FRENZY This page intentionally left blank FRENZY BUBBLES, BUSTS, AND HOW TO COME OUT AHEAD CARL HAACKE FRENZY Copyright © Carl Haacke, 2004. All rights reserved. No part of this book may be used or reproduced in any manner whatsoever without written permission except in the case of brief quotations embodied in critical articles or reviews. First published 2004 by PALGRAVE MACMILLAN™ 175 Fifth Avenue, New York, N.Y. 10010 and Houndmills, Basingstoke, Hampshire, England RG21 6XS. Companies and representatives throughout the world. PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN 1-4039-6131-X Library of Congress Cataloging-in-Publication Data Haacke, Carl. Frenzy : bubbles, busts and how to come out ahead / by Carl Haacke. p. cm. Includes bibliographical references and index. ISBN 1–4039–6131-X 1. Speculation. 2. Stocks—Prices. 3. Investment analysis. 4. Financial crises—History. 5. Internet industry—Finance. I. Title. HG6015.H28 2004 332.6—dc22 200404470 A catalogue record for this book is available from the British Library. Design by Letra Libre, Inc. First edition: December 2004 10987654321 Printed in the United States of America. Dedicated to Anna, Matthew and Evan This page intentionally left blank CONTENTS Acknowledgments ix Introduction 1 1. Perceptions (Seeing is Believing) 9 2. Competitive Cascade 63 3. Follow the Money 113 4. Reality Returns 129 5. We’ve Been There Before 147 6. Managing the Bubble Bath Ahead 169 Notes 185 Bibliography 199 Index 205 This page intentionally left blank ACKNOWLEDGEMENTS THIS BOOK HAS BEEN AN INCREDIBLE OPPORTUNITY and experience to talk with some of the greatest business leaders about one of the most re- markable periods in business history, how it relates to past bubbles, and what lessons can be learned for the future. As a result, this book simply would not have been possible without the help of nearly 100 people, many of whom took time out of their busy schedules to talk with me in great detail for hours and at times over many conversations. This entire book is a reflection of my gratitude to the se- riousness of purpose and honesty with which each of these individuals approached our discussions. Others provided detailed and extremely helpful comments on the text and helped hone some ideas that are pre- sented. I would like to thank Kurt Abrahamson, Michael Armstrong, William Baumol, Scott Bertetti, Tom Bingham, Peter Bisson, John Bogle, Don Cassidy, Robert Clauser, Evan Cohen, David Collis, John Conner, Mark Cuban, Andrew D’Ambrosio, Maziar Delaeli, Gene DeRose, Dave Dorman, Steve Dow, Bill Draper, Tim Draper, Barry Eggars, Stuart Ellman, Dan Estabrook, Bob Feldman, Alan Fields, Steve Friedman, Tom Flynn, John Fontana, Aram Fuchs, Fred Giudfredda, Fred Gluck, Josh Grotstein, John Koskinen, Mark Hagan, Bill Ham- brecht, Paul Harrington, Bill Janeway, Paul Johnson, John Jones, Terrel Jones, Bob Kagle, Habib Kairuz, Craig Kanarick, Will Lansing, Bob Latta, Al Leach, Steven Leslie, Jim Lesserson, Roger McNamee, Roger Meznick, Mark Moradian, Mike Moritz, Chip Morris, Tim Mulony, Martin Neisenholz, Evan Neufield, Dan Nordstromm, Terry Odean, Andrew Odlyzko, Alan Patricof, Michele Peluso, Stephen Penmen, Tom X FRENZY Perkins, Will Porteous, Jesse Reyes, Jay Ritter, Ross Ruben, Edmund Sanctis, Eric Schoenberg, Rob Shepardson, Clay Shirky, Al Sikes, Marc Singer, Peter Sisson, Kevin Slavin, Amy Snyder, Pete Solvik, Lenny Stern, Ross Stevens, Tony Sun, David Turnbull, Troy Tyler, Don Valen- tine, Hal Varian, Mark Walsh, Dan Weiner, Ron Weissman, Geoff Yang, Marty Yuckovitch, Strauss Zelnick. There are a number of people who I also wish to thank who contributed substantively to this book but who wish to remain anonymous. It is worth noting that legal investigations into various activities in in- vestment banks and mutual funds made many people uncomfortable or unable to speak on the record. Their input, nonetheless, contributed greatly to the approach and general content of the book on a wide range of issues. The treatment in this book of unethical and illegal activities were drawn exclusively from the public record. I would also like to thank my editor Toby Wahl for taking a chance on a first-time author. Finally, a special gratitude must go to my wife Anna for putting up with long hours of my writing, interviewing, editing, my new sons Evan and Matthew for providing inspiration, and my mother Linda, father Hans, and brother Paul all a lifetime of support. INTRODUCTION THE BUBBLE OF THE 1990S, DESPITE THE HYPE, was not primarily dri- ven by the Internet. It was driven by human nature. Bubbles are created by human impulses that transcend the Internet, the 1990s, the twenti- eth century, or the United States. We frequently create bubbles when we are presented with an extraordinary and incalculable opportunity and wild uncertainty. We become seized by frenzy. Creative imagination runs wild. Throughout history, the promise of a glorious new world seizes us, setting in motion a cascade of great opportunities and disastrous invest- ments. At the same time, bubbles are not simply “irrational exuberance.” They are fueled by a complex human dynamic that warps how we per- ceive information and respond to competitive pressures. We normally try to understand the economy by tracking the numbers— profits, GDP, stock prices, the unemployment rate, inflation. However, using these indicators exclusively is like trying to understand how a car works just by looking at a speedometer and odometer. Frenzy opens the hood and inspects the engine to reveal the core human machinery of the economy that leads to bubbles. It answers the perennial question: What were people thinking? Frenzy focuses on three types of investors—venture capitalists who start new companies, corporations who acquire start-ups and launch internal initiatives and stock pickers. In the aftermath of the Internet bubble, the lesson is not that reason will thankfully always prevail in the long run. The lesson is that bubbles are in- evitable. Bubbles and the frenzy that drives them are a basic feature of human and economic activity. They are not rare, once-in-a-lifetime events. They occur all the time. Certainly, bubbles as big as the Internet bubble are 2 FRENZY extremely uncommon. But on smaller scales, they are everywhere. For cen- turies, human beings have been captivated by wild manias of enthusiasm when a new, wondrous, and unknown opportunity is introduced—a new market to explore, a new technology, a new product. So far, we have created technology bubbles with the introductions of new innovations such as canals, railways, autos, radios, high technology companies in the 1960s, personal computers, biotech, and many other innovations, each of which seems to transform business capacity, commerce, or social activities. We have also created bubbles based on financial arrangements such as leveraged buyouts (LBOs) in the 1980s. Real-estate bubbles occur frequently all over the world. Even single firms such as Long Term Capital Management fea- tured bubble dynamics. New markets in other countries can create bubbles as well. During the early part of the 1990s, the Asian Tiger countries such as Thailand and Indonesia suffered from bubble dynamics in what became known as the “Asian Miracle.” The Miracle ended with the Asian Economic Crisis of 1997, causing dramatic upheaval in the region and threatening the global economy. As of the writing of this book, there is likely a bubble in China, driven by the excitement that the country will quickly become the world’s biggest economy with a billion customers. Since the 1950s at least, there have been very few years of economic growth that did not generate a bubble in some industry, some new mar- ket opportunity, or some country. Four years after the Internet bubble burst in March 2000, insiders and outsiders have worried about many smaller bubbles in hedge funds, exchange traded funds, biotechnology, outsourcing, nanotechnology, social networking platforms, oil prices, real estate in numerous parts of the world, and plasma screens. In each of these cases, participants have said this is like the Internet in 1999. The frenzy operates similarly in small and big market opportunities. This means that the risks and opportunities of bubbles are ever present. It is comforting, for some, to view bubbles as unusual events caused by the irrational behavior of human beings that interrupts normal, rational eco- nomic functioning. But the reality is that since human beings are the en- gine that drives the economy, bubbles must be accepted as a normal consequence of economic behavior. Commenting on bubbles and busts, Alan Greenspan, Chairman of the U.S. Federal Reserve Bank, said in 1999, “What is so intriguing is that INTRODUCTION 3 this type of behavior has characterized human interaction with little ap- preciable difference over the generations. Whether Dutch tulip bulbs or Russian equities, the market price patterns remain much the same.”1 The Internet bubble was probably the second largest in history. It was likely smaller than the railway mania that overtook Great Britain in 1840s, when, by some accounts, investment in railways consumed 5 per- cent of the entire country’s economic production—equivalent to invest- ing more than $500 billion in the United States today. Size does matter. Big bubbles have widespread effects. The Internet bubble had dramatic global effects, both on the way up and on the way down. When big bub- bles crash, like the Internet bubble, the Asian Miracle, the roaring 20s, the go-go years of the 1960s, long-term capital management, they can be very destabilizing to the global economy By contrast, something like the biotech bubble is narrowly focused on a specific sector, and many never knew that it was going on.