
Ask HN: In plain English what caused the dot com bubble to crash? - ud0
I&#x27;m no finance person but I have an idea what stocks &amp; shares are.
======
piker
Everyone correctly predicted the "New Economy" would change business forever,
about 10 years early. Venture capitalists frantically rushed to fund ".com"
ideas with billions of collective dollars. To get their money back, the VCs
hired investment banks to sell their shares to the public. Those same
investment banks had for many years made "buy/sell/hold" recommendations
reliably on established companies. Thus, when those investment banks
inevitably gave the same .com's they were selling "buy" ratings, the public
trusted those ratings. The public was also overcome with daily reports of the
hyperbolic growth in the value of these public stocks. These reports fueled
the interest in such stocks which caused investors to drive the prices for the
stocks higher in a vicious cycle. However, despite such growth in the price of
the stocks, and the "buy" recommendations of the investment banks, many of the
stocks had business models that could not even theoretically operate at a
profit. No matter how many widgets they sold, they lost more money. Another
group of these businesses were aimed at providing services TO the "New
Economy", ".com" companies.

Eventually, the money from these funding rounds dried up. One-by-one the
flawed business models were revealed, and companies began to go bankrupt. As
businesses with even viable models relied heavily on the "New Economy" .com's
as a customer base, they, too were driven to bankruptcy. Some period after the
stocks were sold to the public, investment banks were also allowed to change
their ratings, and often did, to "sell". News reports of the ".com" crash
began, and sent the public running for the exits. All of these factors
combined for another vicious cycle in the value of ".com" stocks in the
opposite direction.

------
headcanon
ELI5 style; basically there were a number of hype-driven valuations that were
way too high, and when the resulting IPO happened, a lot of people lost a lot
of money. When this happened enough times, investors got scared of technology
and swung the other way.

Pets.com [1] is a great example of this. They spent 11.3 million on marketing
despite having a half-million in sales for their first year. Then they IPO'ed
way too early, and their initial stock at $11 dollars fell to 50 cents six
months later.

We collectively didn't really understand how a lot of internet business models
were supposed to work, and that caused a lot of non-viable businesses to float
on hype. When the hype went away, all these businesses got culled, and only a
few survived (like Amazon). Some of them were just too early for their time,
and modern iterations of the same business models were able to take advantage
of key differences like the prevalence of mobile devices.

In a sense, its a natural human response to new paradigms and technologies.
Internet business valuations from mid-1990's to today follows almost perfectly
the hype curve [2] model.

[1]:
[https://en.wikipedia.org/wiki/Pets.com](https://en.wikipedia.org/wiki/Pets.com)

[2]:
[https://en.wikipedia.org/wiki/Hype_cycle](https://en.wikipedia.org/wiki/Hype_cycle)

------
PaulHoule
Not to argue with the other interpretations, but fraud was a factor too.
Enron, MCI WorldCom and Lucent all perpetrated accounting fraud and put a lot
of stress on competitors.

In a lot of ways all bubbles are alike, you could hear echos of the 1920s in
the 1960s and of the 1960s in the 1990s. "The money game" and it's sequel
"supermoney" tells a great story of the 1960s bubble that is better than
anything I've seen about the 1990s.

~~~
pixl97
Was in IT for a trading firm at the beginning of 2000 and I remember a stock
analyst talking about how great the new Intel Pentium 4 was going to be, and
how Intel was going to sell piles of them and make lots of money, and that's
why you should buy Intel stock.

My jaw dropped. Our business had some test machines, and they absolutely
sucked for our workloads. Even more so we had a hard time getting the
machines, and reports were they were having trouble producing enough for
testing. Additionally rumors were that RDRAM was having all kinds of issues
too. I remember talking to a trader right after that and went "That guy
talking about the Pentium 4s is either lying or completely ignorant of the
current situation". From what I remember, with in a few days Intel stock had
dropped at least 25% after they stated they weren't going to meet production
and release dates.

------
omarforgotpwd
People paid a very high price to buy companies that weren't really worth that
much. When it became clear the companies weren't worth as much as previously
thought, everyone lost thier money.

A share just means buying a small part of a company. For example I can buy
some small fraction of Apple for around $140 today. Owning a piece of the
company entitles me to vote on certain things like who leads the company, and
also to get a share of their profits. The share price is basically set by
adding up all the future earnings of a company and applying some discount. The
fact that you can't really know what future earnings is what makes buying a
stock inherently risky.

~~~
taejo
> The share price is basically set by adding up all the future earnings of a
> company and applying some discount.

The share price _should_ be approximately the average different peoples'
_estimates_ of the future earnings. There's no one organization setting share
prices (you know this, but at the level of explanation you're giving, you
should make this clear).

During a bubble, people sometimes by shares (or houses, or tulips, or any
other goods) _knowing_ they aren't worth the price, but expecting that some
"greater fool" will buy them at a higher price because "everybody knows" the
price is going up and up. Then the music stops, the market runs out of greater
fools, everyone realizes they're stuck holding shares that are worth much less
than they paid.

------
sixQuarks
Many of these comments make it seem like people back then didn't realize it
was a bubble. I beg to differ.

I sold my first startup to a publicly traded company in 1999, in an all-stock
deal. I remember thinking back then that we were definitely in a bubble, and
there was no way it was going to last. The big question was how long it could
keep going.

I sold the startup for 10x what I thought it was worth, knowing that the
market would probably crash before my stock became free-trading (there was a 1
year hold).

Lo and behold, the market crashed about 3 weeks before my stock became freely
trading, I lost 75% of my net worth. It was pretty devastating, but I still
made out with more than I expected.

So, the whole point of this story was to tell you that - at least for me and a
lot of people I knew, we all knew it was all a big bubble. The question was
how long the irrationality could keep going.

------
manyhats
The "crash" wasn't a day-long, week-long, or even month-long stock pricing
event, but lasted 6+ months from the first tech sector to the last going
through the crash.

The first stocks to get hit were the web 1.0 properties in Q1'00 (use Amazon
(ticker: AMZN) or Yahoo (YHOO) as a proxy as there aren't many left standing
that are easy to find historical prices for) and amongst the last were the
comm equipment companies which didn't peak until 6-9 months later (e.g., Cisco
(CSCO) or Ciena(CIEN)).

All of this is completely separate from whether any of these companies had
viable business models. Some did, like the telecoms, their suppliers,
semiconductors, enterprise software. Some did not, like pets.com.

A very small number of dot-coms survived, and ultimately thrived after the
crash (AMZN). Though you would have had to have enormous foresight to properly
select your investments during the boom to not lose a ton of money if you
bought in this frothy period.

All of the company fundamentals were well known at the time. It's not like the
enormous cash burns of certain types of businesses was hidden from view. It
was a badge of honor at the time (also true today in a few places). Some of
that cash made it into other businesses that had been around for almost 100
years, like HP or Lucent, but juiced them, and they suffered withdrawal
symptoms when their customers stopped spending (or even paying their bills).

To a fundamental investor, the perplexing thing about the whole era was
looking at one of many not particularly unique companies that was trading at
25x annual sales, growing 50% a year, and losing money (which is a ludicrous
valuation for a public company). Yet you'd find it at 40x three months later.

To get back to your question, having been close to the situation, I can't
point to a specific event that started the cascade, but once it started, there
was no stopping it. To a fundamental investor in early 2000, the outcome was
perceived as being inevitable, but impossible to predict when it would happen.
If you'd asked them at the time, they would have told you that the tech market
had detached from fundamental behavior back in 1997/98 earlier with no signs
of slowing down.

As an aside, if you were willing to look outside tech, it was an amazing
buying opportunity in pretty much every other sector of the stock market.
Industrials, energy, commodities, real estate, and so on were trading at
discount prices even in the midst of this enormous bull market in tech/telecom
and related stocks. Unfortunately that is not the case today and it's hard to
find any sector that could be considered cheap.

------
Svexark
In 1997, congress lowered the tax on capital gains making non-dividend-paying
stocks cheaper than dividend-paying stocks. It made it very attractive to
invest in companies that didn't pay dividends like tech company IPOs which
were popular at the time because of the growth of computers and the internet.
There was a boom of personal investing as average people were quitting their
jobs to become day traders. Stocks were rising uncorrelated with business
fundamentals but because of the speculation of them increasing even more in
the future.

The "crash" happened when some large companies became too nervous with the
overvaluation and put in large sell orders for their own stock. This caused
everyone else to panic worried that the stocks they owned were worthless and
that they would lose everything if they continued to hold onto them.

The bubble "burst" in 2003 when congress changed the tax laws so that capital
gains was taxed at the same rate again.

------
Spooky23
As I often do, I'll be a bit of a contrarian and take a different angle.

People believed the dot com bullshit because amazing technology gains were
being made by technology. In 1990 you still had typing pools and paper and
manual processes.

The mid 90s were when everything got computerized. People were making millions
rolling out PCs and email. Lotus Notes was transforming business.

People saw the internet as the next big thing, which it was. But the
technology wasn't there yet and the ability to conduct meaningful commerce was
undermined by encryption policy.

------
moomin
There are already much more detailed answers than this one is going to be but:
all bubbles pop. The very nature of the bubble is people are walking around
with assets that are misvalued. The greatest trick in finance though, isn't
spotting overvaluation: it's figuring out when reality is going to kick in.
Every time a price defies gravity (housing, tech stocks, the UK economy),
there's plenty of people who see the crash coming. But timing is everything.

------
BjoernKW
In a nutshell: Unrealistic, contrived business models at way too high company
valuations.

------
Nomentatus
Lies, which couldn't be sustained forever, as in most bubbles. The most common
kind of lie in this era was advertising sales fraud, in which ad sales (and
rates) were wildly inflated by what were really swaps of rights to run ads
that had a net null effect on the companies but were trumpeted as massive
revenues, and massive ongoing increases in revenue, although in fact no money
was changing hands, at all.

------
bsvalley
In 1996 The FED was calling the Internet an "irrational exuberance" because
the global economy wasn't doing well. Then, 3 major events led to the crash.
This is why the bubble burst:

\- 1997 Asian crisis

\- 1998 Russian crisis

\- 1999 Launch of the Euro (flop)

April 14, 2000 was the End of a 3 week crash. The global market trend
officially switched, the rest is history.

~~~
DrScump

      1999 Launch of the Euro (flop)
    

a flop at first, then within just a few years, it _doubled_ with respect to
the dollar (from ~80 cents to ~$1.60).

Now it's back to something like 1.07 to $1.

~~~
bsvalley
I said the "launch" was a flop. Not the euro itself. It launched at $1.19 and
sank to $0.83 within two years. The launch was a flop and got investors
worried.

------
solresol
The right person to read to learn about this is Andrew Odlyzko at UMN:
[http://www.dtc.umn.edu/~odlyzko](http://www.dtc.umn.edu/~odlyzko) . He draws
some amazing comparisons between the dot-com bubble and the railway mania of
the 1850s.

The dot com boom was based heavily upon a myth: that the internet was doubling
every 100 days. Various executives at WorldCom / UUnet kept repeating this for
years, even though it was only true for a few months in 1996. Since WorldCom /
UUnet was the biggest ISP at the time, the business world (and especially
investors) believed this.

At the same time Lucent was doing some creative accounting where they would
sell equipment super-cheap on long-term repayment plans with a buy-back offer.
They showed inflated sales and no liabilities: this too made it look like
their networking business was growing at an astounding rate, which supported
the WorldCom claim.

Now, if it had been true (that the internet was doubling every 100 days
continuously for 4 years), then it would have made perfect sense to invest in
bizarre dot com stocks: there was so much potential upside that there was no
way you could possibly be paying too much for any stock. A company that has an
exponential growth with no end in sight is a very good buy, regardless of how
silly it might look now.

So that's precisely what investors did.

Unfortunately, the myth wasn't true, and it was becoming obvious by 2000. At
this point there was no reason to continue investing in business solely
because they had a strong internet presence. If internet growth was "only"
100% per 18 months (which was probably closer to the truth) then even
established bricks-and-mortar companies would be able to move fast enough to
capture significant internet sales. This is indeed what has happened since.

Without fresh cash injections, the crazier dot coms died, taking with them
large numbers of companies that supported them with hardware, development and
(especially) network infrastructure.

------
TurboHaskal
People bought Aeron chairs until they ran out of money.

------
muddylemon
At the time, no one knew what a dotcom was or how much it was worth. Many
people guessed way too high because they were told that things were different
now and at any moment these companies would begin vomiting money in a way
never seen in history. This was untrue.

------
programmarchy
People were tricked into paying high prices for stocks with low earnings.

------
gregw2
The crash was inevitable due to an unsustainable boom in stock prices.

But the _TIMING_ of the crash is the most interesting thing about the 2000 dot
com crash, and I very rarely see it attributed as described in the following
analysis.

TL;DR: People think the Y2K event was a bust, a non-event, but actually it
caused the Dot-com crash! (At least it caused it to occur when it did, in
March/April 2000...) (Hear me out.)

And in theory, it should have all been forseeable. But nobody at least that
I've heard of saw it coming.

First remember that in any gold rush (e.g. dot-com online riches) where it's
hard to pick who the winners will be, an easy bet is the companies selling the
shovels/infrastructure (in the dot-com case, servers, etc). You don't have to
be smart enough to know where the gold is to get rich off the infrastructure
"boom" and that was a common play for many investors of that era.

The late 90s was a huge time for UNIX companies who were not yet cannibalized
by Linux and had larger server businesses. HP, IBM, DEC and most notably Sun
Microsystems (whose development of Java added some marketing sizzle to their
already leading UNIX server marketshare). And there were software players like
Oracle also. Webservers and even more large database servers backing those
webservers were a multi-billion dollar business. And the sizzle of that sexy
internet business was used to sell more boring conventional backend database
servers to companies who were increasingly getting on the UNIX/TCP-IP
bandwagon in the 90s. The server companies made an attractive stock offering
for brokers trying to pitch high-growth but still somewhat safe stocks to an
unsuspecting clientele just looking to get in on the action. (The owner of the
pizza shop near me was always quizzing me about tech stocks recommended by his
broker. So the hype had gotten pretty high even on "Main Street". He suffered
significant losses btw.)

However, in the first 2-3 months of 2000 all the hardware sales for all the
big server players started to drop off a cliff, relatively speaking. (You'll
see the dot-com crash often dated to occurring in late March, early April).
With such a noticeable off-trend sales drop, the high PE multiples of Internet
poster-children like Sun Microsystems, justified only by continued massive
growth were suddenly not sustainable and contagion among these internet high-
flyers suddenly came into sharp relief and question, spawning a panic/stampede
("who will be next"? "get out while you can!", etc).

Now why did the hardware sales start crashing? It turns out it wasn't the Dot-
com Internet companies slowing their orders (at least not until their stocks
started crashing too)... it was all the companies who had built up a huge
secondary infrastructure of hardware+software for Y2K testing. To verify that
production equipment would properly function when clocks rolled over from
12-31-99 to 1-1-00, many companies just bought small (or even fullsized
production-grade) servers to duplicate their production gear and tested it
would function properly by rolling the clocks forward in advance of the date
and ensuring the software handled the transition.

With Jan 1st 2000 in the rearview mirror, many medium and large companies
slowed their hardware server purchases for a year or so while they re-purposed
their Y2K test servers for normal business use.

For Internet dot-com companies (even though they were a hardware play) like
the flagship internet server company Sun Microsystems, this resulted in a
significant drop in sales, and the awareness of this started hitting the
market as those companies started to issue guidance about 1Q00 earnings.

As I said, once Sun and others started dropping, the Internet play itself was
considered vulnerable and everything came back to earth.

------
id122015
Its nothing unique to dot com. Its just a buble. Same with gold price ups and
downs.

