In October 1720, John Hanger, governor of the Bank of England (BoE), and his fellow directors confronted the imminent collapse of the South Sea Company (SSC). The SSC directors urgently appealed to the BoE for funds to prevent collapse. Should the bank rescue the SSC? The answer to this question hinges upon an assessment of the origins of the market bubble, Britain's strategy of creating trading monopolies, the development and role of the new BoE, and Britain's jockeying to be a major power.
Robert F. Bruner and Scott Miller
Harvard Business Review (UV7532-PDF-ENG)
July 30, 2018
Case questions answered:
- As governor of the Bank of England (BoE), what are John Hanger’s problems?
- How do you know this was a bubble?
- Why was the Bank of England (BOE) formed?
- Why might the BOE consider intervening?
- What price should the BOE consider bailing the SSC out?
- How big was the loss on the South Sea Bubble shares before the BOE sustained that it had become insolvent?
- What should John Hanger do?
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The South Sea Bubble and the Rise of the Bank of England (A) Case Answers
This case solution includes an Excel file with calculations.
1. As governor of the Bank of England (BoE), what are John Hanger’s problems?
The Bank of England (BOE) and its governor, John Hanger, were on the brink of one of the first-ever financial crises in the early 1700s when the British financial system faced the prospect of disintegration. This was a result of the collapse of the South Sea Company’s bubble, where, in its wake, John Hanger and the BOE were left to clean up.
Through this, there were a few key parts to John’s problem. Firstly, the BOE had to rethink its role within a changing economy. Initially founded as a supporter of a different sort of ‘public credit” where they only serviced state or Crown finances, a bail-out of the SSC would set a precedent that they were the anchor of the financial system, changing the notion of what it meant to be the provider of public credit.
Secondly, there was a general conflict of interest between the BOE shareholders and intervening with the SSC in order to keep the financial system afloat.
Finally, and foremostly, John Hanger was faced with the crucial decision of whether to intervene and how to go about it, with the outcome changing the way the British financial system worked forever and the BOE’s role within it.
2. How do you know this was a bubble?
In order to understand the asset pricing bubble that was the stock of the South Sea company, it is important to understand what an asset bubble is. As outlined by (Evanoff et al., 2012), “a bubble exists when the market price of an asset exceeds its price determined by fundamental factors by a significant period of a long time.”
The South Sea Bubble company exuberated the conditions outlined by (Evanoff et al., 2012) where the company’s share price grew at an extreme rate of 666% over 6 months, from 124 GBP to 950 GBP in late June (UV7352, 2020).
Comparing this to England’s GDP growth rate over the period 1650-1700, the economy grew at a mere rate of only 1% per annum within a time period that was called the “Glorious Revolution” (UV7352, 2020).
If a 1% growth rate at the time was considered glorious, then a…
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