The financial markets have spent the last two years uncharacteristically civil, dismissing massive government deficits and loose monetary policy as innocuous byproducts of the economic recovery. Our timeless dance with capital, however, is occasionally contaminated with greed and mismanagement, causing pronounced speculations that increase prices beyond any reasonable measure of value, thereby causing a bubble.
When technology companies had a bright idea in the 1990’s, they were forced to raise large sums of money to bring it to market. In exchange for their investment, venture capitalists demanded shares of stock in the new company, anticipating large profits when the firm went public and traded on a national exchange. Of course, they were not permitted to sell these shares in the first four or five years, and that fueled the unwarranted appreciation of prices.
Richard Bookstaber points out in “A Demon of Our Own Design”that only 10 percent of the company’s shares were eligible to trade, while the other 90 percent had to wait four or five years from the time the internet companies went public before they could be sold. With few shares available, a small demand resulted in large gains. Unfortunately, $50 billion worth of shares became eligible in December of 1999, $65 billion came due in January 2000 and $100 billion was unlocked over the next three months. It goes without saying that the venture capitalists wanted to immediately realize their returns, flooded the market with shares and the dot com crash was in full swing. The collapse of the internet bubble had less to do with economics than it did the exit strategy of investors.