bubbler’s Mirror
• A British Satirical Print
• Listed par value of shares and maximum level of price in the
bubble.
• Sufficient to consider comparative bubbles.
Bubbler’s Mirror: Maximum Percentage Price Increase
of British Firms over par by Industry, 1720
Industry
Total
Total (less large
Number
firms)
Insurance
2013%
1717%
8
Real Estate
1625%
1625%
2
Commodity
1208%
1208%
12
Manufacture
1166%
1166%
6
Atlantic
895%
948%
4
Marine
875%
875%
6
Service/Utility
567%
567%
3
Pacific
349%
349%
1
Bank/Finance
335%
500%
3
Total
1172%
995%
45
A New World Bubble
• Mississippi Company – Companie des Indes (combined
E&W)
• UK Difference EIC/SS
• Dutch Similarity? VOC/WIC
• New data on VOC and WIC from Leydse Courant
• Check for a Bubble
Why Americas?
•
•
•
•
•
War of Spanish Succession?
War of Quadruple Alliance
Slave Trade/Triangle Trade
Louisiana
Dafoe
International Linkage
• South Sea Company Timing
• Insurance Companies
• Dutch WIC
Capital Appreciation in Share Prices, 1720
Prices indexed to 1 at start of series
100
Jamaica ships loss
reported in LC
Aug. 30th Gregorian
Aug. 19 Julian
|
Amendment
to the
Bubble Act
Completed
|
Whitehall
Reprimand
|
10
King's
Request to
Charter
Insurance Co's
|
0.1
Gregorian Calendar Dates in 1720
Rotterdam
Royal Exchange Assurance
London Assurance
South Sea
WIC
#REF!
26-Dec
26-Nov
27-Sep
28-Aug
29-Jul
|
Bubble Act
Signed
29-Jun
30-May
|
Parliamentary
Committee
Report
30-Apr
|
SS Parliamentary
Committee
Formed
31-Mar
1-Mar
31-Jan
1
27-Oct
Rotterdam
subscription issue
|
Atty General
Report
|
Atty General
Committee on
Insurance
Incorporation
Formed
|
1-Jan
Log Capital Appreciation
with Price indexed to first obsevation or January 1, 1720
Treasury enforces
Bubble Act Aug.
18th Julian
|
What sparked the crash?
•Obligation to pay 50,000 pounds on September 11th
•Investigation whether insurance companies acted beyond
their charter on August 29th
•In Jamaica 12 ships sank for insured value of 72,000
announced on August 30th
•Burglary at the home of one of the directors, September
2nd
Spread to Netherlands
• Attempt to Create an Amsterdam Insurance Company
• Success at creating a Rotterdam insurance Company
• Edmond Hoyle
• Rapid imitation across Dutch cities
• Spread to Hamburg.
• Rotterdam Company.
Do we learn from the Dutch Companies?
1. Projects typically associated with particular city (East
Indies company consolidation of smaller companies)
2. If the consolidation was anticipated, every city wanted
to participate
3. Scale of Dutch bubble smaller (see also Gelderblom and
Jonker (2009))
4. Mostly insurance related.
5. Specifically note variety of lines of business.
Irrationality?
Madness of Crowds
Herd Behavior
Archetypes of Crash
Investor Brain Disorder
Removal of Stone
Speculation as
Evil
Or Shift in Risk?
Pastor and Veronesi New/Old Economies
• Bubble stronger in new than in old economy
• Stock prices in both economies bottom at the end of the
revolution
• New economy's market beta should increase sharply before
end of the revolution
• New economy's volatility should should rise sharply and
exceed old economy's volatility
• Old economy's volatility should rise but less than new
economy's one
• New economy's beta and both volatilities should peak at the
end of the revolution
Formal test on innovation
Pastor and Veronesi (2009) develop framework for fastadopted innovations with high uncertainty:
•Rational to invest small fraction in new technology
•Risk first predominantly idiosyncratic
•Learn on productivity gain of innovation
•Shift from “old” to “new” economy by investing more in
new technology
•Risk of new technology becomes systematic
What were the consequences of the
bubble?
1. Surviving firms were very successful (Stad Rotterdam,
Middelburg), which proves the viability of the companies
2. Vast majority never acquired critical mass of capital to
survive the crisis
3. Impact on the real economy minimal (see Slechte
(1982))
4. Non-surviving companies returned capital to investors
Conclusions
1. Evidence against indiscriminate irrational enthusiasm
2. Expectations about Atlantic trade important factor
3. Innovation in insurance market played a large role
4. Expansion of “rights” of corporations