The British Railway Mania (1845-1846)

Monthly Strategy Report September 2016

Alejandro Vidal Crespo Director of Market Strategies Monthly Strategy Report. September 2016

In 1830, the world’s first modern railway line opened, connecting the cities of Liverpool and Manchester. It was the first to be entirely double track along its length, with no horse-drawn traffic permitted at any time, and to be fully timetabled. The revolutionary nature of this infrastructure became immediately apparent, enabling the highly efficient transport of cargo, mail, and passengers. It was also an unequivocal financial success, paying dividends of 9.5% on average to its fortunate owners. It was unquestionably an attractive investment at a time of major socioeconomic change, with the Industrial Revolution underway and rapidly reshaping the uses and needs of nations.

Nevertheless, the British economy slowed in the late 1830s and interest rates on treasury bonds—the main vehicle for saving and investment at the time—reached record highs, making the investment of the huge sums of money required to build railways less attractive. But things would change.

The dynamics of the Industrial Revolution, propelled by logistical improvements provided by the railway, were rapidly changing the economic structure of the country. By the mid-1840s, economic and industrial activity in the United Kingdom had multiplied, generating greater financial capacity across broad swathes of society, from businesses big and small to workers with the ability to save. Naturally, the volume of cargo and passengers transported by train continued to increase exponentially, and the companies that managed the railways were highly profitable. Moreover, the Bank of England cut interest rates from 5.1% in 1839 to 2.7% in 1845.

With regard to the market, this new saving capacity could easily enter the security markets emerging at the time, and the press—growing increasingly massive due to the skyrocketing circulation and distribution of newspapers—disseminated information at a swift pace.

The government was pleased with the situation. Only a few years earlier, in 1825, it had repealed the Bubble Act, enacted after the collapse of the South Sea Company, which had regulated investments in new business ventures after the catastrophic impact that resulted when the previous bubble burst. But now, anyone could start a railway company, collect funds from private investors, and submit a request to Parliament to grant the administrative authorisation needed to build the line, a simple procedure that seldom yielded a negative response: there was no limit to the number of companies that could operate on the rail network, nor excessive zeal to review the projects’ financial reports. And, as we shall see, there were clear conflicts of interest between the MPs who issued the authorisations and the companies that submitted the applications.

But in order for a bubble to materialise, one more crucial ingredient is necessary: abundant and easy access to funding. Although the emergence of financial markets and the speed of information were key, railway companies offered investors the opportunity to acquire shares for only a 10% deposit, reserving the right to call in the remaining 90% at any time. Many families gambled their entire savings, barely covering the 10% deposit.

The fact is that, like all bubbles, the initial idea was ground-breaking. Shares more than doubled in a single year and at the peak of the bubble, in 1846, the approved routes totalled 15,300 kilometres of new railway in the United Kingdom (the current network covers 18,000 km), much of which, of course, was unfeasible from an economic point of view and unviable in terms of infrastructure construction. But in 1846, the Bank of England began to raise interest rates (to 5.2% in 1847) and money stopped flowing into the railroad business, as dividend yields plummeted with the rise in prices.

Banks, able to obtain attractive yields from bonds, stopped funding the bubble and investment dried up. Shares began to fall and the large, established companies bought up the projects they considered truly Monthly Strategy Report. September 2016 viable at rock-bottom prices. Before funding closed, companies asked shareholders to cover the 90% remainder of their due payments, ruining many investors, including such illustrious figures as Charles Darwin, the father of the theory of evolution. Of the 15,300 kilometres authorised, only 10,000 would be built by the sector’s leading companies that would eventually spearhead a major industry consolidation, resulting in only 280 authorised companies.

One of the protagonists of this story was George Hudson, who began as a respected businessman in the railroad industry in 1833, promoting—with other notables from the York region—a railway line that would unite York and Leeds. In the midst of the bubble, he acquired more authorisations and absorbed his competitors, ultimately linking London and Edinburgh by rail and establishing one of the sector’s largest companies, Midland Railway, in 1944.

A respected businessman, he joined Parliament as an MP from Sunderland and participated in the approval of new railway lines at the time of the bubble. When the bubble burst, however, his fraudulent practices were discovered, which included Ponzi schemes wherein new investors in his ventures were paid dividends from capital rather than from profits earned by said companies.

In short, our story illustrates the way in which a bubble can arise from the rapid expansion of a revolutionary new technology in an environment of easy credit and lax regulation, an episode that would repeat itself with the tech boom more than a century later. Are there more on the horizon?