Technology bubble ten years later: The money’s not back

[EJ]

Technology bubble ten years later: The money’s not back

Good news, bad news, and another word of caution for the housing bubble hopeful

I started iTulip.com in 1998 to warn readers that the technology bubble was not just an investor “party” or a neat way to force technology onto the market but was instead an efficient way to savage the heart and soul of the American economy. In 2005, five years after the bubble collapsed, I was at a Stanford investment conference moderating a VC panel hopefully titled “The Money’s Back.” It wasn’t.

Five years later it still isn’t.

Today Thomson Reuters published its PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report and Data.

Investment by Development Stage

First the good news. In 2010, investment in pre-product or “seed stage” start-up technology companies is on track to return to 70% of 2000 levels and above 1999 levels.

Definitions

• Venture Capital - Money supplied by individuals or institutions to finance the losses of innovative new companies
• Seed Stage - Pre-product, pre-revenue
• Early Stage - Product but pre-revenue or minimal revenue
• Expansion Stage - Product and some revenue growth track record
• Late Stage - Rapid revenue growth but pre-profit

The bad news is that this growth reflects the desire by angel investors to avoid deals that require follow-on financing by venture capital firms. After two economic crashes in ten years that produced cram-down follow-on financings that reduced seed stage investors’ ownership in a company by as much as 95% in some cases, the chickens are no longer keen to dance with elephants. That means few capital-intensive start-ups are starting up. Further bad news is that Early Stage and Expansion Stage financing remains at 47% and 32% of 2000 levels respectively. Early Stage and Expansion Stage financing is finally back to levels first reached 11 years ago in 1999. Late stage start-ups are attracting twice as much capital in 2010 as in 1999, reflecting a tendency of VC investors to harvest investments made in the early 2000s rather than invest in newer and more risky ventures.

Capital-intensive start-ups are still finding it tough to locate the financing they need to get to the next stage of development, depending on the industry segment they occupy.

Investment by Industry

The good news is that if you are a Biotech, Medical Devices and Equipment, Electronics/Instrumentation, or Energy – who could have known? – start-up company, 50% of the funds invested in 2010 are going into your industries.

The bad news is that if you are in Networking and Equipment, Retailing/Distribution, Telecommunications, Healthcare Services, Business Products and Services, Media and Entertainment, Software, Consumer Products and Services, IT Services, or Financial Services, investment is still off more than 90% from year 2000 levels. Take particular note of the level of investment in Networking and Equipment and Retailing/Distribution companies, off 98% and 97% since 2000.

A comparison to 1999 levels is less dramatic, and produces a three areas of growth over 1999: Biotech, IT Services, and Medical Devices and Equipment.

At more than 90% off 1999 levels, the first five industry segments shown above are for all practical purposes dead to private investment. Still 70% or more off 1999 levels nearly a dozen years ago, the Semiconductor, Telco, and Networking industries are victims of industry consolidation that collapsed bubbles cause. Cisco now has 70% market share. Intel has virtually no competition. Media and Entertainment is dominated by two main players as is Financial Services. No one wants to fund new companies to compete with these behemoths. Computer networking start-up business plans read like features of Cisco products not distinct new products unto themselves.

The implications are not good for the economy as a whole. While start-ups represent only 3% of the job market they provide nearly 100% of job growth. The aftermath of asset bubbles is stifled competition and reduced innovation in the medium term and higher unemployment and falling productivity in the long-term.

Investment by Region

The good news for Silicon Valley and the Northeast, former hotbeds of venture financing from the year 2000 era, is that these regions are on track to put up $9 billion and $2.8 billion respectively in 2010, a far cry from the $32.3 billion and $11.4 billion invested a decade ago but far better than the $2 billion and $711 million invested in the dark days of 2003 when the Iraq War began.

The bad news is that if you live in Colorado, Texas, the Southeast, South Central, or Midwest U.S., or in the Philadelphia Metro, DC/Metroplex, Sacramento/N.Cal, NY Metro regions, and venture financing appears to have dried up in 2001 and stayed that way, that’s because it has.

While a comparison between 2010 and 1999 is less dire, all regions remain in the red by 31% to 89% over 1999 investment levels.

Ten years later, the market liquidity that drives the economics of venture investing remains elusive, and the NASDAQ trades at less than 50% of its peak.

Asset bubbles do lasting market damage

Ten years after the collapse of the tech bubble, the market for venture capital technology investment remains troubled. The implications for the housing market are obvious.

During the tech bubble too many VC firms chased too few good companies with cheap capital and brought them to the public market where stock prices were driven to absurd levels with hype. During the housing bubble too many mortgage brokers sold cheap mortgages to risky borrowers.

The key difference between these two bubbles is that after the tech bubble collapsed in 2000, the equity financed VC industry never got a government bailout. Scores of VC firms and start-up companies went out of business. But after the housing bubble collapsed, the Fed removed $1.2 trillion in unmarketable asset-backed securities from the balances sheets of commercial banks via the miracle of double-entry bookkeeping: they were added to the Fed's balance sheet as "deposits" and "liabilities" that net to zero. The debt financed mortgage industry was nationalized as Fannie Mae and Freddie Mac were made wards of the state. Today 90% of all mortgages are purchased by the government through these two banks. The only way to re-privatize them is to allow mortgage rates to rise to compensate investors for the real level of risk in the housing market. That means 10% plus mortgage rates. Today the National Association of Realtors announced that "its seasonally adjusted index of sales agreements for previously occupied homes dipped 2.6 percent to a reading of 75.7. That was the lowest on records dating back to 2001 and down nearly 19 percent from the same month a year earlier. The index has fallen more than 40 percent from its peak in April 2005. May's reading was revised slightly downward to 77.7." That's will the lowest mortgage rates in history, thanks to government subsidies.

Without ongoing multi-trillion dollar subsidies, by 2016, ten years from 2006 when the housing bubble started to collapse, the U.S. mortgage market will look like the technology financing market does today. Financing activity in some regions and markets will be off 90% or more and home prices will fall an additional 20% to 50% depending on the region. That's how markets operate. The long-term cost of the housing bubble has not yet started to be felt.

See also:
Yes. It's a housing bubble. August 2002
Housing bubbles are not like stock market bubbles, January 2004
Housing Bubble Correction, Fifteen Years to Revert to the Mean, January 2005
Housing bubble has peaked, June 2006
Housing bubble bust recession by Q4 2007, October 2006

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[we_are_toast]

Re: Technology bubble ten years later: the money’s not back

You once called for an Alt-E bubble, but since have backed off. Mfyahya just started a thread about a pretty significant breakthrough in PV/Thermal electricity generation.

Were VC investors so burned by the tech bubble that they will not open their wallets for a long time to come, or will the next oil spike start a VC tidal wave into the inevitable Alt-E industry?

[jk]

Re: Technology bubble ten years later: the money’s not back

one difficulty in interpreting the data on seed-stage and vc investment by industry is that the year 2000 comparitor cannot be considered in any sense "normal" or representative of a healthy entrepreneurial environment. it was a speculative new-tech environment "on steroids." so its levels give us no real sense of what is healthy.

[jpatter666]

Re: Technology bubble ten years later: the money’s not back

one difficulty in interpreting the data on seed-stage and vc investment by industry is that the year 2000 comparitor cannot be considered in any sense "normal" or representative of a healthy entrepreneurial environment. it was a speculative new-tech environment "on steroids." so its levels give us no real sense of what is healthy.

Got to agree with this -- I work in the IT industry and at the height it was like the housing bubble; you just had to have an "internet business plan" and you could usually get investment money from someone. The amount of fraud and waste I saw.....unbelievable.

[Chief Tomahawk]

Re: Technology bubble ten years later: The money’s not back

I'm guessing EJ/Fred hasn't seen (& might enjoy) David Stockman's appearance on Larry Kudlow's CNBC show yesterday. Stockman went so far as to out the recent "phoney boom".

http://www.cnbc.com/id/15840232?video=1557942119&play=1

[FRED]

Re: Technology bubble ten years later: The money’s not back

I'm guessing EJ/Fred hasn't seen (& might enjoy) David Stockman's appearance on Larry Kudlow's CNBC show yesterday. Stockman went so far as to out the recent "phoney boom".

http://www.cnbc.com/id/15840232?video=1557942119&play=1

He kept silent during the bubble when he was still in office and could have made a difference. Now that he's retired from service he points out the aftermath as if no one knew beforehand. That doesn't work for us. Stockman's no hero.

[thriftyandboringinohio]

Re: Technology bubble ten years later: The money’s not back

He kept silent during the bubble when he was still in office and could have made a difference. Now that he's retired from service he points out the aftermath as if no one knew beforehand. That doesn't work for us. Stockman's no hero.

Agreed, Stockman's article falls short of a heart-felt confession, and is more like an excuse that what he set in motion was good but idiots took it too far and destroyed the world with his bomb.

Still, it may do some good because it is a call from inside Reagan’s Shining City On The Hill to abandon what Stockman calls "delusions" held by people who continue screwing things up in the name of St. Ronald.

Here it is in full.

Four Deformations of the Apocalypse
By DAVID STOCKMAN

IF there were such a thing as Chapter 11 for politicians, the Republican push to extend the unaffordable Bush tax cuts would amount to a bankruptcy filing. The nation’s public debt — if honestly reckoned to include municipal bonds and the $7 trillion of new deficits baked into the cake through 2015 — will soon reach $18 trillion. That’s a Greece-scale 120 percent of gross domestic product, and fairly screams out for austerity and sacrifice. It is therefore unseemly for the Senate minority leader, Mitch McConnell, to insist that the nation’s wealthiest taxpayers be spared even a three-percentage-point rate increase.

More fundamentally, Mr. McConnell’s stand puts the lie to the Republican pretense that its new monetarist and supply-side doctrines are rooted in its traditional financial philosophy. Republicans used to believe that prosperity depended upon the regular balancing of accounts — in government, in international trade, on the ledgers of central banks and in the financial affairs of private households and businesses, too. But the new catechism, as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance — vulgar Keynesianism robed in the ideological vestments of the prosperous classes.

This approach has not simply made a mockery of traditional party ideals. It has also led to the serial financial bubbles and Wall Street depredations that have crippled our economy. More specifically, the new policy doctrines have caused four great deformations of the national economy, and modern Republicans have turned a blind eye to each one.
The first of these started when the Nixon administration defaulted on American obligations under the 1944 Bretton Woods agreement to balance our accounts with the world. Now, since we have lived beyond our means as a nation for nearly 40 years, our cumulative current-account deficit — the combined shortfall on our trade in goods, services and income — has reached nearly $8 trillion. That’s borrowed prosperity on an epic scale.

It is also an outcome that Milton Friedman said could never happen when, in 1971, he persuaded President Nixon to unleash on the world paper dollars no longer redeemable in gold or other fixed monetary reserves. Just let the free market set currency exchange rates, he said, and trade deficits will self-correct.

It may be true that governments, because they intervene in foreign exchange markets, have never completely allowed their currencies to float freely. But that does not absolve Friedman’s $8 trillion error. Once relieved of the discipline of defending a fixed value for their currencies, politicians the world over were free to cheapen their money and disregard their neighbors.

In fact, since chronic current-account deficits result from a nation spending more than it earns, stringent domestic belt-tightening is the only cure. When the dollar was tied to fixed exchange rates, politicians were willing to administer the needed castor oil, because the alternative was to make up for the trade shortfall by paying out reserves, and this would cause immediate economic pain — from high interest rates, for example. But now there is no discipline, only global monetary chaos as foreign central banks run their own printing presses at ever faster speeds to sop up the tidal wave of dollars coming from the Federal Reserve.

The second unhappy change in the American economy has been the extraordinary growth of our public debt. In 1970 it was just 40 percent of gross domestic product, or about $425 billion. When it reaches $18 trillion, it will be 40 times greater than in 1970. This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party’s embrace, about three decades ago, of the insidious doctrine that deficits don’t matter if they result from tax cuts.

In 1981, traditional Republicans supported tax cuts, matched by spending cuts, to offset the way inflation was pushing many taxpayers into higher brackets and to spur investment. The Reagan administration’s hastily prepared fiscal blueprint, however, was no match for the primordial forces — the welfare state and the warfare state — that drive the federal spending machine.

Soon, the neocons were pushing the military budget skyward. And the Republicans on Capitol Hill who were supposed to cut spending exempted from the knife most of the domestic budget — entitlements, farm subsidies, education, water projects. But in the end it was a new cadre of ideological tax-cutters who killed the Republicans’ fiscal religion.
Through the 1984 election, the old guard earnestly tried to control the deficit, rolling back about 40 percent of the original Reagan tax cuts. But when, in the following years, the Federal Reserve chairman, Paul Volcker, finally crushed inflation, enabling a solid economic rebound, the new tax-cutters not only claimed victory for their supply-side strategy but hooked Republicans for good on the delusion that the economy will outgrow the deficit if plied with enough tax cuts.

By fiscal year 2009, the tax-cutters had reduced federal revenues to 15 percent of gross domestic product, lower than they had been since the 1940s. Then, after rarely vetoing a budget bill and engaging in two unfinanced foreign military adventures, George W. Bush surrendered on domestic spending cuts, too — signing into law $420 billion in non-defense appropriations, a 65 percent gain from the $260 billion he had inherited eight years earlier. Republicans thus joined the Democrats in a shameless embrace of a free-lunch fiscal policy.
The third ominous change in the American economy has been the vast, unproductive expansion of our financial sector. Here, Republicans have been oblivious to the grave danger of flooding financial markets with freely printed money and, at the same time, removing traditional restrictions on leverage and speculation. As a result, the combined assets of conventional banks and the so-called shadow banking system (including investment banks and finance companies) grew from a mere $500 billion in 1970 to $30 trillion by September 2008.

But the trillion-dollar conglomerates that inhabit this new financial world are not free enterprises. They are rather wards of the state, extracting billions from the economy with a lot of pointless speculation in stocks, bonds, commodities and derivatives. They could never have survived, much less thrived, if their deposits had not been government-guaranteed and if they hadn’t been able to obtain virtually free money from the Fed’s discount window to cover their bad bets.

The fourth destructive change has been the hollowing out of the larger American economy. Having lived beyond our means for decades by borrowing heavily from abroad, we have steadily sent jobs and production offshore. In the past decade, the number of high-value jobs in goods production and in service categories like trade, transportation, information technology and the professions has shrunk by 12 percent, to 68 million from 77 million. The only reason we have not experienced a severe reduction in nonfarm payrolls since 2000 is that there has been a gain in low-paying, often part-time positions in places like bars, hotels and nursing homes.

It is not surprising, then, that during the last bubble (from 2002 to 2006) the top 1 percent of Americans — paid mainly from the Wall Street casino — received two-thirds of the gain in national income, while the bottom 90 percent — mainly dependent on Main Street’s shrinking economy — got only 12 percent. This growing wealth gap is not the market’s fault. It’s the decaying fruit of bad economic policy.

The day of national reckoning has arrived. We will not have a conventional business recovery now, but rather a long hangover of debt liquidation and downsizing — as suggested by last week’s news that the national economy grew at an anemic annual rate of 2.4 percent in the second quarter. Under these circumstances, it’s a pity that the modern Republican Party offers the American people an irrelevant platform of recycled Keynesianism when the old approach — balanced budgets, sound money and financial discipline — is needed more than ever.

David Stockman, a director of the Office of Management and Budget under President Ronald Reagan, is working on a book about the financial crisis.

[Chief Tomahawk]

Re: Technology bubble ten years later: The money’s not back

He kept silent during the bubble when he was still in office and could have made a difference. Now that he's retired from service he points out the aftermath as if no one knew beforehand. That doesn't work for us. Stockman's no hero.

Fred, I'm a little confused, I guess primarily because I haven't tracked Stockman's career path.

I had previously thought his "in office" stint was during Ronald Reagan's presidency, which would pre-date the Clinton tech/stock bubble and W credit bubble. Please clarify. Thanks!

[Chief Tomahawk]

Re: Technology bubble ten years later: The money’s not back

"Still, it may do good because it is a call from inside Reagan’s Shining City On The Hill to abandon what Stockman calls "delusions" held by people who continue screwing things up in the name of St. Ronald."

Good point. I would cite the W tax cuts effectiveness as TREMENDOUSLY outsized by the magnitude of the credit bubble which coincided. Can't wait until the academic research arrives to back it up.

[FRED]

Re: Technology bubble ten years later: The money’s not back

Fred, I'm a little confused, I guess primarily because I haven't tracked Stockman's career path.

I had previously thought his "in office" stint was during Ronald Reagan's presidency, which would pre-date the Clinton tech/stock bubble and W credit bubble. Please clarify. Thanks!

I could be wrong, but I don't recall hearing a peep of protest out of Stockman during the technology or housing bubbles.

[Slimprofits]

Re: Technology bubble ten years later: The money’s not back

I could be wrong, but I don't recall hearing a peep of protest out of Stockman during the technology or housing bubbles.

He was too busy at Salomon Smith Barney and the Blackstone Group....

[jk]

Re: Technology bubble ten years later: The money’s not back

stockman admitted shortly after leaving his job as director of omb that he had cooked the books to create a "rosy scenario" so that reagan could massively expand the deficit. he left the gov't to take a job on wall street to get rich. NOW he's gotten scruples.

[Rajiv]

Re: Technology bubble ten years later: The money’s not back

stockman admitted shortly after leaving his job as director of omb that he had cooked the books to create a "rosy scenario"

See Inside Omb: Politics and Process in the President's Budget Office By Shelley Lynne Tomkin

[we_are_toast]

Re: Technology bubble ten years later: The money’s not back

A 1985 interview with von Hayek in the March 25, 1985 issue of Profil 13, the Austrian journal, was just as revealing. Von Hayek sat for the interview while wearing a set of cuff links Reagan had presented him as a gift. “I really believe Reagan is fundamentally a decent and honest man,” von Hayek told his interviewer. “His politics? When the government of the United States borrows a large part of the savings of the world, the consequence is that capital must become scarce and expensive in the whole world. That’s a problem.” And in reference to Stockman, von Hayek said: “You see, one of Reagan’s advisers told me why the president has permitted that to happen, which makes the matter partly excusable: Reagan thinks it is impossible to persuade Congress that expenditures must be reduced unless one creates deficits so large that absolutely everyone becomes convinced that no more money can be spent.” Thus, he went on, it was up to Reagan to “persuade Congress of the necessity of spending reductions by means of an immense deficit.

http://flaglerlive.com/8577/david-st...sh-trickledown

Mr. Stockman's plan has finally succeeded, the beast has been starved. I hope he's enjoying our dying country.

[oddlots]

Re: Technology bubble ten years later: The money’s not back

Wasn't it Grover Norquist who said he wanted to shrink government to the point where it could be unceremoniously drowned in the bathtub...

Cue the austerity.

This was all foretold by the perpetrators themselves.

Debt peonage, tolls on everything... and partying on Wall Street.

F*ck I hate the west.