A System for Sharing Risk and Sharing Profit

Voyages with ships that might not return

A sea voyage requires upfront payment for the ship, provisions, and crew. There is no income until the return, and moreover, some ships never return at all. Betting everything on a single vessel means that one shipwreck ends everything.

This is where a system for providing funds was needed. The royal coffers alone were not enough, and merchants from Lisbon, as well as financiers from Genoa and Florence, joined in. They invested a little in one ship, and spread their investments across many. Sharing the risk, and sharing the profit. The form of the joint-stock company was still in the future, but its prototype began to take shape here. It is said that this system began to be established in the latter half of the fifteenth century. This practice predated the Dutch East India Company by more than a hundred years.

Losses limited to the investment

An organization that gathers investment to conduct business is a company. In particular, when a system was created to raise funds by selling shares and limiting losses to the amount invested, people became able to invest substantial sums.

The idea of sharing risk was institutionalized in a more sophisticated form. Alongside public bonds, this became a major pillar of modern finance.

A frenzy over paper

A man appeared who claimed he could make debt disappear as if by magic. He was a Scotsman named John Law. He said that money did not need to be metal; paper would do. If banks printed banknotes and circulated the economy, the country would become rich.

In 1720, the shares of his bank and the Mississippi Company became the object of a frenzy. The stock price rose to astronomical heights, but eventually, it burst. It was the world's first collapse of paper money and a financial bubble. The bubble burst when the demand to exchange banknotes for specie could no longer be met. Law could print banknotes, but he could not create gold coins. The people who lost their fortunes lost faith in paper money, and this scar left France with a distrust of banknotes for a hundred years.

Bank runs create a chain reaction

October 1907, New York. The fire started at a trust company. As anxiety about its management spread, depositors rushed to its windows. It was a bank run.

On October 22, the Knickerbocker Trust paid out eight million dollars in three hours and suspended operations. However, this was not a failure. It resumed business the following March. Yet, this suspension triggered a chain of bank runs, and the market froze. Lenders disappeared, and the very atmosphere of the city turned to suspicion.

At the time, there was no law outlining guidelines for a panic, but the Treasury Department deposited funds into banks: twenty-five million dollars on October 24, and thirty-six million dollars by the end of October. Even without legal tools, water was being carried to the fire.

Dividing investments among multiple ships, and among multiple investors. The idea of sharing risk became the backbone of the joint-stock company.