The Bursting of the Tech Bubble, Part 2

The Coming Economic Collapse: How You can Thrive When Oil Costs $200 a Barrel
by Stephen Leeb, PhD., Glen Strathy

(Page 2 of 4)

I am certain you can guess the result. In a period of about nine to twelve months, this man lost roughly 70 percent of his retirement savings.

It is nearly impossible for an investor to recover from a loss like this. A 70 percent loss on, for instance, a $100,000 portfolio leaves its owner with only $30,000. Even if the owner manages to double his money before retirement, that still leaves him with $40,000 less than he had at the peak.

And this man's case was far from unusual. I knew many bright, well-educated people during that period who were convinced that "this time it is different" - that the tech bubble was not a false mania, like the South Sea Bubble or the late 1920s. It was the real thing. A new paradigm had taken hold. A new world was dawning in which a company's present earnings, assets, and debt levels did not matter. As long as a company had innovative technology, or could sell products from a Web site, its stock was sure to make investors rich. Hordes of people believed they could not go wrong buying tech stocks, and feared nothing except missing the opportunity. Many risked more money than they had by buying stocks on margin or with other forms of borrowed cash.

What the majority of investors had forgotten, or perhaps never stopped to think about, was that the victims of past speculative manias had been just as certain of becoming rich.

But that is the nature of speculative manias: people en masse forsake reason and objective thinking and succumb to a primordial instinct to run with the herd. Hundreds of years ago, when a herd of buffalo was stampeded toward a cliff by Native American hunters, no buffalo poked his head above the crowd to look where they were going. Each creature simply accepted his neighbors' belief that there was an urgent need to run. From then on, they were driven by pure adrenaline, each buffalo's panic and excitement reinforcing his neighbors'. So it was with investors in the tech bubble. Greed, and a fear of being left behind, triggered the same instinctive state of excitement and panic that kept everyone's eyes glued to the financial media, their fingers hovering over the trigger buttons of their stock trading programs.

When the bubble burst, the result was financial suffering and loss on a scale bigger than anything since the Great Depression. The NASDAQ fell from 5,000 points to just over 1,000. Many of the technology and Internet companies to which average people had hitched their future went bankrupt, or were forced to downsize. We were left with a massively overbuilt tech industry and a much poorer consumer. Trillions of dollars of wealth were lost that could have financed the retirement plans, the college funds, and the other hopes and dreams of millions of investors.

Even worse, the popping of the technology bubble put the U.S. economy in an extremely perilous situation. The very fabric of our civilization came close to disintegrating.

What saved us from disaster was the rapid response from our leaders. The Federal Reserve stabilized our economy by quickly lowering interest rates to nearly zero, and in real terms to less than zero. The federal government cut taxes aggressively. Manufacturers offered zero percent financing on cars - actually less than zero, when you subtract inflation. Consumers were virtually spoon-fed money.

Low interest rates also provided a free lunch for those who refinanced their mortgages. In effect, the surge in home refinancing and the perception that home values would rise faster than mortgage rates gave the consumer a double boost. More money became available to spend, and the value of homes increased.

Without that quick response, the results could have been catastrophic. Consumers would have had far less money to spend. With the resulting decline in consumer spending, it would be hard to exaggerate how severe the recession might have become.

Remarkably, in the wake of September 11, 2001, Americans still kept their faith in the future. Yet that faith could have been shaken to the core if the number of jobs started to dry up, if home values began to fall, and if consumers suddenly found themselves without the means to pay off their huge debt loads.

Clearly, there would have been a drastic change in the consumer psyche. Fear would have replaced faith. Income levels could have fallen so far that future tax cuts would have had little positive effect (there would have been much less income on which to cut taxes). The same would have been true for cuts in interest rates. If the Fed had waited until after home prices had started falling to lower interest rates, the huge financial windfall that came from home refinancing would never have occurred.

Economic weakness would have led to increased consumer fears, which in turn would have led to greater weakness. The banks, which hold the debt of our highly leveraged society, could have been severely stressed. New lending would have been curtailed, and no doubt all but the strongest banks would have been tottering. It would have been a vicious circle of consumer fears, less spending, weakening banks, falling home and asset prices, ever greater consumer fears, further declines in spending, threats to even the strongest banks, and crashing home and stock values. Once this vicious circle took hold it would have been extremely difficult, if not impossible, to save the economy.

Fortunately, our leaders did the right thing. The unprecedented amount of liquidity rescued our economy, and society as a whole. The collapse of many tech companies led to less capacity. Stocks began to rally. Eventually, the all-too-real threat of a vicious circle became something of a virtuous circle.

All in all, we were very lucky to survive the tech bubble. We were lucky to handle the aftermath in a short space of time. We were lucky we had the ability to flood the economy with liquidity so quickly. The crisis we face today in oil cannot be solved as easily. We may not be so fortunate this time.

Copyright © 2006 by Stephen Leeb

About the Author

Stephen Leeb is the president of Leeb Capital Management and editor of the prestigious newsletter The Complete Investor. Renowned for finishing among the leaders in the Wall Street Journal's and Forbes's annual stock-picking contests, Leeb is the author of four previous books. His wife and longtime collaborator, Donna Leeb, has a diversified background in business writing and holds a master's degree in journalism from Columbia University.