IP: Tech stock boom was a legal con game (12/16/2000)

[Dave Farber <farber@cis.upenn.edu>]

http://www0.mercurycenter.com/svtech/columns/gillmor/docs/dg121700.htm



Tech stock boom was a legal con game

BY <mailto:dgillmor@sjmercury.com>DAN G<mailto:dgillmor@sjmercury.com>ILLMOR
Mercury News Technology Columnist

The technology boom has been called the largest legal creation of wealth in 
the history of the planet. Maybe so, but that's not the whole story.

As the events of 2000 have shown, it's also been the greatest legal con 
game of all time.

I stress the word ``legal'' -- even though we're likely to learn in coming 
months and years about significant criminal activity accompanying the 
tech-stock bubble that began deflating last April.

The violations of law will be the exceptions. They will only highlight the 
uglier truth. As commentator Michael Kinsley has pointed out in another 
context, the real scandal is often what's legal.

This time, countless investors lost vast amounts of money in technology 
investments. Yes, they were greedy. They bet stupidly, even blindly, as 
suckers tend to do when they join a stampeding herd.

So yes, to some degree, they conned themselves. But they had plenty of help.

A daisy chain of entrepreneurs, venture capitalists, Wall Street investment 
bankers and stock brokerages pulled off something unprecedented. They 
transferred almost all risk into the public markets.

The people with the least amount of information were sold the most 
speculative investments. The sellers were insiders who fully understood the 
reality.

In older days, venture capitalists took big risks. They'd invest in 
start-up companies, hoping to hit an occasional home run to make up for the 
losers. If a portfolio company did go public or get sold, their payback 
would be many times the original investment, because they'd have bought in 
at pennies per share.

In older days, investment banks looked carefully at companies before taking 
them into the public markets or selling follow-on offerings, asking about 
mundane things like reliable earnings. Equity analysts did serious homework 
on the companies they followed.

For about 18 months to two years, everything changed. The Internet mania 
swept away common sense and old-fashioned ethics.

At the heart of the mania, as always, were kernels of truth. Technology was 
plainly changing the economy. Early risk-takers had gotten incredibly rich, 
and so had some late-comers who had truly great new ideas or who bet on 
market momentum.

Investors wanted a piece of the action. The ones who hadn't joined the 
stampede began to feel like suckers. That was the most dangerous time.

I don't know if the venture capitalists and investment banks created the 
craze, but they definitely fueled it. Hype, not profits, took over. 
Analysts became little more than shills. No deal was too crazy to make. No 
company was too speculative to take public.

In a market like that, there was almost no risk for the early investors and 
investment banks. They could sell anything, and they did.

What this meant, though, was that public investors were now taking the kind 
of risks that venture capitalists had borne just a few years earlier. Yet 
the public investors were buying shares that were far more expensive than 
the VCs were ever willing to touch.

My own profession bears a share of responsibility for the debacle. 
Journalists served more as stenographers than skeptical observers while 
technology executives, public-relations people, market ``analysts'' and 
other self-serving participants in the con talked up the New Economy and 
insisted that some fundamental laws of economics had been repealed.

We celebrated the 21-year-old billionaire of the week. We raved about 
companies with tiny revenues and no prospect of earnings as the harbinger 
of a new world, when the newly rediscovered reality was firmly rooted in 
old truths.

One headline last year asked, evidently with a straight face, ``Does P/E 
Matter Anymore?'' Think about that. This was asking if earnings mattered. 
Of course they do. Investors don't put money into enterprises unless they 
expect to make money at some point. Some companies get sold before they 
make a dime. Some investors sell their holdings to greater fools. Yet 
actual profits from running businesses do matter eventually, because they 
are the basis of business.

I don't doubt for a second that technology will ultimately lead to massive 
and, for the most part, positive changes in our economy and society. We're 
already feeling some of the beneficial impacts.

Nor do I doubt that technology-related investments are smart in the long 
run. What I don't know is whether the current crop of companies, with a few 
exceptions, will be the long-range survivors in a revolution that is just 
beginning.

Capitalism is all about risk and excess. People make money on new ideas, 
and others follow. Markets get saturated and business cycles turn down. 
People lose money. Just as a stopped clock is precisely accurate twice a 
day, markets hit equilibrium briefly on the way up and the way down, 
because investor sentiment is a blunt instrument. The overall trajectory 
trends up, but the market oscillates and always will.

The losers in the debacle of 2000 are part of the capitalist system. So are 
the winners, who made their money from greater fools.

In a world where shame still had meaning, the participants in that cynical 
gravy chain would contemplate the carnage they helped engineer. They might 
even hint at regret.

I'm not going to hold my breath.



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