There was an interesting article in Tuesday’s New York Times about the so-called “Bubble 2.0,” and the growing belief of many that we’re on the verge of a second Internet bubble burst. One quote really stood out to me — one of the people interviewed stated that “entrepreneurs [have] begun to think that the financing game is best played by avoiding actual revenues — since that only limits the imagination of investors.”
The article made me ask myself — why does history repeat itself?
Consider that from 1999 to 2001, there were plenty of people who, like now, were happy to throw out their finance textbooks and leave startup valuations to “the imagination of investors” rather than looking for actual revenue. And for a while it seemed to be working. People got rich. We were told that we were in the middle of the “new economy”, and that the rules of the “old economy” didn’t apply anymore. In fact, people were so convinced of this “new economy” that some even tried to create wholly new, Internet-based currencies like Flooz.com (remember the Whoopi Goldberg commercials?)
We all know how that turned out. The majority of the hot new Internet startups burned through incredible amounts of money, and investors eventually bailed out of their investments when “the imagination of investors” became less important than future profits. Tech workers went from being paper billionaires to collecting paper checks from their nearest Unemployment office.
The lesson that I thought we had learned from Bubble 1.0 was that we shouldn’t invest solely on “imagination.” However, instead of learning this lesson, investors repeated their mistakes just a few years later as they poured money into the real estate market. There was no rational reason for the sudden and dramatic increase in home prices, aside than the fact that everyone else was investing. Many investors started “flipping” homes for a living or buying up many homes as investment properties. And for a while it too was working. People became rich overnight. Real estate was clearly “different” (just as our “new economy” had been).
As we’ve learned, though, real estate is not different. People overcommitted themselves, and now are being foreclosed upon left and right. Homes and apartments are sitting empty. Condominium buildings are being converted to rentals. Prices are falling quickly. What we’re seeing is that popular thinking — best demonstrated by a popular Miami real estate website’s tagline, “Bubbles are for bathtubs” — was clearly wrong.
To be fair, the real estate investors that helped build the housing bubble were generally not the same people involved in either the first tech bubble or the current tech market (I’m not ready to call it a bubble, yet). But others, including the homebuilders, banks and even the Fed, should have been able to look at the market and see that history was repeating itself.
So, to get back to Tuesday’s New York Times article — are we repeating our mistakes of the past and will this lead to a Bubble 2.0? It’s hard to say. There are some key differences between the tech market now and in 2001. It’s less expensive to start an online company today than in the past (something Rogomo has benefitted from), meaning that the barriers to entry are lower and that it’s a new crop of investors in the current market. However, much like Bubble 1.0, it seems clear that many investors are still basing their investments on “imagination” rather than hard numbers. In addition, much like the real estate market, established companies are overpaying for innovation for the simple reason that their competitors are doing so as well (i.e., eBay/Skype, Google/Doubleclick, etc.). The value of these startups are increasing dramatically. People are getting rich (again). But will it last this time?
The reason that history repeats itself is because we refuse to learn from our mistakes and instead let greed and hubris cloud our judgment. The investors driving up the so-called Bubble 2.0 valuations don’t believe (or at least hope) that the lessons from the original tech bubble apply to them. They should know better than to ignore history.
Personally, I learned my own valuable history lesson from the original tech bubble that will forever guide my investments — don’t take investment advice from Deloris Van Cartier.
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