The Cazique. The conman

In the early years of the nineteenth century, British investors had enjoyed a period of reliable returns. To finance its war efforts on the Continent, the government had borrowed vast sums, with the national debt reaching 230% of GDP by the late 1810s. On this debt, investors could expect a ‘risk free’ return of around 5%.

The end of the Napoleonic Wars delivered a regime change in financial markets.

The City of London emerged as a safe haven for European capital, supplanting Amsterdam as the world’s most important financial centre.

Waterloo brought an end to the debt binge. With government borrowing retreating towards peacetime levels, the government no longer needed to pay the high rates of interest to encourage investors to lend.

In 1822, the Bank of England cut interest rates by 1%, the first reduction in over a century.

Peace brought prosperity and optimism. Investors’ confidence soared. As did their appetite for risk.

An ocean away from the City, newly-independent states in Latin America sought to finance their fledgling nations by issuing debt. The result was a perfect marriage between borrower and investor. Income-hungry investors were keen to put their money to work. And where better to do so than in a continent brimming with natural resources, now free from the shackles of Spanish colonial rule?

It was in this early period of financial globalisation, and with the birth of new markets for debt, that our Cazique, Gregor MacGregor, spotted his opportunity.

Born in Stirlingshire in 1786, Gregor MacGregor claimed descent from Rob Roy. Formerly a soldier in the British army, MacGregor sailed to Caracas in 1810 to join the Venezuelan revolutionary army.

He was soon promoted to Brigadier-General and tasked with the defence and expansion of his new homeland. MacGregor was generally commended for his service, although several of his escapades resulted in perilously close shaves. For instance, during an attempt to seize Porto Belo, in modern-day Panama, the Scotsman’s forces were ambushed in the night. MacGregor, awoken by the noise of gunfire in the town, threw his bed clothes from the window onto the beach below and jumped out after them. He then scrambled to the water’s edge and plunged into the sea. He was eventually recovered, barely conscious, by the Venezuelan navy.

In 1821, after a colourful career in the Americas, MacGregor returned to Britain. And he returned with a plan.

By this time, London society was enthralled by Latin American affairs, especially the newly formed state of Gran Colombia and its first president, Simón Bolívar. It helped then, that MacGregor’s wife, Princess Josefa, was a cousin of the great liberator himself, and the MacGregors quickly became coveted adornments to London dining tables. But a question remained – princess of where exactly?

MacGregor had answered that just a few months earlier, in a proclamation to the inhabitants of the territory of Poyais. It read:

POYERS!

On the 29th April 1820, the King of the Mosquito Shore and Nation, by a deed executed at Cape Gracias a Dios, granted to me and my heirs for ever, the Territory of Poyais.

The Territory of Poyais shall be an asylum only for the industrious and honest, none others shall be admitted amongst us; and THOSE, I trust, you will receive with open arms, as brothers and fellow citizens.

He concluded:

POYERS!

I now bid you farewell for a while…I shall again be enabled to return amongst you, and that then it will be my pleasing duty to hail you as affectionate friends, and yours to receive me as your faithful Cazique and Father.

His Highness Gregor, the Cazique, intended to establish a new kingdom on the Mosquito Coast, over an area of shoreline extending across present day Nicaragua and Honduras. The kingdom would be named Poyais.

The Cazique claimed to have discovered an Eden, a “delightful and most valuable country” with “great salubrity of the air”, fertile soil, riverbeds bulging with “native globules of pure gold”. The land would be “a constant fund of health and activity”.

All that was required to uncover Poyais’s great wonders were willing settlers and an injection of capital.

MacGregor set about alerting potential investors and colonists to his scheme.

He published an exhaustive guidebook, endorsed by Thomas Strangeways, the Cazique’s supposed “Aide-de-camp and Captain of the 1st Native Poyer Regiment”.

The guidebook was a verbose, at times bizarre, exposition of the new territory. The narrative frequently descended into technical discussions of subjects ranging from plant husbandry to means of protection from the native quadrupeds (including Mexican cats, gibeonites and nine-banded Armadillos).

Whilst lacking the candour of “Guinness is good for you”, it proved to be effective marketing.

That the settlers would become rich seemed beyond doubt. These first dollars were a taste of the bounty that lay in wait in the Cazique’s utopia.

MacGregor capitalised on the unquestioning trust people often grant those from their own religious or ethnic group. This trick – known as an affinity crime – is used by conmen the world over. He persuaded almost 300 Scots to make the inaugural passage to Poyais. Doctors, lawyers and blacksmiths were furnished with the tools they would need to colonise the exotic and verdant land. Eager to arrive prepared, the settlers exchanged their gold and savings for Poyais dollars, which MacGregor had had printed at the Bank of Scotland’s press.

That the settlers would become rich seemed beyond doubt. These first dollars were a taste of the bounty that lay in wait in the Cazique’s utopia.

With the colonists taken care of, MacGregor set about financing the creation of the new settlements. His requirement was just £200,000, a modest amount to raise in London’s sovereign debt markets in 1822.

It was agreed with the respectable City banking firm of Sir John Perring, Shaw, Berber & Co. that Poyais would underwrite its bold project by means of long-term debt. This took the form of bonds with good rates of annual interest, guaranteed by the revenues of the Poyais national government.

South American loans were a great attraction for international investors at the time. But news from Latin America was scarce, and investors often could not tell which nations’ obligations were the better credits. Pricing was more a factor of size, the interest rate on the bonds, and the prestige of the arranging firm than it was a reflection of the investment’s true risk.

The Poyais debt issue was a perfect case of information asymmetry. Investors couldn’t know much about the country, because the land of Poyais existed only in MacGregor’s imagination.

The loans appeared to represent fresh opportunity. In this wave of financial globalisation, investors feared missing out on the latest fashion. MacGregor observed the mania and, with it, his chance to make a fortune.

Stock prices are supposed to reflect all the information available to the market. That’s the basis of the Efficient Market Hypothesis. Something can be overpriced or underpriced only when there is asymmetry of information – when one party knows more than the other.

The Poyais debt issue was a perfect case of information asymmetry. Investors couldn’t know much about the country, because the land of Poyais existed only in MacGregor’s imagination.

The scrip for the Poyais loan was offered for sale on Wednesday 23 October 1822, in the amounts of £100, £200 and £500. The discounted purchase price was 80, with the bonds issued below par, and payments made in instalments, to allow speculators to make substantial profits.

A deposit of 15% secured the certificate, with the remainder due in two instalments on 17 January and 14 February 1823. The bonds were to mature in 30 years and the annual interest rate was 6%, secured on all the revenues of the government of Poyais.

The walls of Ruffer’s London offices are replete with reminders of when investments go bad. On one such wall hang two of these very scrips – Poyais bonds.

Fashion is a powerful force in financial markets. But, as Oscar Wilde observed, “fashion is a form of ugliness so intolerable that we have to alter it every six months.” The fashion for Poyais debt barely lasted six weeks.

In the winter of 1822, sentiment began to turn against investments in South America after an outbreak of political disorder across the continent. The Times of London warned investors against Poyais debt: “Why should they abandon the certainty of the British funds to dabble in others, the value of which, as it appears, so entirely depends upon the unaccredited chargé d’affaires of an unacknowledged republic?”

Unease turned to distrust and Poyais bonds were soon caught up in the hectic selling typical of financial panic. Nervous investors attempted to limit their losses; the price of the scrip plummeted. Trust in the ability of governments in the New World all but evaporated – the fictitious Poyais was no exception.

Without the steady stream of cash from the loan, the Poyais scheme quickly unravelled. Unpaid bills from MacGregor’s extensive advertising efforts stacked up, and reports of disquiet began to filter through from the Mosquito Coast, where the settlers had just made landfall.

Accusations of fraud simmered, and City lawyers sharpened their quills. The Poyais swindle was foiled, MacGregor exposed as a scoundrel.

It was the prevailing financial weather of the early 1820s that allowed MacGregor’s grand Poyais fabrication to get as far as it did. Excitement about burgeoning new markets led to speculation, and a bubble was born.

In the history of financial crime, the pain is typically borne by the investors who throw caution to the wind in the hope of making a quick buck. With Poyais, investors were not the only victims. The settlers who had voyaged to the Mosquito Coast found an inhospitable wasteland. Within months, the hardy Scots were left destitute, disease-ridden and abandoned. Some escaped to Belize, around 50 made it back to Britain. The majority died.

MacGregor’s scheme was cunning and deceitful like most financial skulduggery. Tragically, it was also lethal.

Accusations of fraud simmered, and City lawyers sharpened their quills. The Poyais swindle was foiled, MacGregor exposed as a scoundrel.

At their core, financial bubbles are imbalances of information.

The Latin American bond bubble was no different. Investors were sold new and exciting propositions but had very little information about them. There was no way to determine which investments could generate the greatest return – and which might be a racket. Investors owned Latin American debt not because of what it was

(they couldn’t know) but because they believed in a story.

MacGregor exploited this information asymmetry. He tapped into investors’ willingness to take a risk on something they knew little about. In the case of Poyais, the financing of an imaginary country.

Today, with a growing volume of information at our fingertips, we can expect more asymmetries, and more bubbles. The challenge for investors remains the same. It is to identify these imbalances and avoid ending up on the wrong side of them.

So long as there are bubbles – and with them, opportunities to make money fast – there will be conmen, like the Cazique, seeking to exploit them.