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Pop!

Name: Pop!
Author: Daniel Gross

Daniel Gross

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eBook - ePub

Pop!

Daniel Gross

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About This Book

Bubbles—from hot stocks in the 1920s to hot stocks in the 1990s—are much-lamented features of contemporary economic life. Time and again, American investors, seduced by the lures of quick money, new technologies, and excessive optimism, have shown a tendency to get carried away. Time and again, they have appeared foolish when the bubble burst. The history of finance is filled with tragic tales of shattered dreams, bankruptcies, and bitter recriminations.

But what if the I-told-you-so lectures about bubbles tell only half the story? What if bubbles accomplish something that can only be seen in retrospect? What if the frenzy of irrational economic enthusiasm lays the groundwork for sober-minded opportunities, growth, and innovation? Could it be that bubbles wind up being a competitive advantage for the bubble-prone U.S. economy?

In this entertaining and fast-paced book—you'll laugh as much as you cry—Daniel Gross convincingly argues that every bubble has a golden lining. From the 19th-century mania for the telegraph to the current craze in alternative energy, from railroads to real estate, Gross takes us on a whirlwind tour of reckless investors and pie-in-the-sky promoters, detailing the mania they created—but also the lasting good they left behind.

In one of the great ironies of history, Gross shows how the bubbles once generally seen as disastrous have actually helped build the commercial infrastructures that have jump-started American growth. If there is a secret to the perennial resilience and exuberance of the American economy, Gross may just have found it in our peculiar capacity to blow financial bubbles—and successfully clean up the mess.

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Information

Publisher

HarperCollins e-books

Year

2009

ISBN

9780061850103

Topic

Economia

Subtopic

Storia economica

1 BUBBLES “R” US

Oops!…I did it again.

—BRITNEY SPEARS, MAY 2000

On October 9, 2006, with the Dow hovering near a record 12,000, the markets got a jolt. Google, the eight-year-old money machine, announced it would buy YouTube, the eighteen-month-old Web video-sharing phenomenon, for $1.65 billion in stock.

Uh-oh. Stocks at multiyear highs. A young tech company using its high-flying stock to snarf up, at a seemingly outrageous valuation, a company with little revenues but gazillions of eyeballs. (YouTube held its financials closely but loudly trumpeted the 100 million videos viewed daily at the site.) The positive reaction in the stock market. (Google’s stock rose 8.5 points on the news, creating enough new value to make the transaction essentially free.) The rumors and gossip surrounding the acquisition target’s also-ran peers, like Facebook. “It sounds like a tale from the late 1990’s dot-com bubble,” wrote astute deal observer Andrew Ross Sorkin in the New York Times. Less astute deal observer Matt Lauer seconded the notion, opening the October 11 Today show with this irresistible teaser: “Bubblicious. Could Google’s billion-dollar purchase of YouTube signal another dot-com boom?”

Bollocks.

Despite the media’s rush to portray the deal as a return to the glory days of 1999, before Lauer’s hairline and CNBC’s ratings had receded so dramatically, the Google-YouTube tie-up emphatically did not herald a return of the dot-com bubble. Rather, it was a logical and historically resonant result of the 1990s bubble. Google, the dork-powered cream of the Web 2.0 crop, was founded in 1998, gained critical mass amid the postbust tristesse, went public in August 2004, and instantly took flight. Superior search algorithms account for Google’s astonishing performance and profitability. The stock market valued Google that day at about $128 billion—more than it did most components of the Dow Jones Industrial Average. And while the company used about 2 percent of its high-flying stock as currency, Google could have simply written a check. It had about $9.8 billion in cash and marketable securities on its balance sheet.

But all that code would have been worthless if not for the excess human and technological capacity surrounding the Internet that was created in the 1990s. Google prospered by hiring engineers and computer scientists, many of whom had been made redundant after the bust; by lashing together hundreds of thousands of cheap servers; by tapping into an installed base of 172 million U.S. Web surfers, many whom enjoyed zippy broadband connections; by selling ads to hundreds of thousands of online advertisers desperate for leads, links, and clicks; and by placing ads on blogs and social networking sites.

YouTube, which went from zero to 100 million videos per day in the time it takes an infant to learn to walk, was likewise built on infrastructure laid down in the 1990s. Without near-universal broadband (ever try streaming a video over a 56K dial-up modem?) and the spread of what Forbes publisher Rich Karlgaard calls the continuing “cheap revolution” in technology, teens would not be able to make videos on their PCs and digital cameras, upload them to the Net quickly, and post links on their MySpace pages. There’s much more to the Web 2.0 phenomenon than Google and YouTube: the virtual universe Second Life; Wi-Fi networks; the burgeoning blogging industry; iTunes; the $211.4 billion e-commerce juggernaut, growing at 20 percent per year; and the $16 billion online advertising industry. Next, add the macroeconomic numbers that are more difficult to crunch. How much cash do corporations save each year due to falling data transmission and storage costs? What’s the value of the time saved—and hence money earned—from instant messaging, file sharing, BlackBerrys, the online phone service Skype, ordering groceries online through Peapod, using Google to conduct research, and outsourcing insurance claims processing to Bangalore? In the years since the bubble burst in 2000, the way Americans work and communicate has changed dramatically, in large part because the technological infrastructure laid down in the 1990s has been put to such remarkable use.

The cycle seen in fiber optics and dot-coms in the 1990s and the early part of this decade—a burst of frantic building and excess capacity, outlandish hype, and cutthroat price competition, bankruptcy and consolidation, self-pity and finger-pointing, short-term losses for many and long-term gains for everybody—is nothing new. Similar manias and bubbles surrounded other promising economic and technological developments: the telegraph in the 1840s and 1850s, the railroads in the 1880s and 1890s, stocks and credit in the 1920s. These bubbles, and their contribution to America’s remarkable record of economic growth and innovation, are the subject of this book.

What’s an investment bubble? There’s no satisfying textbook definition. But it goes something like this. In every generation, people arise to proclaim that a new technology or a new set of economic assumptions and financial tools promise untold riches. The new, new thing will both alter history and free us from its musty grasp. As a result, the old rules simply no longer apply. Promoters concoct pro forma numbers that extrapolate impressive short-term trends indefinitely into the future. Evangelists and proselytizers urge people to abandon reason and steady habits, and browbeat those who steadfastly stick to their sense of rationality. As telecom promoter George Gilder put it in a December 31, 1999, premillennial op-ed in the Wall Street Journal, “The investor who never acts until the financials affirms his choice is doomed to mediocrity by trust in spurious rationality.” Yes, there are always some fuddy-duddy doubters. In 1995, surveying an unfolding investment craze in a new technology, one pessimist wrote: “A few will pay off, but when the frenzy is behind us, we will look back incredulously at the wreckage of failed venture and wonder, ‘Who funded those companies? What was going on in their minds?’” But, hey, what does Microsoft founder Bill Gates know about new technologies that George Gilder doesn’t?

As the bubble takes shape, a chorus of pundits, shills, and true believers concoct eminently solid reasons why this time is different. The authors of the 1999 howler Dow 36,000, James Glassman and Kevin Hassett, and Irving Fisher, the Yale economist who in 1929 proclaimed that “stock prices have reached what looks like a permanently high plateau,” genuinely believed that the nation stood on the verge of a new era. So did Henry O’Reilly, whose enthusiasm for the telegraph was so great that he rounded up capital and strung up wires throughout Pennsylvania and Ohio in the 1840s, heedless of the utter lack of demand for the service. And so did David Lereah, chief economist of the National Association of Realtors, who in February 2005 published a book bearing the top-calling title Are You Missing the Real Estate Boom? The Boom Will Not Bust and Why Property Values Will Continue to Climb Through the End of the Decade—and How to Profit from Them. Naturally, housing prices peaked in a matter of months.

As the bubble takes flight, the sector swells to an out-size part of the economy and pushes up demand for the commodities and services it consumes. Now the phenomenon crosses over into the larger consciousness, even if only a small portion of Americans are financially caught up in it. “The striking thing about the stock market speculation of 1929 was not the massiveness of the participation,” wrote John Kenneth Galbraith. “Rather it was the way it became central to the culture.” I still remember, with astonishing vividness, the guys behind the counter at my rotisserie chicken place in New York watching CNBC in 1998 and holding forth about the utility of options. Meanwhile, crooks, charlatans, frauds, and mountebanks are elevated into visionaries. In his 2000 book, Telecosm, George Gilder predicted that Bernie Ebbers’s MCI WorldCom “stands ready to release many more trillions of dollars in wealth in Internet commerce and communications and threaten monopolies around the globe. He is a hero of the dimensions of Rockefeller and Milken.” (That wasn’t the dumbest projection in Gilder’s book. This was: “Profits will migrate toward newspapers and magazines.”)

The bubble fully aloft, investors and managers are seized by pervasive me-tooism, a conviction that the fourth, fifth, and sixth movers will enjoy first-mover advantage. Every khaki-clad MBA in the dot-com era had a business plan in his pocket, arguing that if he could take just 5 percent of whatever space he happened to be in, he’d be golden. Unfortunately, fifty other khaki-clad MBAs had the exact same idea. In the United States, a good business gets funded—and then funded again and again—especially when a sector is hot. At the end of 2006, there were sixty-three ethanol refineries with a combined annual capacity of 5.4 billion gallons under construction; during 2006, total production capacity was 5.3 billion gallons. The same mentality led railroad promoters to build multiple trunk lines traversing the continent to connect business centers. Railway mileage in the United States nearly doubled between 1880 and 1890; by 1893, one-quarter of the U.S. rail system was in bankruptcy.

Meanwhile, an important parallel process takes place. During bubbles, a great deal of money and energy is spent building up the mental infrastructure surrounding a new technology—convincing people to invest, to use new media, to make Internet phone calls, to reserve hotel rooms by telegraph, to send grain by rail instead of by canal barge, to buy stocks and investment trusts instead of leaving cash under the mattress. Part of the madness—and brilliance—of the 1990s was the eagerness of so many companies to run businesses at negative margins in order to attract users. Kozmo.com, a New York–based courier service, would deliver a Snickers bar to your desk. Amazon.com had a business model predicated on losing money, the more the better! The competition created by excess capacity—too many e-retailers, too many fiber-optic providers, too many railroads, too many telegraphs, too many condos competing for too few customers—inevitably leads to vicious price competition that is a positive good for consumers.

Next comes the end stage. As business plans start to go sour, managers panic. They slash prices feverishly, cook the books, or just plain lie. Joseph Schumpeter, the economist who promulgated the notion of creative destruction, compared the upper strata of an entrepreneurial economy to a hotel, always full but with guests always checking in and checking out. When bubbles start to deflate, the guests at the Schumpeter Hyatt pick one another’s pockets, clobber one another senseless, and then leave without paying the bill.

Finally, when economic reality catches up to dreams and hype, the bubble bursts. Pop! It’s the airship Hindenburg at Lakehurst, New Jersey, in May 1937, a massive explosion followed by bankruptcies, declining asset values, red-faced brokers, and promotional books piling up on the remainder tables. Oh, the portfolios! Like the solid citizens of River City in The Music Man, hardworking and utterly gullible, we were all too eager to look beyond the obvious scam and see the potential for a tremendous wind orchestra. In the nonfiction version, however, Dr. Harold Hill doesn’t stay to marry the librarian. He leaves town, gold coins spilling out of his pockets as he hops the train. As fiber-optic behemoth Global Crossing went bust in 2002, founder and CEO Gary Winnick, who sold tons of stock at the top, was puttering around his obscene $94 million residence in Bel Air. And we think: how could we be so stupid, so thick? How could we imagine that Pets.com, sending fifty-pound bags of Kibbles ’n Bits through the mail, was a viable business model? How could we join Condo Flip and use credit cards to put down payments on unbuilt Miami condos?

A period of ritualized mourning and self-flagellation worthy of the Shiite Ashura follows. Ironically, a chronically underpaid lot—journalists—finally prosper as book-length jeremiads are commissioned. And so we have a rich history of bubble literature, morality tales that highlight greed, naïveté, the tendency toward madness and criminality. “The public mind was in a state of unwholesome fermentation…The hope of boundless wealth for the morrow made them heedless and extravagant for today,” Charles Mackay wrote of the eighteenth-century South Sea Bubble in his 1841 volume, Memoirs of Extraordinary Popular Delusions. John Kenneth Galbraith, in his enduring classic The Great Crash, 1929, described “the mass escape into make-believe, so much a part of the true speculative orgy.” Roger Lowenstein’s best-selling 2004 postmortem, Origins of the Crash: The Great Bubble and Its Undoing, flays fin de siècle America for “a mass refusal to acknowledge reason—even a mass indifference to reason.”

It’s hard not to read these books without feeling a sense of self-loathing, shame, and embarrassment, and to leave the library with a firm lesson in hand. Excessively speculative investments in fixed assets are bad—bad for investors, bad for employees of the bubble companies, and bad for the economy.

Of course they’re right. But what if they’re only half right? While the literature on bubbles and their piercing is deep and rich, the literature on the positive aspects of bubbles is slim. And yet. One can’t help but think that the sack-cloth-and-ashes approach misses part of the story. The pernicious downsides of bubbles are obvious: the financial losses and corruption, the wasted efforts and resources, the deep wounds and the scars they leave. Six years after management decided to accept AOL’s high-flying stock as currency, Time Warner’s shareholders are still bitter and angry at then-CEO Gerald Levin for accepting the deal. Levin, who retreated to Santa Monica to create a high-end holistic mental health clinic, is too blissed out to care. But what about the upside? Hasn’t anyone ever made the case for bubbles? Or at least for some bubbles?

It seems like a tough case, in part because losses are so easily defined—Mr. Investor buys a hundred shares of Cisco Systems at 70 in 2000. It falls to 18. He’s out $5,200. MCI WorldCom’s investors saw nearly $180 billion in market capitalization evaporate. But the gains—economic, social, and cultural—are less obvious and more difficult to calculate. It is always thus. Economists note—and have proved—that Wal-Mart has made significant contributions to overall productivity, and provides benefits to millions of consumers in the form of lower prices for everything from giant jars of pickles to Garth Brooks CDs. But the mom-and-pop hardware store that closed in the wake of Wal-Mart’s arrival, and the American factory that closed because Wal-Mart demanded its products be sourced in China, makes better copy. Just so, the tales of short-term woe experienced by bubble-burned investors, who constitute a minority of the population, frequently overlook the substantial long-term benefits that accrue to everyone, and to the economy at large, in the years after.

And if you take the long view—in this case, a pretty long view—it’s possible to detect a pattern that emerges in bubbles and their aftermaths. Especially bubbles that leave behind a new commercial and consumer infrastructure. With apologies to Oliver Stone, these bubbles, for lack of a better word, are good. These bubbles are right; these bubbles work. Thanks to the American penchant for creative destruction and the U.S. bankruptcy system, investors—and the economy at large—tend to get over bubbles quickly. Bourgeois practicality, suppressed during the bubble, resurfaces. The stuff built during infrastructure bubbles—housing and telegraph wire, fiber-optic cable and railroads—doesn’t get plowed under when its owners go bankrupt. It gets reused—and quickly—by entrepreneurs with new business plans, lower cost bases, and better capital structures. And when new services and businesses are rolled out over the new infrastructure, entrepreneurs can tap into the legions of users who were coaxed into the market during the bubble. This dynamic is precisely what has made Google the “it” company of this decade. Solar-powered, Prius-driving, earnings-guidance-refusing, don’t-be-evil Google, a company that like so many others was built on the wreckage of Global Crossing and eToys.

Looking back, many similarly iconic companies and industries that have stimulated economic growth, and that helped define America’s commercial culture, were either formed in those hothouse bubble environments or can trace their origins to their aftermaths. Consumer packaged goods and mass retailing, data services and mass media, the vast financial services sector, tourism, telecom, and what venture capitalists still call “the Internet space.” Sears, the Associated Press, Western Union, Fidelity Investments, Google—they may all have developed anyway. But they certainly would not have developed as they did without the Pop! dynamic.

Between 1846 and 1852, the number of telegraph miles in the United States rose more than tenfold, from 2,000 to 23,000. Excess capacity caused prices to plummet, and most telegraph companies, mainly backed by small local investors, wilted. Within a decade, most lines ended up in the hands of a single consolidator, Western Union. The country wound up with a utility that businesses of all sizes could use. And the rapid spread of cheap telegraphy set other key industrial innovations into motion: the creation of the Associated Press and a quantum leap in news gathering, national markets in stocks, commodities, and business information.
The investment mania surrounding railroads created a commercial platform that midwifed a national market for goods and services. A spasm of overbuilding in the 1880s spawned vicious rate wars. By 1893, nearly 25 percent of the railroad miles in the United States were in bankruptcy. This time, bondholders—many of them foreigners—were the losers. The winners: J. P. Morgan and other consolidators, as seven large groups wound up controlling about two-thirds of the nation’s rail system by the early twentieth century. Consumers and businesses won, too. Many of the industries and companies that would define the twentieth century were built over cheap, far-reaching rail freight systems: Montgomery Ward and Sears, Roebuck, the transport of refrigerated food, and national brands of packaged goods.
The 1929 stock market crash helped plunge the U.S. economy into a deep depression and scared off an entire generation of investors. The Dow Jones Industrial Average wouldn’t regain its 1929 peak until 1954. But in contrast to the other Pop! episodes, the importance of the investment and credit bubble of the late 1920s—and the long-term advantage it created—lay almost wholly in the response it stimulated. As part of the New Deal, the Roosevelt administration and Congress created a new financial infrastructure for the nation: the FDIC (Federal Deposit Insurance Corporation), which made it safe for people to bank again; the Securities and Exchange Commission, which made it safe for people to invest again; a...