Sunday, April 09, 2006

ENRON and the South Sea Bubble

We are so poor at learning. In the book "Extraordinary Popular Delusions & the Madness of Crowds," Charles Mckay provided a rivetting history of how people are taken in by the promise of wealth, however ludicrous it may be. In 1624, tulips were being sold in Holland for more than gold. In the early 1700s a group of merchants formed the South Seas Trading Company, which originally simply purchased some debt from the British Government to be repaid at 6% interest. However, on this solid foundation, they proposed to make money by trading in South Anerican gold and the stock soared. Now no-one read the fine print, which said that King Philip of Spain would only let one ship a year set sail. As the stock soared, many other companies were formed to take advantage of the capital in the market. Sadly, on one day in September, 1720, no one wanted to buy. So the cries of "sell, sell!" grew louder and many wealthy people lost all, as well as many poorer ones.

So there have been many other financial bubbles. In the 1920's it was Florida land, in the 1990s it was the Internet and ENRON. The continued belief that it is possible to make extraordinary financial returns with no risk is amazing. How could sensible people believe that Webvan could make enormous returns in a very low margin industry with huge investment in warehouses and truck makes the mind boggle. But not only did experienced business people talk about a "new financial model," in which profit was not important, but many of them continued to prosper afterwards. While ENRON was a high-profile failure, many others occurred at the same time. Empty shells of buildings which used to house huge companies joined the ghosts of the offices of the South Sea Company.

The one thing of which we can be sure is that there will be many more.

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