Dot.con

John Cassidy · 2002

Thesis

The internet boom of the late 1990s was a classic speculative bubble, not a new economic era: a genuine technology became the story behind an alliance of entrepreneurs, venture capitalists, stock analysts, investment bankers and journalists, encouraged by the Federal Reserve, that drew millions of ordinary investors into buying stocks at prices no business could justify.

The main ideas

The internet was a real revolution. The stock market treated it as a reason to abandon valuation.
Each participant in the boom profited from its continuation and had little reason to stop it.
Stock analysts became promoters, paid in effect by the investment-banking business their ratings helped win.
Initial public offerings of companies with no profits soared on their first day, drawing in more investors.
The media and the Federal Reserve helped expand and prolong the bubble.
When it burst, the losses fell hardest on the ordinary investors who had arrived last.

From memex to Netscape

John Cassidy, a staff writer at The New Yorker, begins with the long history of the technology, from Vannevar Bush's 1945 vision of a "memex," a machine for linking information, to the world wide web. The technology was real and transformative, he argues; the question is how it became the basis for a financial mania.

His turning point is the initial public offering of Netscape, maker of the first popular web browser, on August 9, 1995. Priced at $28, the stock opened at $71 and closed the day at about $58, for a company that had never made a profit. The offering showed investors and bankers that a story about the internet could produce enormous gains overnight.

The mechanism Cassidy describes is that a genuine innovation supplies the narrative that a bubble needs: the claim that this time the old rules of valuation no longer apply.

Implication: when a real technological change is used to justify prices that ignore earnings, the truth of the technology does not make the prices reasonable.

The alliance

Cassidy's central argument is that the bubble was sustained by an alliance whose members all profited from it. Entrepreneurs raised money on the strength of growth rather than profits. Venture capitalists took companies public quickly and sold their stakes. Investment banks earned large fees from the offerings. And stock analysts, who were supposed to give investors independent advice, became promoters.

His symbols are the analysts. Mary Meeker of Morgan Stanley, whose 1996 internet report became a guide for the boom, appears in a chapter titled "Queen of the 'Net." Henry Blodget, then at CIBC Oppenheimer, predicted in December 1998 that Amazon's stock would reach $400, and it did within weeks, making him famous and winning him a job at Merrill Lynch.

The mechanism is that analysts' pay and prestige depended on the banking business their enthusiasm helped win, so their incentives ran against telling investors to sell.

Implication: before acting on expert advice, find out how the expert is paid and whether the advice serves that interest.

The IPO machine

As the boom accelerated, the first-day jumps of internet offerings grew. On November 13, 1998, theGlobe.com, a website offering online communities, was priced at $9 a share, traded as high as $97, and closed at $63.50, a first-day gain of more than 600 percent. Companies with little revenue and no prospect of profit went public on the strength of website traffic and business plans.

Each spectacular debut attracted more money into the next one. Ordinary investors, many trading online for the first time, chased the gains.

The mechanism is a feedback loop: rising prices drew in buyers, whose buying pushed prices higher, attracting more buyers, while companies and bankers rushed to supply new shares to meet the demand.

Implication: when the main reason people are buying an asset is that its price has been rising, the buying will stop when the price does.

Greenspan's green light

Cassidy gives two chapters to the Federal Reserve and its chairman, Alan Greenspan. In a speech on December 5, 1996, Greenspan asked how anyone could know when "irrational exuberance" had unduly escalated asset values. But he did not act on the concern. Instead he came to believe that information technology was producing a genuine increase in productivity that justified faster growth, and in 1998, after the collapse of Long-Term Capital Management, the Fed cut interest rates three times.

The Fed raised rates through 1999 and 2000, and in the book's account helped prick the bubble it had allowed to grow.

The mechanism is that a central bank that declines to lean against an asset bubble, and eases credit when markets are shaken, signals to investors that the boom is protected.

Implication: do not assume that the authorities will prevent a bubble, or that their confidence in a new economy is a reason to buy.

The crash

The Nasdaq index peaked at 5,048.62 on March 10, 2000. By October 2002 it had fallen about 78 percent. Many of the celebrated companies disappeared: the online pet-supply retailer Pets.com was liquidated less than a year after going public, and the grocery-delivery company Webvan filed for bankruptcy in July 2001.

The merger of AOL and Time Warner, announced in January 2000 and valued at about $165 billion in stock, came to symbolize the peak: an internet company using its inflated shares to buy an established media business.

The aftermath confirmed Cassidy's account of the analysts. In 2003, ten Wall Street firms paid a total of $1.4 billion to settle charges over conflicted research, and Blodget and the telecom analyst Jack Grubman were barred from the securities industry for life.

Implication: in a bust, the companies that survive are those with real revenues and the capital to wait. Judge any boom company by whether it could survive the end of easy money.

Limits

It adds little new reporting. Reviewers noted that much of the book retells stories already told in the press, and one found it never quite identifies the con of its title.
Its framing benefits from hindsight. The internet did transform the economy, and some boom-era companies, such as Amazon, became enormously valuable, so not every high price of the period was a delusion.
When the bubble began is disputed. Some economic research suggests the stock market as a whole was not clearly overvalued until about 1998, later than narratives that date the mania from Netscape in 1995.

Devil Take the Hindmost — the long history of speculative manias, of which this was the latest.
The Big Short — the next bubble, built on mortgages, and the conflicts that sustained it.
The Intelligent Investor — the discipline of valuing a business by its earnings, which the boom abandoned.