New Evidence on the First Financial BubbleWilliam 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

firms)

Number

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

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 72,000announced 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 (EastIndies 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 andJonker (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 beforeend of the revolution• New economy's volatility should should rise sharply andexceed old economy's volatility• Old economy's volatility should rise but less than neweconomy's one• New economy's beta and both volatilities should peak at theend of the revolution

Formal test on innovation

Pastor and Veronesi (2009) develop framework for fast-adopted 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