Why the Operations of the South Sea Company Proved to be Financially Unsound - Essay Example

137066 Explain why the operations of the South Sea Company proved to be financially unsound. What are the similarities and differences between this firm and the collapse of Enron in 2001? The book upon which the essay is based is Balen, M (2003), A Very English Deceit: The South Seas Bubble and the World’s First Great Financial Scandal. London: Fourth Estate. The purpose of the essay is to test your ability to assimilate information and to order it in support of specific arguments. Students are expected to read the book to answer the essay question. The objective is for students to think out the answer themselves, using general knowledge and plus material from Balen (2003). The essay should contain a clear, concise argument. Marks will be based on how well the question is answered, grammar, spelling, and writing style. If you know nothing about a subject (e.g. Enron or financial bubbles) you may need to do some additional background reading. Any references used (including Balen) should be properly cited in the text, with a complete reference at the end of the essay under “References”. The South Sea Company was originally set up on the premise that trade with Spain would increase as a consequence of the War of the Spanish Succession.1 The South Sea Company planned to make money by persuading speculators to exchange government stocks for South Sea Company stock. The South Sea bubble that occurred because the company gained the sole right to buy government bonds yet had nothing to sell apart from its own stock. The company failed to keep expectations realistic and proved incapable of restoring confidence when the bubble burst. The company actually had no other source of income; it never had a plan A let alone a plan B.2 Those investors in the South Sea Company that had sold their shares during the boom in prices made handsome profits; those that held shares when the bubble burst were ruined. The bubble burst once investors worked out what the company had known all along, it had no source of income to pay the portions of the British national debt in the absence of trade with Spain.3 The South Sea Company had to exaggerate the prospects of its stock in order to provide large returns for the powerful people it had bribed with stock and increased public demand to frenzy.4 They made very convincing arguments for their schemes to reduce the national debt and to make the shareholders of their company handsome dividends. Government acceptance of the company’s schemes were more importantly clinched by bribes, company directors kept share prices high to maintain public confidence high. The bubble was sustained by people’s greed outweighing their common sense. The bubble was built upon unreal expectations and unrealistic economic foundations so it was a bubble waiting to be burst, the company got in a vicious cycle it had to sell shares to raise money, yet shares were never going to save the company. The biggest problem for the South Sea Company was that they had very few actual assets, they had trade agreements with Spain and trading charters from the British government. The often-poor relationship between Britain and Spain meant that those agreements and charters were not viable.5 There are striking similarities between the South Sea bubble and the collapse of Enron. Firstly the directors of both companies tried to influence their respective governments through corruption and extensive lobbying. Enron did not on paper get as much from its attempts to influence politicians, not being granted any monopolies or gaining favorable legislation. If anything the dishonest actions of the Enron directors were worse than the South Sea Company directors had been, as they had a predetermined strategy. Their operations to keep their company afloat had to be more elaborate and systematic.6 Enron had been the seventh largest company in the United States in terms of assets and turnover. Enron had close links American governments and sponsored Democratic and Republican politicians alike to ensure such links continued no matter which party held power.7 Enron like the South Sea Company became the victim of unwise investments upon the stock markets, which lost it considerable sums of capital.8 Like South Sea, Enron hid its true plight from potential investors to stay in business in longer. The company’s public accounts were fraudulently changed so that the company seemed far healthier than it actually was. Fraudulent accounting kept enough companies and individuals investing in the company to delay its ultimate collapse. However such was the scale of losses made on the stock markets that new investors and turnover from the company’s many businesses could not prevent bankruptcy. The increasingly perilous state of the company’s finances did not prevent its leading directors and managers from funding and therefore trying to influence politicians. Indeed Enron made considerable donations to the Republicans congressional and presidential election campaign funds. Perhaps in hindsight the money could have been better spent on paying of creditors. 9 Given the sheer size of Enron its collapse had major economic implications as well as political consequences.10 At its demise Enron held assets estimated to be worth $90 billion, its collapse was even held responsible for a devaluation of the American dollar. Unfortunately for many of its directors they did not avoid prosecutions for fraud. The level of deception needed to keep Enron afloat meant that those prosecuted could not plausibly deny the charges brought against them.11 Enron basically gambled and lost on the stock markets which meant that its senior management resorted to fraud to avoid bankruptcy and selling off the company’s best assets. Fraud however could only obscure incompetence for a limited period. Enron unlike the South Sea Company did have viable and diversified sources of income, it had business plans that were derailed by bad decisions, and its directors resolved on deliberate accounting frauds to buy the company time.12 Therefore there are similarities between the collapse of the South Sea bubble and the bankruptcy of Enron. Both companies seemed financially more secure than they actually were. They were companies that were attractive to investors; the South Sea Company due to price of it shares at the height of the bubble, Enron because of its size and the diversity of its assets and investments. Both companies also presented themselves as being sure fire winners for investors, the South Sea Company inflated its own share prices, Enron fiddled its accounts to hide its mounting loses. Both companies believed that they bribed the right people in the right places and did not ensure that their books balanced enough to allow survival when times were harder. The South Sea Company had no source of income and no coherent or sustainable strategy; all it had was shares and monopolies that were worthless. On the other hand Enron had lucrative sources of income, which would have kept in business, had it not taken foolish risks? Enron had strategies that did not work; the South Sea Company only had confidence amongst its naïve investors. References Ashley M, (2002) A brief history of British Kings & Queens, Robinson, London Balen, M (2003), A Very English Deceit: The South Seas Bubble and the World’s First Great Financial Scandal, London: Fourth Estate. Duncan R & Goddard J (2005) Contemporary America, Palgrave, Basingstoke and New York Gardiner & Wenborn (1995) The History Today Companion to British History Collins and Brown Ltd, London Morgan K O, (1993) The Oxford Popular History of Britain, Oxford University Press, Oxford Schama S (2001) A History of Britain - The British Wars 1603-1776 BBC Worldwide, London Ward G, (2003) The Rough Guide History of the USA, Rough Guides Ltd, London and New York Read More