by Cole Bashford
In March of 1989, Tim Berners-Lee created a proposal for a new project while working at CERN (the European Organization for Nuclear Research). His project was designed to face the demand for automated information sharing between intellectuals across the globe. He invented what is known as the World Wide Web, which was a way for people to navigate and connect easily on the internet.
The creation of a global medium for information sharing in this fashion has never been seen before. As access to Web browsers became free in the early ’90’s, the World Wide Web, became accessible for all people who could afford a computer. Clinton also made efforts during his presidency aiming to bridge the digital divide, resulting in large waves of new internet users, both for personal and business use. In 1985 there were about two thousand computers connected to the internet and eight years later in 1993, more than two million computers were connected.
Many onlookers viewing the rise of the Web saw it as a seemingly limitless opportunity for new businesses. Existing businesses also saw the Web as a new way to expand and rise as a company. This was a brand new market that could be tapped into by anyone with a creative idea. The Web provided an opportunity to all people, regardless of economic standing or social position, to assert themselves in a brand new market. All that it took to succeed was a good business sense and/or technological understanding.
One significant market that was created as a result of the Web is the Ecommerce Market. Ecommerce is the process of purchasing of available goods and services over the Internet using secure connections and electronic payment services. But in the early ’90’s internet users were wary of giving out their personal information on the internet. Except for one industry, online pornography, which was paid for with a lack of care for privacy and safety by the users. Eventually public key encryption was created to properly protect the buyers information. This is a major factor in the ability of businesses to succeed on the internet.
From 1997-2000, a bubble developed on the stock market, partially as a result of massive influx of new businesses and investors in technology. This would later become known as the Dot Com Bubble. In March of 2000, the bubble popped and within a month one trillion dollars was lost from the value of NASDAQ, which is representative of many of the large tech stocks. Of course this does not represent many of the smaller tech companies that were publicly traded on the market.
The first major contributing factor for the bubble is the “irrational exuberance” displayed by the investor as quoted by Alan Greenspan. He believed that many investors during the ’90’s were funding companies with little to no business plan and a lack of planning. This resulted in many new startups spending irrationally, rather than spending to improve their business. Many businesses however, were able to survive the bubble’s burst and dominate the eCommerce space.
The Taxpayer Relief Act of 1997 (TRA97) had lowered the tax rate on Capital Gains but kept the tax rate on Dividend paying stocks high. The timing of this Act played a direct impact on the development of the bubble.
The emergence of this Dotcom bubble cannot be attributed to any single factor. However, there exists a combination of factors that played a role in the emergence of the bubble. Waves of new internet users and investors flooded the tech market, causing volatility in the Dotcom stocks. These stocks became overvalued and much of their value was based on speculation. Finally when the TRA97 passed, the bubble had been born.
U.S. Mass Accessibility
Clinton and his administration believed that being connected to the internet and having the ability to know how to use the internet were opportunities that should be granted to every US citizen.
The following are opportunities that are unattainable for people who lack internet access: the ability to shop in an eCommerce space and to competitively shop, an opportunity to start an online business or work from home, the ability to make well informed decisions about health care options, and a platform to learn a plethora of new skills upon.
In his 2000 State of the Union Address, Clinton spoke about how to address the Digital Divide and to give opportunity to education and tools for access to the internet. (3)(Full text of info on Divide below)
Bill Clinton
Opportunity for all requires something else today — having access to a computer and knowing how to use it. That means we must close the digital divide between those who’ve got the tools and those who don’t.
-Connecting classrooms and libraries to the Internet is crucial, but it’s just a start. My budget ensures that all new teachers are trained to teach 21st century skills, and it creates technology centers in 1,000 communities to serve adults. This spring, I’ll invite high-tech leaders to join me on another New Markets tour, to close the digital divide and open opportunity for our people.
-I want to thank the high-tech companies that already are doing so much in this area. I hope the new tax incentives I have proposed will get all the rest of them to join us. This is a national crusade. We have got to do this, and do it quickly. (3)
56:04-57:13 for information on internet (Additional link if not functional https://youtu.be/vg_qI3yzCLk?t=336 )
In 1999, the Department of Commerce revealed interesting data from 1998 department of Census data. They found that:
(5)
This divide was built upon race, economic standing, access to education and geographic location. But the president and his cabinet sought to eliminate the divide through legislation. They proposed:
- $2 billion over 10 years in tax incentives to encourage private-sector donations of computers, sponsorship of community technology centers, and technology training for workers;
- $150 million to help train all new teachers to use technology effectively;
- $100 million to create 1,000 community technology centers in low-income urban and rural areas; and
- $50 million to expand home access to computers and the Internet for low-income families. (5)
There was a strong sentiment in the 90’s expressing that the internet was the way of the future and that every person should have access to it. This is shown both in government regulation and the state of the stock market.
This sentiment directly related to the formation of the bubble as it increased the speculation of tech startups.
New Stock Market Traders
One major impact that the emergence of the Web had on the Worldwide economy was the ability to give direct access to the stock market to anyone with a computer. Previously there were a set number of brokers who could broker the deal. But now, thanks to low commissions and the ability to control your entire portfolio, the stock market becomes accessible to millions of informed Americans. After the internet, the percentage of Americans investing in the stock market jumped from 5% to 20%. (8)
There were 12 online brokerage firms in 1994, and by 2003 there were 140 firms. (12) Competition led to lower prices and by 1996, Scottrade offered online trades for as low as $7 a trade. Day-trading online had become a possibility and millions of Americans had become hooked. (7)
There were a few issues with this modern wave of day traders and new stock market investors. Many of them were uninformed about what they were investing in, solely following the speculation of others. (12) But, with the rapid rise of the internet, it was nearly impossible to predict the direction that the Web would turn next. Day traders also heavily increase the volatility of markets, so a new wave will have large effects.
Another main issue seems to be a lack of diversification in their portfolios. Many day traders lost much of their portfolios following the Dotcom bubble burst, they should not have put too much stake into one single market, no matter the potential for gain. Many of these investors were too risky. (9)
Irrational Exuberance
Many analysts highly overvalued certain stocks based solely on the number of users. Investors considered the “network theory”, which states as each additional node joins the network, then the value of the network increases. But these analysts failed to consider how some of these companies will turn a user into profit, and for some companies there was no income stream. These are companies that will not last as a publicly traded company.
During the 90’s there was also rampant overvaluations for new tech companies. These valuations were based around all of the potential that surrounded the internet, rather than the potential of their company and their idea. Many of these companies were still not generating any revenue, and their valuations were based on their potential a few years into the future.
HSBC Holdings, the world’s largest bank, conducted research on the P/E ratios of new tech companies; they found that these companies were being overvalued by 40%, when compared to other industries. The P/E ratio shows the ratio of the price of a company’s stock to the company’s earnings per share, and is used to compare different companies on the market.
In December of 96’ Alan Greenspan, the Federal Reserve Chairman, made a speech in which he attempted to warn investors of the volatility of an inflated market. He expresses similar concerns to what the findings of the HSBC found.
“Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.” (6)
Alan Greenspan
Greenspan was warning investors of the escalated values of the current market. In the end of the quote, he emphasizes not becoming complacent of the complexity of the market and the economy. But his warning would not be listened to by the majority of Americans.
Lack of Business Sense
Every company wanted to be the next Netscape with a huge IPO, and every investor wanted to find the next Netscape. As a result, there is a huge amount of money invested in new tech startups, especially those with Dotcom next to their name.
Rise and fall of the IPO Proceeds over time
One company that had its IPO in the peak of the tech trading frenzy was TheGlobe.com. This was an early social media site that made money using online ads. They set their IPO price on the market for $9 a share, but the stock opened at $87. The stock rose to $97 before closing at $63.50, raising $27.9 million dollars for the company. (1)
But TheGlobe.com had a very poor business model. They were spending millions of dollars to bring in millions of users, but only generating minimal ad revenue for each user. In the first six months of 98′ they lost 95 cents per unique user, and a year later they lost $1.65 per user. But the market valuation, based on Market Cap, for TheGlobe.com was $95 a user. (1)
By 2001, TheGlobe.com was delisted from the NASDAQ stock exchange for failing to meet value requirements of $1/share. Below is a short clip on the market appeal and ultimate failure of theglobe.com 24:20-26:20 (10)
As a result of overvaluations from the stock market, these companies would have to meet expectations of companies valued at this size to stay profitable. But many companies that failed as a result of the market crash, spent their money in unwise and excess behaviors. This is displayed in a comedic manner in this clip, 28:20-33:45. (10)
Many of the Dotcom startups did not need the large amount of capital that they were given. This led to excess spending on items such as expensive chairs, extravagant offices, first class airline tickets, luxury hotels and Gatsby-esque parties.
Overvaluations and huge IPO’s do not blend well with bad business managers.
Successful Businesses
While the Dotcom age is often remembered for its many failures, due to the large economic impact of its crash, there were many businesspeople and businesses that were able to endure the crash and remain successful through the coming years.
These businesses were the ones that were able to keep costs low and find a way to meet the consumer demands while also making a profit. Sites like eBay and Amazon specifically succeeded in driving out the competition.
Amazon, as a startup run by Jeff Bezos, sought to “extend and solidify our current market leadership position” and “focus relentlessly on our customers.” To do this, he kept his prices as low as they could be for competitions sake. He also developed extensive tracking habits on consumers, which has benefitted the long term ability for Amazon to appeal to its customers.
eBay took a different approach to overcoming the bubble. They kept costs low, while focusing on bringing in new sellers of all markets. Their two main focuses were to bring in high quality items to be sold and brand name awareness. Quality management and knowledge of the consumer while turning a profit equals a sound business plan.
These companies today in 2018, are admired and trusted by their users,but these websites did not always possess the trust from their users to handle online transactions. Online transactions were able to be hacked by knowledgable people. The implementation of firewalls benefitted these companies greatly. With enough funds they could purchase secure firewalls to protect their users’ safety. (11)
A similar process was also used by NetScape, as described in this article;
A history of online payment security
“Seeing that people would be using the internet to regularly make online financial transactions, Netscape Communications created a way to ensure that shopping systems, online banking and online retailers were able to offer their clients encryption through their internet browser’s Secure Sockets Layer (SSL) to ensure secure data transfers.”
In 2018, with the emergence of online banking and online gambling, data continues to be protected using new techniques. (11) There are now features like online PIN’s, two factor Authentication, and even text confirmations.
Having consumers who truly trust in your business and investors who believe in your business model, are signs that a company will succeed and thrive in a growing market.
The Taxpayer Relief Act of 1997 (TRA97)
Years after the bubble burst, and many Dotcom companies failed, losing trillions of investors’ dollars, there was speculation that the businesses were not entirely the cause for this bubble. Investors believe the bubble began to grow in April of 1997. A paper written by Zhonglan Dai, Douglas A. Shackelford and Harold H. Zhang describes the relation of the TRA97 to the Dotcom bubble crash. (4)
In this photo we see the Price per Share of the S&P 500 compared to the Trailing Year Dividends per Share. This is designed to show how overvalued the tech stocks became, beginning in 1997, relative to their earnings the following year. (4)
We use the Taxpayer Relief Act of 1997 as our event to empirically test the impact of a change in the capital gains tax rate on stock return volatility. TRA97 lowered the maximum tax rate on capital gains for individual investors from 28 percent to 20 percent for assets held more than 18 months. TRA97 is particularly attractive for an event study because the capital gains tax cut was large and relatively unexpected, and the bill included few other changes that might confound our analysis.
[…]
Consistent with expectations, we find that non- and lower dividend-paying stocks experienced a larger increase in return volatility than high dividend-paying stocks. We also find that stocks with large unrealized capital losses had a larger increase in return volatility after a capital gains tax rate reduction than stocks with small unrealized capital losses. However, we do not find a similar relation with unrealized capital gains.
Dai, Shackelford and Zhang
To summarize, the government enacted the TRA97 following a large deficit reduction. This lowered the rate that capital gains are taxed at from 28% to 20%. While the tax for dividends remained at 28%.
This gave a reason for investors to invest more heavily in low dividend paying stocks, which largely included new Dotcom companies. Day traders could now also trade with an 8% reduced tax, lowering the tax threshold by 29%.
The uneven tax cut resulted in higher return volatility for low dividend paying stocks compared to high dividend stocks.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 set the two rates equal to one another once again, removing some volatility from the low dividend paying stocks. (4)
This graph shows the change of volatility as a result of unequal tax rates. But whats odd is that there was no major crash in the mid 80’s. (4) This seems to be because of the rapid amount of change that accompanied the internet and the other factors that also led to the crash.
TRA97 seemed to be the final straw that broke the camel’s back and the bubble was born.
Citations
(1) “10 Big Dot.com Flops.” CNNMoney. Accessed December 19, 2018. https://money.cnn.com/galleries/2010/technology/1003/gallery.dot_com_busts/6.html.
(2) “TheGlobe.com.” Digital image. Web.archive.org. January 17, 1999. https://web.archive.org/web/19990117021828/http://www.theglobe.com:80/.
(3) “THE STATE OF THE UNION; President Clinton on State of Union: ‘The Strongest It Has Ever Been’.” The New York Times. January 28, 2000. Accessed December 19, 2018. https://www.nytimes.com/2000/01/28/us/state-union-president-clinton-state-union-strongest-it-has-ever-been.html.
(4)”Here’s Why The Dot Com Bubble Began And Why It Popped.” Business Insider. December 15, 2010. Accessed December 19, 2018. https://www.businessinsider.com/heres-why-the-dot-com-bubble-began-and-why-it-popped-2010-12.
(5)CLINTON-GORE ADMINISTRATION. “OUTLINING AMERICA’S AGENDA FOR THE INFORMATION AGE.” National Archives and Records Administration. Accessed December 19, 2018. https://clintonwhitehouse4.archives.gov/WH/Work/030300_1.html.
(6)Greenspan, Alan. “Remarks by Chairman Alan Greenspan.” The Fed – Money Stock and Debt Measures – H.6 Release – April 26, 2018. Accessed December 19, 2018. https://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm.
(7)Hur, Johnson. “History of Day Trading.” BeBusinessed. September 06, 2017. Accessed December 19, 2018. https://bebusinessed.com/history/history-day-trading/.
(8)Hur, Johnson. “History of Online Stock Trading.” BeBusinessed. September 06, 2017. Accessed December 19, 2018. https://bebusinessed.com/history/history-of-online-stock-trading/.
(9)Kelleher, Kevin. “5 Lessons from Survivors of the Dotcom Crash.” Fortune. Accessed December 19, 2018. http://fortune.com/2014/01/03/5-lessons-from-survivors-of-the-dotcom-crash/.
(10)Mastin, Chas. YouTube. February 19, 2013. Accessed December 19, 2018. https://www.youtube.com/watch?v=EsVpNB2Lv3U&t=1463s.
(11)Rossi, Ben. “A History of Online Payment Security.” Information Age. July 20, 2015. Accessed December 19, 2018. https://www.information-age.com/history-online-payment-security-123459855/.
(12)Smith, Kalen. “History of the Dot-Com Bubble Burst and How to Avoid Another.” Money Crashers. Accessed December 19, 2018. https://www.moneycrashers.com/dot-com-bubble-burst/.
