There are two kinds of bubbles. There are actual economic ones that artificially drive up valuations across broad categories in an unsustainable way, impacting markets on a mass scale. And there are psychological ones, where the real economic fall-out is limited to a small pool of insiders, but there’s a broad societal lack of trust; a disillusionment that results from everyone buying into a grand euphoria that turns out to be misplaced.
The recent housing bubble was clearly an economic one: There was a widespread belief that housing prices would always go up over time and today millions of people have lost their homes because they believed it.
The great tulip bubble of the 1630s was more of a psychological one. A few years ago Tulipmania author Anne Goldgar researched the bubble we all used to cite before the late 1990s, and found that there was surprisingly little economic devastation when the unsustainable high tulip prices fell, because the tulips bulbs were still in the ground. There were contracts to buy these tulips once they bloomed, but money would only change hands then. So when the market crashed, people just reneged on the contracts. This economically hurt speculators– only modestly since tulip speculation was a side job for most of them– but really no one else. In fact, Goldgar had a hard time finding a single person who was bankrupted by it.
But the reason we still talk about the tulip bubble was the vast psychological and societal devastation: The widespread reneging on tulip contracts forever changed the trust in contracts and agreements, and like all bubbles, people felt foolish for believing in it.
The dot com bubble was both economic and psychological. There was obviously huge financial devastation — and many of the people affected were kicked out of their homes, like we see with the housing bubble today. Many rebuilt their lives, found new jobs, and rebuilt their nest eggs by investing in stocks more wisely.
But the reason we still talk about the 1990s bubble (constantly) is the emotional or psychological devastation. The Internet was something that captured everyone’s imagination– it was one of those once-a-century inventions and because it coincided with a time of huge democratization of the stock market everyone could grab a piece of it, even more easily than you could play a role in the housing bubble. So it wasn’t just the insiders, it wasn’t just the millions who worked for lousy dot coms, it wasn’t just the VCs, it wasn’t even just the reporters and analysts who chronicled it– it was everyone who ever bought a stock in a money losing company that they believed would never go down. That’s a lot of people feeling foolish after March 2000.
What I’m unwilling to grant is that there’s such thing as a “Wag-the-Dog” bubble. In other words, a bubble that only exists in media reports and overwrought Twitter feeds, but lacks either a broad economic reach or a broad sense of euphoria. I’m taking the name from that Dustin Hoffman movie where the press concocts a fake war to distract the public from a scandal. I guess there is such a thing as a “Wag-the-Dog” bubble because people have been buying into these reports for months. It just doesn’t have any impact other than near term page views and a feeling of relief that reporters “CALLED IT THIS TIME!” in case an actual bubble does emerge.
The Wag the Dog bubble has gained steam of late, but it has been years in the making. Ever since people started investing in consumer Web startups again, reporters have been saying we’re in another bubble. There’s been no real evidence of it since 2006, save one thing: Venture capitalists increasingly investing in consumer Web startups at higher valuations.
There are a lot of other things to explain this. One explanation is that it’s the basic job of a VC to make risky bets at valuations which are supposed to reflect future promise and may never materialize. That’s why they get 20% or more of the company rather than charging terms, say, a bank would for a small business loan. There’s also the fact that the consumer Web is now a world-wide phenomenon with more than 1 billion people online. And there’s the fact that there’s a glut of venture capital trying to wedge itself into more capital efficient companies, so naturally a supply-demand imbalance will result in higher prices.
There have also been plenty of examples of the rising tide not lifting all boats. MySpace has cratered during this “social media bubble,” companies like Digg and Six Apart are shadows of what they could have been and plenty of companies haven’t been able to raise money. And even with the recent expansion of the “$1 billion club” we’re talking about less than thirty companies among thousands started every year. And there’s little economic fallout from VCs investing at heady valuations, since they have a liquidation preference and will at a minimum make their money back in the worst-case-scenario fire sale transaction.
But never mind facts, Waggers wanted to say it was a bubble just in case the bubble was slowly building they could call it first. And then, the broader stock market crashed. I wondered last week, how will people twist this into evidence of a bubble? Some chimed in saying it was a bubble that was just ahead of the public markets. That sentiment that makes no sense if you consider the very definition of a bubble is a mass economic or euphoric phenomenon, not something where insiders are being ahead of the market. Others came up with a more ludicrous suggestion after the Dow had its worst day since 2008 on Monday: The bubble popped.
Wait a minute. You mean the bubble that never appeared? So….I guess our fictional war is over now?
Beyond the obvious point above, is another one: This crash is so not about Pandora’s IPO and LinkedIn’s P/E ratio no matter how much waggers want it to be. There was the little matter of the S&P downgrading the US’s credit after two weeks of Washington reenacting the Keystone Cops. And that other niggling fear about Spain or Italy going the way of Greece and defaulting on debt payments. And the tiny matter of the US’s anemic economic growth in the first half of the year. The startup economy has long been decoupled from the things causing this sell off: Unemployment remains at 9% in the country, while there’s an aggressive talent war in most of Silicon Valley.
Yes a few IPOs have postponed this week. That’s a basic cautionary move any company would take in a broader market like this, and none of the companies in question were exactly Zynga, Groupon or Facebook.
At the most extreme, stocks of recent tech IPOs were collateral damage. Can anyone cite someone who lost their job as a result of this “bubble” bursting? A company going under? Also, while recent tech IPOs were hit along with everything else, they didn’t get the worst of it. Have you taken a look at bank stocks? The Journal has a great article on why this crash is different from 2008, but at least those two declines have some parallels that caused people to cry deja vu. Note they didn’t write a story on why it’s not like March 2000, nor does their story even mention tech. Because no one looking at the broader economic picture would think that. At some point, if we get paid to inform people what’s going on in our little ecosystem, we have to actually look around at the reality of what’s happening.
So, still no evidence of an economic bubble in tech. What then about a psychological bubble? Well if anything, we just saw the bizarre opposite of it. If a psychological bubble is when people get emotionally wrapped up in a phenomenon where wildly overvalued things seem fairly priced, this was a case where people got emotionally wrapped up in fear that prices we are seeing could be wildly overvalued. We may need a new word for what we just saw. An event of widespread hysteria wailing about something that wasn’t happening that had no widespread economic repercussion. I mean something other than calling it a monster hiding under the bed. Yeah, thank God it just burst.
This reminds me of a conversation I was having recently with Peter Thiel about bubbles, which I partially referenced here. I asked him whether it was possible– as people have claimed– that this is just a different type of bubble, and that’s why there’s no clear economic evidence to support it. Something like the psychological bubble of the Tulips in other words.
He rejected the idea and rejected that one could even be building. Why? Because there was just no room for euphoria these days, he says. The 30-something and up generation is still too burned from the dot com bubble to ever suspend such disbelief again that Internet companies could rise and rise and rise without a catch. And the college age generation has been burned by the housing bubble– with jobs in the toilet, their parents house poor, and an astounding number of them having to move back home according. According to the US Bureau of Labor Statistics, the unemployment rate for workers with a college degree is the highest it has been since it started tracking the data in 1970. Don’t believe it’s taking a toll on euphoria? Read this. There was a glimmer, Thiel says, of kids about the age of Mark Zuckerberg who could believe, but that’s not enough people to believe enough to carry a bubble.
I guess that helps explain why something that never started could be over so quickly. Don’t get too comfortable though. All we need is another well-performing Tech IPO for the waggers to be back.