The graph on the article is misleading. Show me trending for the last 5 or 10 years. The number of exits over the past two is a completely irrelevant metric because all sorts of investors were squeezed shortly after the recession started.
Calling internet startups a bubble in the same breath as the housing market bubble is doing a disservice to the readers. Every single American was seeing housing prices soar. All sorts of people were borrowing 100k against their new found home equity to "invest" in their home, despite the fact that homes have no revenue, while the majority internet companies do.
Most people running startups in the community I'm most active in (Toronto) have revenue. For example: dateideas.ca is only 6 months old and they have revenue, guestlistapp.com has been out of beta for about half a year (launched a year before that) and they have fairly substantial traction, then you have the bulk-ward of the Toronto tech scene, freshbooks.com, with over 2 million users and a solid business model. Just look at their hiring page, 22 positions listed for a 50 person company.
There is a huge difference between building valuations based on a solid business model and changing public trends (ie, more people getting on/trusting the internet), and building valuations on selling ponzi scheme debt that overvalue non-revenue generating assets like housing. The same article could have been written about clothing manufacturing in England just after the industrial revolution started.
Calling both the housing market and internet startups a bubble is not doing anyone a disservice. Both sectors experienced irrational valuation increases in which the bad rose with the good. These increases were not based on economic fundamentals but on the half witted belief that everyone could be a winner and that prices would rise today because they rose yesterday. A classic description of a bubble, in both cases.
> Calling both the housing market and internet startups a bubble is not doing anyone a disservice.
Well it is. It is hurting the egos of many people here as many are involved in startups. Accepting the fact that it might be a bubble would mean somehow joining the ranks of the hated housing market speculators and bankers.
I am not saying whether it is a bubble or not. But if you see a large rationalization effort into making this "not a bubble" that might be a plausable explanation.
I don't think anyone attributes the bubble, or lack thereof, to the people working hard to make their visions happen. Rather, the "bubble" aspect usually involves purely speculative investing frenzy from financial sources: be it VCs, angels, or banks.
In the case of Internet Bubble 1.0, you had such a huge buildup (and stage set for a huge burst) because you had three forces working in tandem and reinforcing each other:
1) Big banks underwriting IPOs on questionable businesses with unproven models and no revenue expectations.
2) VCs and/or angels rushing to fund pretty much any idea, no matter how sketchy, because of the above.
3) An influx of would-be founders (especially nontechnical founders) and speculators basically gold-rushing out to the Bay Area to try to get something off the ground -- often driven primarily, if not solely, by a lottery ticket mentality, and not by love of their product or business model.
Whether we're currently in a bubble largely depends on your belief in the solidity, or lack thereof, of the companies being funded. Amount of funding, frequency of funding, etc., are only aspects of a bubble -- but they are not sufficient to describe a bubble. It's only a bubble if the investment has reached a point of irrationality, and the only way to determine irrationality is to examine the companies themselves against the investment they've received.
The underlying asset in a bubble is usually inherently valuable until the bubble itself starts driving creation of assets that wouldn't have otherwise exists. The housing bubble drove the prive of homes up enormeously, but the houses were very useful to their owners and had real value. Then speculators came and made a lot of houses that were above and beyond what normally would be required, but because of the bubble made sense. I think most of the "WEB 2.x IS A BUBBLE!" crowd are seeing people jumping in to invest at dumb valuations and startups being created for no reason other than to chase the money, and that is what they are fearful of. That could inflate the arena and make it worse for genuine startups.
Bubbles are, by definition, predicated on the perception of some measure of value that is not really there. This could include creation of unreal assets or fictional derivative values on real assets, as happened in housing. But it doesn't have to. You can easily have a bubble that involves nothing more than overvaluation of tangible assets. Commodities bubbles, for instance.
That's not a disservice. It's a reality check -- EDIT dispelling the even more half witted belief that "I can make money because he did", regardless of the quality of your idea or it's commercial viability.
> Well it is. It is hurting the egos of many people here as many are involved in startups. Accepting the fact that it might be a bubble would mean somehow joining the ranks of the hated housing market speculators and bankers.
I agree with you on the graph--very poorly constructed, and the time interval is too short. But:
Calling internet startups a bubble in the same breath as the housing market bubble is doing a disservice to the readers. ... All sorts of people were borrowing 100k against their new found home equity to "invest" in their home, despite the fact that homes have no revenue, while the majority internet companies do.
I wouldn't go as far as saying this comparison is a "disservice." Sure, the article is judgmental and poorly researched. But when Patricof says there is "probably a bubble in the number of start-ups," well, that's supported by what we've heard recently.
Don't we see Ask HNs from failed founders who took out a large amount of savings to start their companies? And don't we keep hearing about how more people are starting businesses while their opportunity cost is low during the recession? These are traits we share with the housing bubble, and they shouldn't be ignored.
There is some value to revenue though; it represents traction in generating money. It's a step on the road. It's past idea, and getting customers. It's not profit, yet, but it's something.
A lack of revenue means nobody is paying for your service or products, period, which is very troubling. In the first big bubble, there were a lot of companies that sold at huge valuations while having no or negligible revenue.
It's one thing to be in the process of monetizing, another to have your monetization plan as "advertising(?)"
From my point of view, you get an idea first, customers second, revenues third, and profits fourth. Only once you have profits is your business really successful. To command large valuations without even generating revenue... that seems crazy to me.
Because you haven't proved that anybody will pay for what you're selling.
If you have revenue, but not profit, that means people will pay (either for advertising or the software)... which is a very promising start. All you "need to do" from there is increase their number... at least with software, where making more is essentially free.
Unless you give dividends, profit is mostly just money you forgot to invest in your business. A successful business is about sustained growth with a balanced budget.
In accounting terms, an "investment", at the time you make it, does not change your profitability. This is because you are assumed to have received in return an asset of equal value. For example, the purchase of equipment results in a decrease of your cash balance, but an increase in your fixed assets of the same amount. An "expense", on the other hand, does reduce your profitability. So profits are not a sign of a lack of investment, but of revenue that exceeds your expenses, which seems pretty desirable to me.
Accounting: Assets = Liabilities + Capital. This deals with the Balance Sheet.
Expenses/Revenues are reported on the Income Statement. Two completely different things. An income statement basically explains how well you're using the items on your balance sheet.
The emergence of an active secondary market in shares of start-ups yet to go public has allowed founders and early investors in firms such as Facebook and Twitter to bank fortunes without waiting for a traditional exit by IPO or acquisition. These secondary-market prices feed hype about what these firms might be worth, were they to list on the stockmarket. Not many shares are available; many punters are chasing them. And those punters tend to be outsiders, such as fund managers and private-equity firms, who may not understand the tech business as well as insiders do.
Wait a minute. There's an unregulated secondary market where pension fund managers and other non-tech people invest other people's money into stuff they don't understand?
Previously the argument was that only wealthy people will lose out on their risk money if this is a new bubble, but if large investors like pensions and the like are also feeding this bubble than maybe we do have a new equity bubble on the way - except this one is happening on unregulated markets and so perhaps even more dangerous.
It seems to me that bubbles only form to catastrophic sizes around the unregulated edges of markets.
e.g. If not for the ineffectual IPO regulation, the dot-com boom couldn't have built so much irrational exuberance. Similarly with nonexistent regulation of derivatives and the ratings thereof during the real-estate bubble. And also with Savings & Loans being deregulated in the late 80s, leading directly to that real estate disaster.
I'm not sure how you can possibly characterize the housing bubble as occurring in the "unregulated edges" of markets.
Banks purchased AAA rated MBS because they were legally obligated to own AAA securities (by Basel I and II) [1]. The securities underlying an MBS are heavily subsidized and regulated by the government, and several major players in the market were backed by the government [2].
Derivatives are a sideshow. The speculative bubble was created by banks and real estate speculators ("homeowners", as politicians call them, even though most of them only own highly leveraged call options on a house), with the strong encouragement of the government.
[1] You can satisfy capitalization requirements by purchasing AAA bonds from another party.
[2] In spite of assorted claims that they had nothing to do with the crisis, the GSEs seem to require the biggest bailouts.
The ratings were obviously unregulated. The oversight committees that received reports that agencies were slapping AAA on garbage outright ignored those complaints.
The unregulated derivatives were a necessary instrument to obscure the risk of the underlying assets. I don't know how you could imagine institutional investors being conned into thinking trash tranches of subprime mortgages were safe investments without derivatives obscuring their contents and ratings agencies blessing garbage as AAA.
If the bubble only wiped out speculators, it would have been the sideshow. The money that chases high risk is a rounding error compared to the money that can only chase 'safe' investments.
Without derivatives and fraudulent ratings the bubble couldn't have ensnared nearly as much money, the banks couldn't have become so precariously leveraged and the system itself wouldn't have been on the brink.
Let me get this straight. The government requires banks and other financial institutions to purchase securities rated AAA by one of five ratings agencies. As of 2006, the ratings agencies could even be subject to some penalties if they screw up the ratings in certain ways. The ratings agencies are all selected by the SEC. The downside risk is bounded below by the implicit guarantee of a government bailout, and again the biggest players in the market are government sponsored entities.
I think we have a very different definition of "unregulated".
Also, I don't know where you get the idea that the crash of the housing bubble was somehow based on people being conned into buying securities that were too complex to understand. An MBS is a fairly simple security, and so far MBS's have done exactly what they are supposed to do: allow you to take exposure to a long position on housing.
> "I think we have a very different definition of "unregulated"."
Yes. I recognize unenforced regulation as not being regulation.
Also, the implicit guarantee of a bailout wasn't a known or accepted feature of our financial system prior to TARP.
> "I don't know where you get the idea that the crash of the housing bubble was somehow based on people being conned into buying securities that were too complex to understand"
The crash wasn't. But the feature of the situation that put our entire financial system on the brink were the securities.
Again: if high-risk crap wasn't rated AAA and being sold to institutional investors, then much less of it would exist, exposing the banks to much less risk. More of what they could sell would be properly rated, meaning there would be enough reserves and insurance to cover the expected losses. There still would have been a bubble and crash, but it would have been more on the order of the Dot Com cycle, than what we just experienced.
When dot coms bottomed, investors were wiped out, but the banks themselves were fine. When the properties behind the securities bottomed, the banks were obligated to continue making payments. Payments they couldn't possibly make, because they didn't have enough reserves or insurance to cover the spread between the risk they _said_ they had and the risk they were actually exposed to.
Yes. I recognize unenforced regulation as not being regulation.
If regulations were unenforced, why were banks bothering to meet capitalization requirements at all? Why invest in MBS at all rather than something with higher returns? And if capitalization regulations were unenforced, why bother selling your own loans and purchasing an MBS of loans from some other bank (paying a chunk to loan packagers in the process)? And why bother buying wasting money getting a AAA rating from the government specified ratings agency?
What regulation do you believe was not enforced?
Also, the implicit guarantee of a bailout wasn't a known or accepted feature of our financial system prior to TARP.
Again: if high-risk crap wasn't rated AAA and being sold to institutional investors, then much less of it would exist, exposing the banks to much less risk.
This is not in dispute. Also not in dispute: if regulations didn't demand that banks own lots of AAA rated securities, they wouldn't have bought as much.
You may be able to, with the benefit of hindsight, pinpoint some specific regulation that might have prevented the bubble. But lack of that particular regulation is not the same thing as an unregulated market.
Interesting that you waste so much "productive time" that you claim you value so much arguing about those things on HN. It's not like HN exactly attracts the crowd that will write next banking regulations, is it? Then what's the point of having these arguments here? If it's about getting more karma, then it's obvious you'll get plenty from extremely libertarian tech crowd here, but it's not like your 12000 karma is convertible into real dollars?
Another observation is that many times you come in with an argument you seem to purposefully derail it into something that more suits you. The original argument was:
Similarly with nonexistent regulation of derivatives and the ratings thereof during the real-estate bubble.
instead of addressing those two issues you go into government involvement in housing market and Basel requirements. Those are important issues not unrelated to housing bubble, but that wasn't original point!
Of course housing market was heavily regulated and influenced by government. But market for housing securities wasn't! It is basic knowledge now that pretty much everyone could structure, rate, insure and sell pretty much anything to pretty much everyone. I don't understand how you could argue with that?
And finally, back to the topic, is it not indicative of something that SecondMarket is now the marketplace for both the toxic housing junk and hi-fly tech start-ups?
Well put. At some point, the market structure/complexities intended to provide a benefit, became too difficult to manage and too easy to exploit. It's a tough balancing act.
Was going to comment on your MBS statements, but this report has much better analysis:
BBB corporates vs. AAA RMBS seem to have similar credit spreads (07/2008).
Certain credit enhancements would make AAA RMBS/AAA corporates equal risk.
AAA corporates have a default rate of 5 out of 10,000 - 07/2008.
P.S. For the ggparent comment, here's a decent (from 2002) summary of pension fund investment restrictions by country:
> It seems to me that bubbles only form to catastrophic sizes around the unregulated edges of markets.
Most recent economic crisis was primarily driven to crazy low interest rates, set by the Federal Reserve.
Everything else about the crisis pales in significance compared to the disaster that loads of almost free cash causes. If you set interest rates below the price of inflation, you're always going to have a short, illusory boom, followed by a massive crash. Like, around 100% of the time that's going to happen.
Those interest rates were set by regulation. Derivatives shenanigans is nowhere near as scary as effectively-free-money, which always breaks things always.
Inflation is not a constant. The single most destructive force in a crash is deflationary pressure which can quickly feed on its self and spiral out of control.
PS: When people start buying T-Bills with negative interest rates you know you have a problem. (This has happened on a few occations over the last few years.)
> The single most destructive force in a crash is deflationary pressure which can quickly feed on its self and spiral out of control.
Well, that's part of the Keynesian view yes. I'm personally of the belief that currency-fuckery causes crashes in the first place, and that more currency-fuckery isn't the answer [1].
But let's just say Keynes is right for now. That still doesn't explain why the healthy Clinton/Bush economies had crazy-low interest rates, which was the main cause of this mess.
[1] While it has a humorous spin, the Keynes vs. Hayek rap is incredibly well informed about both positions, and it's pretty easy to follow and entertaining -
Monetarism has very little to do with Keynes, its' main figurehead is Milton Friedman (not too far to the left of political spectrum from your beloved Hayek).
That's the unintended consequences around the stricter IPO/reporting laws.
Instead of making IPOs more difficult to do, they just don't get done. So instead secondary markets spring up, completely unregulated, around the companies. The politicians won't realise this until we have a major flameout somewhere and a lot of people lose a lot of cash.
You can't stop people from speculating, especially when they're doing it with other people's money. Stopping IPOs on NASDAQ has merely forced them 'underground' so instead of an IPO, you get a secondary market. I mean, one of the people from craigslist that got equity managed to sell to ebay. There's a crazy secondary market for you.
Yeah really. And the valuations in this unregulated, easy-to-manipulate secondary market in turn influence valuations for angel and venture investing ...
"For the first time since 2000, internet and technology entrepreneurs can raise seed capital with little more than a half-formed idea and a dozen PowerPoint slides."
I didn't mean that as an insult to YC companies, or YC, but when YC started they were literally funding teams with ideas. In Reddit's case, YC convinced the team to do a different idea than what they had presented.
I'm thinking YC now funds more mature companies, but that probably is a sign that there is less of a "bubble" now than there was before.
It says that founders are less technical, and more likely to be based in NYC not SV.
But YC, the poster-child of the new wave, is totally "technical founder", and I also read that the share of VC investments in California vs Rest Of The World has risen from 47% in ~2000 to over 50% now.
I think the Economist is describing a different wave than YC. The poster child for its wave is Groupon, which has lately stole the press cycle by turning down the $6B acquisition offer from Google. (Which was a masterful PR move, BTW - we don't even know if there was an acquisition offer, yet by leaking that they turned it down, Groupon has become the new hotness in every media outlet's eyes.)
YC seems to invest much more in B2SmallB startups, which are less visible from a media perspective and require more technical savvy. Reddit's their most famous success because it was one of the few that is purely consumer web, but their other investments have included Wufoo, Heroku, ClickFacts, Auctomactic, FrogMetrics, and RescueTime, all of which are aimed at small businesses.
I love reading about world affairs in The Economist, but seeing how poorly they covered this topic is making me take a second look at my preferred magazine.
I read a copy last week that I grabbed while in an airport. It had some good articles on China and its military capabilities, but then had a horribly written, pompous article about Google with factually incorrect information and exaggerations.
Very disappointing. What is happening to the Economist?
> Very disappointing. What is happening to the Economist?
Nothing - it's the same magazine it always was. Only this time it's covering a topic for which you have a large degree of expertise. I imagine someone with vast knowledge of China and its military capabilities is shaking their head at the article you just lauded.
You nailed it. Journalism will always seem "challenged" on a topic on which you are an expert. If they don't completely screw it up with factual errors, give them an A+ and take everything else with a grain of salt.
I worked on a biofuels startup for 2 years, focused on a lesser known crop. During that time I did not read a single article on our sector which did not contain major factual errors.
I was just trying to say that it need not say much about the newspaper when some articles are good and some are bad, because they employ many writers (anonymously, of course).
So perhaps saying that there is a decline in quality is over-analyzing it...
I think this article fails to understand a fundamental trend that has been going on from 2000 to 2010 and wasn't going on in 1998. Increased market penetration of web based devices. Having a business in 1999, when the potential population of internet users is roughly 1/10th what it is now, when you do not have such a large population of non-tech people using very sophisticated devices and the web constantly. Of course, even in such a favorable environment, it is possible to have a bubble, however the numbers even they themselves use are both statistically insignificant and not telling the whole story.
Real and open market valuations in a market that is semi-real and definitely not open
ie. you have investors making investments with no reporting, analysis and imperfect information but the prices are not discounted because of the imperfect information.
Is there going to be a time in the next 5 years where most people change their views about the [usefulness/profitability] of [investing/creating/buying] [housing/start-ups/restaurants]?
If your answer is yes then there is currently a bubble.
Why are they calling overvaluation by private investors a stock market bubble? I know -- they didn't say "stock market", but that's what "bubble" refers to. It's a word that conjures up images of the the dot-bomb era with a crashing stock market and thousands out of work. Having a few startups overvalued by some private investors is not going to create the same effect.
Why is it that the media can't go for more than two years without making a big fuss about tech bubbles? There is no bubble. We're in a financial downturn -- a bad one.
A big reason the dot-com bubble was bad was because normal people with more to lose were depleting their retirement savings buying stock in stupid companies that recently went public. There are no more IPOs. The public at large cannot participate in this bubble. This financial part of this bubble involves a bunch of rich guys and even richer investment firms. Who cares if these people lose .001% of their net worth betting on startups?
The problem is the 'rich guys' are using the average Joes money, often lent to/invested with them by banks and pensions funds to try and secure the largest return possible.
Even if they're using their own money, the cynic inside me predicts that if/when the house of cards comes crashing down, Mr and Mrs Taxpayer will be asked to 'stabilise' the industry in the interests of national economic security.
Calling internet startups a bubble in the same breath as the housing market bubble is doing a disservice to the readers. Every single American was seeing housing prices soar. All sorts of people were borrowing 100k against their new found home equity to "invest" in their home, despite the fact that homes have no revenue, while the majority internet companies do.
Most people running startups in the community I'm most active in (Toronto) have revenue. For example: dateideas.ca is only 6 months old and they have revenue, guestlistapp.com has been out of beta for about half a year (launched a year before that) and they have fairly substantial traction, then you have the bulk-ward of the Toronto tech scene, freshbooks.com, with over 2 million users and a solid business model. Just look at their hiring page, 22 positions listed for a 50 person company.
There is a huge difference between building valuations based on a solid business model and changing public trends (ie, more people getting on/trusting the internet), and building valuations on selling ponzi scheme debt that overvalue non-revenue generating assets like housing. The same article could have been written about clothing manufacturing in England just after the industrial revolution started.