Dot ComBustion

Dean Baker
San Diego Union-Tribune, October 12, 2000
Houston Chronicle, October 18, 2000
Baltimore Sun
, October 24, 2000
Buffalo News
, October 22, 2000
York Daily Record
, October 19, 2000

As we approach the 13th anniversary of the 1987 stock market crash, and many of the high rolling stocks of recent years go plunging into the basement, it's time to ask a few questions. First, what does it mean when companies that never turned a profit, like or, have market values several times larger than well established profitable retailers like Sears or K-Mart?

In principle, the stock market is allocating capital among firms. When prices get way out of line, as seems to have been the case, capital is being misdirected. This means that money which could have been profitably invested elsewhere, was instead squandered on the ill-conceived ideas of the dot com crew. In other words, tens, or even hundreds, of billions of dollars, which could have been productively invested, was instead diverted to failed ventures and the luxury living of their originators.

Should this bother us? If anyone is concerned about the impact of budget deficits on the economy, then they should be equally concerned about the pile up of failed dot coms. The misdirection of capital in the private sector imposes every bit as high a cost as when the government squanders money that could have been used more productively elsewhere. It is striking that this case of massive private sector waste has received so little attention from people who worry endlessly about budget deficits, or even the possibility of future budget deficits.

The second question worth asking concerns the well-being of the people who made bad investments in these companies. On the one hand, it's hard to have too much sympathy for them. After all, most of them anticipated making a fortune and few had plans to share their good luck with the rest of us. Also, a bit of common sense should have raised warning flags about the risks associated with these ventures.

But, the collapse of these stocks should provide some caution about the security of our markets more generally. After all, how many people bought into these stocks after having been assured by "experts" about their growth potential? The fact is, Wall Street has many brokers and stock analysts whose advice is not worth the price of a phone call. These people have misled not only the get-rich-quick crew, but millions of hard working people who are depending on the stock market to pay for their kids' education or their own retirement. Many of these people have almost no knowledge of the risks involved -- that the stock market does not only go up -- but that it can go down as well.

This point is important, because it is not just the dot coms which have taken a downward turn. Even many well established companies, like AT&T and Microsoft, are selling at close to 50 percent off their recent highs. By standard valuation methods, the stock market is still close to twice its proper value. This means that millions of middle income families may find their dreams shattered by a dropping market.

It's not clear that anything can or should be done to save these people's investments. But there are a few points worth making. As the stock market was reaching levels that most economists recognized as unsustainable, it would have been helpful if leading government financial figures, like Federal Reserve Board President Alan Greenspan, Treasury Secretaries Rubin and Summers, and even President Clinton, issued clear and unambiguous warnings to the public. Instead, they seemed to celebrate the growth of the bubble, hoping that it wouldn't deflate on their watch.

Second, after years of attacks on the viability and desirability of Social Security and arguments for investing worker’s money in private accounts, a stock market correction will demonstrate how important this program really is to the nation's workers. Millions of families that suffer big losses in the stock will be thankful that their Social Security benefits are still available to support their retirement. A serious stock reversal will likely kill off plans to privatize the system once and for all.

Finally, a stock market reversal may reorient the thinking of much of the nation. Finding the next Microsoft had become an all consuming past-time for millions of people as they spent their leisure hours reading the business pages, watching financial news, and subscribing to special stock picking services. In many cases, the fixation on the stock market was a manifestation of problem gambling. Perhaps a stock market plunge will be the shock therapy that cures this illness, and prompts people to focus on more important things in life.

Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.