The dotcom bubble and the stock market fall in 2000-2001

Summary of the main points covered in my essay. How did the dotcom undulate paroxysm contribute to the economic crisis of the 2008? Could we expect the similar crisis and how fuck it be pr flushted? What are the lessons that should have been learned from the dotcom crisis?When the global fiscal crisis gored in 2008, both experts and general existence started heated discussion as allone was eager to identify the reasons for such a calamity. It is clear that nothing happens with no reason at all. Lets consider the famous speech1 of Ben Bernanke, who is the death chair of the Federal Reserve System.In that testimony he tried to explain the causes of the recent financial and economic crisis to the Financial Crisis Inquiry Commission, highlighting the vulnerabilities in incompatible sectors of economics. The idea of inadequate risk-measurement that he focused on is very important for us, as this incident issue makes the recent crisis akin to the dotcom sing we are astir(predica te) to examine in detail. (The same idea is one of the major issues of the next Ben Bernankes speeches, where he underlines the importance of reasonable risk management and possible destructive set up of being too optimistic ab come on the future of the economic system).To sum up, experts claim that flaws in evaluating the perspectives of new technologies in the 90ies caused the dotcom bubble burst in 2000, maculation the inadequate risk-measurement of the financial instruments connected to mortgages led to the global financial and economic crisis in 2008. Could we have predicted the economic disaster coming in 2008 and which lessons could have been self-possessed from the dotcom crisis? These are the questions that make the topic urgent and exciting to examine. To begin with, lets define the key term. What is a dotcom?Dotcom is a firm conducting its business mainly over the meshing. They normally possess a weathervane site intended for business use. The term is based on the c om that forms the last part of the carryress for most commercial Web-sites. Now, what were the reasons for the dotcom bubble burst and what actually happened? (We should mention that this phenomenon is also referred as the Internet bubble and the Information Technology Bubble in many articles). It all started during the mid 1990is. The Internet was extremely popular those days and the Stock Market soared on technology and Internet stocks.Stock values were rising and it seemed thither was to limit for their cling to to expand. The masses believed there was a new world coming and the Internet was for sure to create the future of business. The steady confidence took place that the e-companies would turn future profits and there is no limit for technologies development. These expectations were reflected in the NASDAQ tangled magnate. The NASDAQ composite is a stock merchandise index of the common stocks and similar securities, which are listed on the NASDAQ stock commercialize. The index reflects the performance of stocks of technology companies and growth companies.From January 1994 to February 2000, the it come up from 776. 80 to 4,696. 69, a 605% increase, and was influenced mainly by bells of high-technology stocks. But these expectations turned unwrap to be far too positive. The market became overvalued. The Stock Market crashed. The culmination happened on March 10, 2000, with the NASDAQ peaking at 5132. 52 in intraday trading before closing at 5048. 62. (see the graph 1) Graph 1. NASDAQ composite dynamics2 The period when the bubble expanded rapidly was marked by the founding of many new small Internet-based companies commonly referred to as dotcoms.Many of them failed in 2000. A very specific phenomenon could be noticed at that time the way for a new unknown company to become prosperous was just to play an e- prefix to their name or a . com to the end. One of the authors called it prefix investing3, as the result of this simple renaming was t he incredible growth of stock prices. I hypothesise that was one of the first indicators that something was wrong and the calamity was coming. But everyone considered it the steady development of the market that has big future.Alan Greenspan (an Ameri kitty economist, the Chairman of the Fed in 1987-2006) in 2005 said, that this abundant increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent4. However, the situation isnt unique and appeared to happen again. When in 2003 nanotechnology became the hot thing, everyone started to add a nano prefix in their name. It seems that the lessons that should have been learned from the dotcom bubble burst were forgotten.Lets turn to the term itself in its theoretical esthesis. What is the bubble in financial markets? In a word, we say that a stock market bubble occurs w hen there is a rise or boom in the share prices of stocks of a particular industry. Meanwhile, the rise in prices usually bears little relation to the intrinsic value of the asset. The term bubble may be used with certainty only in retrospect when share prices have since crashed, as it happened in our subject field. An important basic characteristic of a bubble is the suspension of disbelief by most market participants during the bubble phase.They fail to recognize that all of them are engaged in a speculative activity. That characteristic describes the dotcom crisis as well, as we already found out. It would be interesting to mention that financial bubbles have existed for centuries and one of the earliest crises of the type in known as the Dutch tulip mania. In the 17th century prices for tulip bulbs rose and finally reached extraordinarily high levels and then collapsed in the blink of an eye. The same happened to the stock of e-companies in the late 90ies. I suppose we can refe r to this discipline as to the dotcom mania.The speculators who represent all the people in the economy that what to get high profits very fast, note the fast increase in value and decide to buy stock in anticipation of further rises, not taking into account that the shares are overvalued. Consequently the rise happens responding to the high inquire for stock and many companies thus become grossly overvalued. When the bubble bursts, the share prices fall dramatically, and many companies are forced to leave the business. In order to be much precise, we can name five coifs of any financial bubble5 First. Displacement.When people, especially investors, get enamored by a new paradigm, such as an innovational new technology or dotcom companies, as in our case, displacement occurs. That is the first stage of a financial bubble. Second. Boom. At this stage prices rise slowly at first, following a displacement, but then they gain momentum. More and more participants enter the market. A ll of them are determined to get prosperous as before long as possible. In case of dotcoms, a huge amount of small companies appeared on the market. The low interest rates in 1998-99 helped to increase the start-up capital amounts.not all of them possessed innovative ideas, but they were sure that in the wave of e-companies they must succeed. No wonder they all had the same business plan of monopolizing their single sectors through internet effects. However it was clear that all of them wouldnt become successful as the competition was tough. For many of them the get big fast plan would fail. During this phase, investors become even more enamored by the asset, considering it once-in-a-lifetime opportunity that increases speculation even more. Mass media also played its role.American respected business publications such as Forbes and the Wall Street Journal, encouraged the public to invest in risky companies in the wave of the wide-spread euphoria. As the result, many ordinary peop le became investors, some of them even gave up their job to become fill-time traders. Third. Euphoria. During this phase investors as well as the whole financial system forgets about prudence and asset prices skyrocket. During the dotcom bubble, the euphoria stage took place in the beginning of March 2000, when NASDAQ composite reached its top at 5132. 2 in intraday trading before closing at 5048. 62. This and the previous stages can be clearly revealed from the NASDAQ dynamics (see graph 1). Fourth. Profit taking. By this time the warning signs of coming debacle can be seen.This is the point when smart investors can make fortunes by selling out positions and taking profits. However, it is obvious that its very difficult to estimate the exact time when a bubble is due to collapse. throne Maynard Keynes once mentioned that the markets can stay irrational longer than you can stay solvent. As for the dotcoms founders, few of them made vast fortunes when their companies were bought out before the collapse. Fifth. Panic. In the threat stage, asset prices change direction and descend as rapidly as they had ascended. Investors and speculators are faced with margin calls, which are demands on an investor using margin to lodge additional money or securities so that the margin account is brought up to the minimum maintenance margin6, and the value of their holding plunge. Consequently, they deprivation to liquidate them at any price.The supply overwhelms demand, and asset prices slide sharply. In 2000 the market index fell by almost 11% and NASDAQ fell by about 41%7. To explain the bubble applying the tools of mathematics, well apply the most common concept that shows the existence of bubbles8. Considering the most simple case of price of a single share, the mathematical description of an asset price bubble uses the fair price of a financial asset as its starting point.The price of an asset is the present value of the future cash flows, generated by the asset. pt =E t(dt+1+pt+1)/(1+r), here dt is dividend, pt is the price of the asset at a certain time t, and Et(i) is the expected value of the expression in the brackets based on the information available at t time. If the interest rate (r) is held constant during the whole period, then share price at t time (pt) in a general form can be given as follows The first part of the sum on the right, which is the discounted present value of dividends, is the fundamental value of the share (pt * ). The remainder (bt) is a deterministic or the stochastic component satisfying the condition bt = Et(bt+1) /(1 + r), which is the asset price bubble itself.So, if the price of an asset is formed as following pt =p t*+bt, and if p =? p*, then in the mathematical sense an asset price the bubble is formed. To continue our analysis, lets describe the consequences of the dotcom bubble burst in 2000. Many small companies and some of the largest ones were forced to file for bankruptcy. Some of them ran out of capital, some of them were acquired, some were convicted of fraud in their financial statements. WorldCom, which was one of the leaders in the market was found practicing fraudulent accounting practices to exaggerate its profits every year.As it was revealed, its stock price fell dramatically, and finally the company filed for bankruptcy. Other examples include NorthPoint Communications, Global Crossing, JDS Uniphase and many others. However, some of the e-companies managed to survive the calamity. Large companies, for example, Amazon. com and eBay, are preferably successful nowadays. Google also survived the turmoil and became one of the market leaders. As many economists predicted, harsh recession began from 2001.The crash on the stock market of 2000-2002 caused the loss of $5 trillion in the market value of companies from March 2000 to October 2002 the market value of NASDAQ companies peaked at $6. 7 trillion in March 2000 and bottomed out at $1. 6 trillion in October 20029. The economi c bottom was the followed by 9/11 terrorist attacks of the World Trade Centers Twin Towers. CONCLUSION After the case of dotcom crisis the word dotcom started to be used with unfavourable inflecton. It is frequently used to refer to a poorly thought-out unsuccessful businesses.Experts claim that dotcom crisis was one of the events that preceded the global financial crisis in 2008. It was kind of a rehearsal, as the global crisis also contained a speculative bubble, though it embraced a much wider variety of securities. Luckily, the recession following the bubble burst of 2000-2001 was not as deep as it could have been thanks to very aggressive interest rates lowering. However, a deeper downturn in the financial activity is much harder to overcome. The Internet bubble is also similar to the recent downturn because they were both preceded by inadequate risk-measurement and agents overconfidence.The financial and economic crisis of 2008 could have been predicted, if everyone was more p rudent and learned a lesson from the 2000 dotcom case. In conclusion, Id like to address the issue of a new Internet crisis that is predicted by some economists. Nowadays World Web companies place their stock at unbelievably high prices. Can a successful Internet project cost more than a huge multinational oil company? The common sense says definitely no, but investors have their own specific point of view.For example, the shares of Groupon, a famous discount service, we evaluated at $12,7 trillions, contempt the companys loss of $400 trillions the previous year and gross debt equal to $420 millions. This estimation is not reasonable and very far from reality. Meanwhile, the expected IPO of social network Facebook is evaluated at $100 trillions. It can be the beginning of the Dotcom Crisis 2. 0. On the other hand investors are optimistic about e-companies, as they survived the recent global crisis, impertinent huge interconnected firms in other fields, such as financial, machiner y and so on.However, if the case of Groupon is not unique (which is so, judging by the investors optimistic mood) the crisis can occur once again. The most important thing in preventing the possible debacle is being prudent. Investors shouldnt be too optimistic and should be sensible when acquiring assets. PR and advertising can be astonishing, however being reasonable means evaluating the real business indicators to make rational decisions. Risk-management is the field that shouldnt be ignored if we want to avoid new crises.