Internet start-ups: Another bubble?
economist.com
economist.com
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.
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.
but to the extent people are in denial, drawing this kind of analogy is very definitely doing a service
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.
If the shoe fits....
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.
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.
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.
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.
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.
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.)
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 -
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 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.
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.
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.
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.
You have no idea what you are talking about.
http://en.wikipedia.org/wiki/Savings_and_loan_crisis
http://en.wikipedia.org/wiki/Long-Term_Capital_Management#19...
http://en.wikipedia.org/wiki/Government-sponsored_enterprise...
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.
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?
Was going to comment on your MBS statements, but this report has much better analysis:
http://books.google.com/books?id=w9jIQuZIWPUC&lpg=PA59&#...
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.
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.
Really?
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.
Don't get me wrong, I think the right idea should be fundable based on a few PowerPoint slides. I just don't see it happening very often at all.
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.
Discrepancy?
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.
Very disappointing. What is happening to the Economist?
Perhaps they are just out of their depth wrt technology articles. They should have probably just stuck to politics/economics.
So perhaps saying that there is a decline in quality is over-analyzing it...
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.
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.
ie. you have investors making investments with no reporting, analysis and imperfect information but the prices are not discounted because of the imperfect information.
The secondary market is therefore also an excellent place to burn someone big time.
If your answer is yes then there is currently a bubble.
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.
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.