The South Sea Company was a British joint-stock company founded in January 1711, created as a public-private partnership to consolidate and reduce the cost of the national debt. To generate income, in 1713 the company was granted a monopoly (the Asiento de Negros) to supply enslaved Africans to the islands in the "South Seas" and South America. When the company was created, Britain was involved in the War of the Spanish Succession and Spain and Portugal controlled most of South America. There was thus no realistic prospect that trade would take place, and as it turned out, the Company never realised any significant profit from its monopoly. However, Company stock rose greatly in value as it expanded its operations dealing in government debt, and peaked in 1720 before suddenly collapsing to little above its original flotation price.
Initial speculation
The scheme to thus consolidate all government debt and to manage it better in the future held out the prospect of all existing creditors being repaid the full nominal value of their loans, which at the time before the scheme was publicised were valued at a discounted rate of £55 per £100 nominal value, as the lotteries were discredited. The government's ability to repay in full was widely doubted. Thus bonds representing the debt intended to be consolidated under the scheme were available for purchase on the open market at a price that allowed anyone with advance knowledge to buy and resell in the immediate future at a high profit, for as soon as the scheme became publicised the bonds would once again be worth at least their nominal value, as repayment was now more certain a prospect.
Unless the Spaniards are to be divested of common sense, infatuate, and given up, abandoning their own commerce, throwing away the only valuable stake they have left in the world, and in short, bent on their own ruin, we cannot suggest that they will ever, on any consideration, or for any equivalent, part with so valuable, indeed so inestimable a jewel, as the exclusive trade to their own plantations.
Inflating the share price
The company then set to talking up its stock with "the most extravagant rumours" of the value of its potential trade in the New World; this was followed by a wave of "speculating frenzy". The share price had risen from the time the scheme was proposed, from £128 in January 1720, to £175 in February, £330 in March and following the scheme's acceptance £550 at the end of May. What may have supported the company's high multiples (its P/E ratio) was a fund of credit (known to the market) of £70 million available for commercial expansion which had been made available through substantial support, apparently, by Parliament and the King.
Shares in the company were "sold" to politicians at the market price; rather than paying for the shares, these recipients simply held the shares, with the option of selling them back to the company at any time, receiving the increase in market price. This method, as well as winning over the heads of government, the King's mistress, et al., had the advantage of binding their interests to the interests of the company, to secure profits, the stock needed to rise. By publicising the names of their elite stockholders, the company managed to clothe itself in an aura of legitimacy, which attracted and kept other buyers.
Top reached
The price of the stock went up over the course of a year from about £100 to almost £1,000 per share. Its success caused a national frenzy—herd behaviour—as all types of people, from peasants to lords, developed a feverish interest in investing, in South Seas primarily but in stocks generally. One famous apocryphal story is of a company that went public in 1720 as "a company for carrying out an undertaking of great advantage, but nobody to know what it is".
The price finally reached £1,000 in early August 1720, and the level of selling was such that the price started to fall, dropping back to £100 per share before the year was out. This triggered bankruptcies amongst those who had bought on credit, and increased sales, including short selling (i.e., selling borrowed shares in the hope of buying them back at a profit if the price fell). In August 1720, the first of the instalment payments of the first and second money subscriptions on new issues of South Sea stock were due. Earlier in the year John Blunt had come up with an idea to prop up the share price, the company would lend people money to buy its shares. As a result, many shareholders could not pay for their shares except by selling them.
Recriminations
By the end of September the stock had fallen to £150. Company failures now extended to banks and goldsmiths, as they could not collect loans made on the stock, and thousands of individuals were ruined, including many members of the upper class. With investors outraged, Parliament was recalled in December and an investigation began. Reporting in 1721, it revealed widespread fraud amongst the company directors and corruption in the Cabinet. Among those implicated were John Aislabie (the Chancellor of the Exchequer), James Craggs the Elder (the Postmaster General), James Craggs the Younger (the Southern Secretary), and even Lord Stanhope and Lord Sunderland (the heads of the Ministry). Craggs the Elder and Craggs the Younger died in disgrace; the remainder were impeached for their corruption.
The Commons found Aislabie guilty of the "most notorious, dangerous and infamous corruption" and he was imprisoned. The corruption around the South Sea bubble was the impetus for the writing and publication of Cato's Letters which became an important work first for the Radical Whigs and then into the libertarian ideology of the American Revolution.