Former Fed Chairman Alan Greenspan used to say -- and I’m paraphrasing here -- it’s difficult to identify a bubble until it bursts.
Those of us who went through the tech bubble of the mid to late 1990s -- only to see it explode in 2000 -- can attest that Greenspan’s assessment is completely false. We knew we were in a bubble; we just didn’t believe it would ever burst.
Today, a similar scenario seems to be playing out in the bubble strewn tech arena once again as seemingly over-blown valuations of such firms as Facebook and Groupon chillingly remind us of those dot.com companies that grow out of smoke and mirrors only to attract investors into a quicksand of un-returnable investments.
Some analysts will say there’s a huge difference and that at least today’s companies generate some revenue. What they earn from that revenue continues to be questionable and, since so many of these firms are still raising money in private equity offerings, they do not have to disclose publicly the kind of financials savvy investors like to study before placing their bets.
A question of value
In the mid-1990s, it seemed that any company with a dot.com behind its name was attracting money either through private investors or the public. They included such Internet software companies as Netscape, eBay and Yahoo! Google was a minor player at the time and only of value to journalists. Today’s tech stars are the mobile phone, tablet and social networking firms.
Today’s valuations are soaring with Apple becoming the second most valuable company in the world -- behind ExxonMobil -- with a market cap of $305 billion. But it got there by selling tons of iPhones and iPads. The more troublesome valuation is the $50 billion that private investors have placed on Facebook, which is 50 times revenue. That’s revenue and not earnings mind you. Meanwhile, Groupon, a cyber-coupon company, is valued at $15 billion.
Whether we're in a bubble or a boom, there is cause to worry since the last boom-turned-bubble had a fairly disastrous end -- especially for investors who saw the tech-heavy Nasdaq index fall from more than 5000 points in March 2000 to 1100 in late 2002.
Federal Reserve role
Writing for Bloomberg BusinessWeek, Chris Farrell says that with investors growing “giddy again, odds are the Federal Reserve Board will confront far sooner than expected one of the most difficult and divisive issues in central banking: Should it attempt to deflate an asset price bubble before it grows large enough to threaten the financial system and economy when it pops?”
In his article, Farrell suggests that the answer to that question is "no," but that doesn’t mean the Fed shouldn’t do something. He recommends the Fed prepare institutions for the fallout of another bursting bubble rather than trying try to head one off with a targeted, but bold, regulatory initiative.
Farrell points out that it's a tricky business figuring out whether an asset is over- or undervalued and says the solution this time is for the Fed to place a far greater emphasis on regulatory initiative than monetary policy when confronting bubbles. He adds that the Securities & Exchange Commission (SEC) should step up its scrutiny of private investors and company valuations in the growing trading market for private share offerings of such marquee high-tech companies as Facebook, Twitter, and LinkedIn. Even more important, Farrell says, the Fed needs to exercise the extra oversight powers it got in the Frank-Dodd financial services reform legislation last July.
The bottom line on bubbles according to Farrell, is that plenty of mobile Internet companies, social networking firms, and other information technology companies will get funded over the next few years and many of them will fail. But, hey, that's capitalism. He says regulators need to concentrate on preventing major financial institutions from feeding the frenzy and putting the rest of us at risk.
