Dot-com bubble

Based on Wikipedia: Dot-com bubble

The Day the Music Stopped

On Friday, March 10, 2000, the NASDAQ Composite stock market index hit 5,048.62. That single number represented the peak of one of the most spectacular financial manias in history. Within two years, nearly four trillion dollars in market value would evaporate. Companies that had been valued at billions would become worth nothing at all. And an entire generation of investors would learn a brutal lesson about the difference between a revolutionary technology and a sound investment.

But here's the strange thing: they were right about the revolution.

The internet really did change everything. It just didn't change it on the timeline investors had priced in, and it didn't make everyone rich who bet on it. The dot-com bubble is a story about what happens when genuine technological transformation collides with human greed, fear, and the irresistible urge to get rich quick.

The Seeds of Mania

To understand how otherwise intelligent people convinced themselves that a company with no revenue was worth billions of dollars, you need to understand what the mid-1990s felt like.

In 1993, a piece of software called Mosaic appeared. It was a web browser, which is just a program that lets you view pages on the World Wide Web, which was itself a way of linking documents together across the internet. Before Mosaic, using the internet required technical knowledge. After Mosaic, your grandmother could do it.

The transformation was breathtakingly fast. In 1990, only fifteen percent of American households owned a computer at all. By 1997, that number had more than doubled to thirty-five percent. What had been a luxury became a necessity. We were entering what people called the Information Age, an economy built on knowledge and connectivity rather than factories and physical goods.

At the same time, interest rates were falling. When interest rates are low, borrowing money becomes cheap, which means more capital is available to fund new ventures. The Taxpayer Relief Act of 1997 cut the top marginal capital gains tax, which meant investors got to keep more of their profits when they sold stocks that had gone up in value. This made people more willing to take risks.

And then there was Alan Greenspan.

Greenspan was the Chair of the Federal Reserve, the institution that controls monetary policy in the United States. He was revered, almost worshipped, as a financial oracle. When he spoke, markets moved. And he was saying optimistic things about stock valuations, which investors interpreted as a green light to keep buying.

The Gold Rush Logic

Here's how the thinking went: The internet was going to fundamentally reshape commerce. Traditional retail would be disrupted. Physical distribution channels would become obsolete. Any company that established itself early in this new landscape would reap enormous rewards.

This logic was not entirely wrong. Amazon, which sold books online starting in 1994, really did grow into one of the world's most valuable companies. eBay, which let ordinary people auction items to each other, created an entirely new form of commerce. Google, which launched in 1998, became so dominant in search that its name became a verb.

But the logic had a fatal flaw. Because the internet was new and nobody knew which companies would succeed, investors decided to bet on all of them. And because the potential rewards seemed unlimited, they paid almost any price to get in.

Venture capital, which is money invested in early-stage companies in exchange for ownership stakes, became absurdly easy to obtain. Investment banks, who made their money from initial public offerings (the process by which a private company sells shares to public investors for the first time), were eager to take any internet company public. It didn't matter if the company had ever made a profit. It didn't matter if it had revenue. Sometimes it didn't even matter if it had a finished product.

All that mattered was having ".com" in your name.

The Numbers That Should Have Terrified Everyone

Let's talk about the price-earnings ratio. This is a simple calculation: you take a company's stock price and divide it by its earnings per share. It tells you how much investors are willing to pay for each dollar of profit the company generates. A high ratio means investors expect rapid growth. An extremely high ratio means investors have lost their minds.

At the peak of the dot-com bubble, the NASDAQ's price-earnings ratio hit 200. To put that in perspective: the Japanese stock market bubble of the late 1980s, one of the most notorious financial manias of the twentieth century, peaked at a price-earnings ratio of 80.

The dot-com bubble was two and a half times crazier than that.

In 1999, shares of Qualcomm, a telecommunications company, rose in value by 2,619 percent. Twelve other large companies each rose over 1,000 percent. Another seven rose over 900 percent. The NASDAQ Composite gained 85.6 percent in a single year.

And yet, here's a remarkable fact: more stocks actually fell in value than rose in 1999. Investors were selling shares in slow-growing but profitable companies to buy shares in internet startups that had never earned a dime. The market was becoming increasingly concentrated in a smaller and smaller number of wildly overvalued technology stocks.

A Culture of Delusion

The mania infected everything. The Wall Street Journal, one of the most respected financial publications in the world, published an article suggesting that investors should "rethink" the "quaint idea" of profits. CNBC, the financial news network, covered the stock market with the breathless excitement usually reserved for championship sports.

People quit their jobs to trade stocks full-time. Secretaries and janitors who had received stock options as part of their compensation became millionaires on paper. The phrase "on paper" is important here, because many of these employees were prohibited from selling their shares for months after their companies went public, and by the time they could sell, the shares were often worthless.

The savvy operators knew what was happening. Mark Cuban, who had founded a company called Broadcast.com, sold it to Yahoo for $5.7 billion and then hedged his Yahoo shares, protecting himself from the decline he suspected was coming. Sir John Templeton, one of the greatest investors of the twentieth century, made a fortune by short-selling dot-com stocks. Short-selling is betting that a stock will go down rather than up. Templeton called the situation "temporary insanity" and "a once-in-a-lifetime opportunity."

His strategy was elegant: he would short stocks just before their lockup periods expired. The lockup period is the window after an initial public offering during which company insiders are prohibited from selling their shares. When those periods ended, Templeton correctly anticipated that executives would dump their shares as fast as possible, driving prices down.

Get Big Fast, or Get Lost

The companies themselves operated on a philosophy that sounds insane in retrospect but made a kind of twisted sense at the time. The mantra was "get big fast" or "get large or get lost."

The idea was that internet businesses would benefit from network effects. A network effect is when a product or service becomes more valuable as more people use it. The telephone is a classic example: one telephone is useless, but a network of millions of telephones is incredibly valuable. Social networks, marketplaces, and communication platforms all exhibit network effects.

So the strategy was to spend lavishly to acquire customers as quickly as possible, even if that meant giving away products and services for free or at a steep loss. Once you had captured the market, the theory went, you could raise prices and become profitable.

This led to spectacular spending. Companies threw elaborate launch parties. They leased palatial office spaces. They sent employees on luxury vacations. They bought Super Bowl ads at two million dollars for thirty seconds of airtime. In 2000, seventeen dot-com companies advertised during the Super Bowl. The previous year, it had been only two.

The telecommunications industry caught the fever as well. After the American Telecommunications Act of 1996 loosened regulations, telecom companies invested more than $500 billion, mostly borrowed money, into building out infrastructure: fiber optic cables, network switches, wireless towers. The problem was that they built far more capacity than there was demand to fill it. When the bubble burst, they found themselves drowning in debt with no customers to pay it off.

The Year 2000 Problem and the AOL-Time Warner Disaster

As the new millennium approached, companies were spending heavily on technology for an unexpected reason: fear. The Year 2000 problem, often called Y2K, was a widespread concern that computer systems would malfunction when their internal clocks rolled over from 1999 to 2000. Many older programs stored years as two-digit numbers, and there were worries that computers would interpret "00" as 1900 rather than 2000, causing failures across critical systems.

Companies spent billions preparing for potential disasters that largely never materialized. When January 1, 2000 arrived and civilization didn't collapse, some of that fear-driven technology spending dried up.

But the mania wasn't over yet. On January 10, 2000, America Online announced a merger with Time Warner. AOL was an internet service provider, the company that millions of Americans used to connect to the internet. Time Warner was one of the largest media conglomerates in the world, owning cable networks, film studios, magazines, and more.

The merger valued AOL, which was primarily a technology platform, higher than Time Warner, which owned actual content and infrastructure. Many analysts questioned whether this made any sense. It didn't. The merger would later be called one of the worst corporate deals in history. But at the time, it seemed to confirm that the old economy was being consumed by the new.

The Unraveling

The end came with surprising speed.

On March 13, 2000, just three days after the NASDAQ peaked, news broke that Japan had entered a recession. This triggered a global sell-off that hit technology stocks especially hard. Investors began to reconsider.

On March 20, Barron's, a respected financial magazine, published a cover story titled "Burning Up: Warning—Internet companies are running out of cash—fast." The article predicted imminent bankruptcies across the sector. That same day, a company called MicroStrategy announced it needed to restate its revenues because of "aggressive accounting practices." Its stock, which had risen from $7 to $333 per share over the previous year, fell 62 percent in a single day.

The Federal Reserve raised interest rates. Higher interest rates make borrowing more expensive and reduce the amount of capital sloshing around looking for risky investments. Suddenly, money wasn't so easy to get.

Then came the Microsoft ruling. On April 3, Judge Thomas Penfield Jackson ruled that Microsoft had violated antitrust laws through monopolistic practices. Microsoft's stock fell 15 percent in a single day, dragging the NASDAQ down 350 points. The ruling had nothing to do with the viability of internet businesses, but it spooked investors who were already nervous.

On April 14, 2000, the NASDAQ fell 9 percent in a single day, capping a week in which it had lost 25 percent of its value. Investors were selling frantically, partly because Tax Day was approaching and they needed cash to pay taxes on the previous year's gains.

By June, dot-com companies were slashing their advertising budgets. The party was over.

The Parade of Failures

What followed was a massacre.

Pets.com had become a symbol of the dot-com boom. It sold pet supplies online and was famous for its sock puppet mascot, which had appeared in a Super Bowl ad. Amazon had invested in it. It went public in February 2000 and shut down in November of the same year, just nine months later. The sock puppet was auctioned off for a fraction of what the ad campaign had cost.

Webvan was an online grocery delivery service that had raised over a billion dollars. It built enormous automated warehouses across the country, preparing for demand that never materialized. It shut down in 2001, firing two thousand employees.

Boo.com, a fashion retailer, burned through $188 million in just eighteen months. WorldCom, a telecommunications giant, collapsed in a massive accounting fraud. NorthPoint Communications, Global Crossing, Adelphia—the list of failures seemed endless.

By the time the downturn bottomed out in October 2002, the NASDAQ had fallen 78 percent from its peak. All of the gains of the bubble years had been erased. More than $5 trillion in market value had disappeared.

The September 11, 2001 terrorist attacks accelerated the decline, shaking investor confidence that was already fragile. And then came the accounting scandals: Enron in October 2001, WorldCom in June 2002, Adelphia in July 2002. It emerged that some of the most celebrated companies of the boom had been built on fraud and deception.

The Survivors

Not everyone died. And the survivors offer a useful lesson.

Amazon lost a staggering amount of its market value during the crash. Cisco Systems, which made the networking equipment that powered the internet, lost 80 percent of its stock price. But both companies survived and eventually thrived. Amazon became one of the most valuable companies in the world. Cisco remains a technology giant.

What did the survivors have in common? Two things: a sound business plan and a well-defined niche in the marketplace. They weren't trying to be everything to everyone. They had figured out what they were actually good at and focused relentlessly on it.

eBay survived. Google not only survived but came to dominate online advertising. Traditional retailers who had dismissed the internet began building their own online presences, and some of them succeeded.

The Strange Aftermath

Here's the irony of the dot-com bubble: it actually helped create the internet we have today.

All that investment in telecommunications infrastructure, all that fiber optic cable laid across the country and under the oceans, didn't disappear when the companies that built it went bankrupt. It got bought out of bankruptcy at pennies on the dollar and put to use. The overcapacity that had seemed so foolish during the bust meant that connectivity became cheap. High-speed internet became affordable for ordinary consumers.

The lessons of the failed companies were absorbed by the survivors. Business models got smarter. Entrepreneurs became more careful with capital. The venture capital industry learned, at least for a while, to focus on companies that had plausible paths to profitability.

New business models emerged that genuinely made sense. Google's search engine and keyword-based advertising created a way to monetize attention that actually worked. The airline industry moved much of its booking online. Customer relationship management, advertising, and retail were all genuinely transformed.

A Pattern That Repeats

The dot-com bubble was not unique. It fits into a pattern that has repeated throughout the history of capitalism.

In the 1840s, there was a railway mania in Britain. Investors poured money into railway companies, many of which failed spectacularly. But the railways that survived transformed transportation and commerce.

In the early 1900s, there was an automobile bubble. Hundreds of car companies were founded. Most of them disappeared. But the ones that survived created an entirely new industry.

Radio in the 1920s. Television in the 1940s. Transistor electronics in the 1950s. Each new technology triggered a wave of speculation, a bubble, a crash, and then eventually genuine transformation as the survivors figured out how to make the technology work.

The pattern suggests something profound: financial bubbles may actually be the way that capitalism funds genuinely revolutionary technologies. The speculation attracts capital that wouldn't otherwise flow to risky ventures. Most of that capital is lost, but some of it builds infrastructure and companies that change the world.

This is cold comfort if you lost your life savings betting on Pets.com. But it helps explain why bubbles keep happening. They're not just madness. They're a strange, wasteful, cruel, but perhaps necessary mechanism for funding the future.

The Lessons That Weren't Learned

You might think that such a spectacular crash would teach investors to be more careful. And for a while, it did. But not for long.

Less than a decade later, the financial system would experience an even larger crisis, this time centered on mortgage-backed securities and housing prices rather than internet stocks. The mechanisms were different, but the underlying dynamics were familiar: excessive optimism, easy credit, the belief that this time was different, the conviction that prices would keep rising forever.

Perhaps the deepest lesson of the dot-com bubble is that we never really learn. Each generation of investors must discover for themselves that speculation can be dangerous, that prices can go down as well as up, that revolutionary technologies don't automatically make good investments.

The entrepreneurs and investors of the dot-com era really were witnessing a revolution. They were right about the internet's importance. They were right that it would transform commerce, communication, and culture. They were just catastrophically wrong about the timing, the valuations, and which companies would survive to reap the rewards.

In the end, the dot-com bubble was a story about the gap between vision and execution, between potential and reality, between the future we can imagine and the future that actually arrives. That gap is where fortunes are lost. But sometimes, if you're lucky and careful, it's also where fortunes are made.