I
The collapse of the Nasdaq was a turning point in American history. For the past five years, the stock market, particularly the Nasdaq, had been a symbol of American technological leadership and economic power. Most of all, it had been a symbol of American self-confidence. Ronald Reagan used to claim that the 1980s represented “morning in America,” but this claim rang somewhat hollow in an age when gnarled operators like Ivan Boesky and Robert McFarlane were busy going about their business. It was during the 1990s, following the collapse of the Soviet Union and victory in the Gulf War, that the United States really rediscovered a feeling of youth and vigor. Old restrictions seemed to slip away, and the country stepped into the future like an animal shedding its winter coat. The rise of Silicon Valley and the Internet was something fresh—something untarnished by financial scandal or memories of Vietnam. It gave new life to the most potent American myth of all: that the future is boundless.
Now this myth had been exposed. Suddenly the country faced a future with limits: economic limits, political limits, and cultural limits. In Washington, the assumption of budget surpluses stretching out indefinitely would have to be rethought. On campuses, students would be forced to reconsider their careers. With the lure of instant riches in an Internet start-up removed, law school or medical school wouldn’t look like such a bad bet after all. In boardrooms, corporate executives would have to revise their strategies for creating shareholder value. Simply creating an online division or floating an Internet tracking stock would no longer be enough. And everywhere, the belief that it was possible to make easy money by buying and selling pieces of paper would have to be let go.
The United States is a nation of many strengths, but facing up to reality is not one of them. For almost a year and a half after the April 2000 Nasdaq crash, there would be a marked reluctance to accept that the long boom had come to an end. From Alan Greenspan down, officials in the public and private sector would repeatedly insist that any economic downturn would be shallow and short-lived. On Wall Street, while the Nasdaq would show no signs of recovering, the Dow would remain stubbornly above 10,000, despite the fact that the financial outlook for many of its constituent companies was steadily deteriorating. Most remarkably of all, American consumers, the mainstay of the economy, would refuse to concede that they couldn’t carry on spending every dollar they earned, and that, at some point, they would have to start rebuilding their savings. Even in the early summer of 2001, when economic growth had practically ceased, consumer spending would increase at a healthy clip. It wasn’t until the terrorist attacks of September 11, 2001, that Americans would finally acknowledge that the 1990s were truly over, and that a darker, more uncertain future had dawned. Until then, the consequences of the bursting of the speculative bubble would play themselves out, but with few people ready to concede that things had changed irrevocably.
A collapse in asset prices can affect an economy in three main ways. It can reduce consumer spending by making people poorer; it can damage the banking system, especially if banks have lent a lot of money against assets whose value has collapsed; and it can hit investment spending because firms find it more difficult to raise money. The importance of each channel varies depending on the specific circumstances, but the overall impact is usually major. In Britain at the start of the 1990s, a collapse in house prices led to a steep drop in consumer spending, which plunged the economy into a recession that cost Margaret Thatcher the prime ministership. In Japan, at around the same time, a collapse in the stock market and the price of real estate led to big losses for the banks, which had lent recklessly during the 1980s boom, and the decrepit state of the banking system hobbled the Japanese economy throughout the 1990s. The most famous bust of all was the Great Depression, which followed the Great Crash of October 1929. Economists are still divided about exactly what caused the Great Depression, but a combination of all three factors—a reverse “wealth effect on consumption,” a stricken banking system, and a slump in investment spending—was probably to blame, together with some policy mistakes by the Fed.
Following the Nasdaq crash, consumer spending and the banks both held up pretty well, at least initially. The collapse in stock prices impacted the economy mainly through reduced investment spending, but even this took a while to manifest itself. When it did, the effect was dramatic: Throughout the late 1990s, a virtuous circle had prolonged the economic expansion. As stock prices rose, firms could raise as much money as they wished for investment projects. (In effect, the Internet was one huge investment project.) The resultant surge in investment led to faster economic growth and faster productivity growth, which in turn boosted corporate profits. When investors saw profits rising, they poured more money into the stock market, which forced stock prices even higher, starting the process over. After the stock market bubble burst, the virtuous circle was replaced by a vicious circle. Many firms struggled to raise money, which led to a sharp decline in investment spending, especially on technology. The fall in investment caused a slowdown in economic growth and productivity growth, which, in turn, led to a drop in corporate earnings. With earnings falling, the stock market came under more selling pressure, thus restarting the process. At each turn of the circle, more of the economy was affected. To begin with, the damage was largely restricted to Internet firms. Then it spread to the rest of the technology sector, before finally encompassing the entire economy. As had been the case during the long boom, the logic of the downturn was self-reinforcing and inexorable. By the time of the terrorist attack in September 2001, the economy was already on the brink of a recession. And even before the attacks, there were signs that things were about to get a lot worse.
II
The first victim of the Nasdaq crash to be publicly identified was Baruch Israel Hertz, the proprietor of Track Data Corporation, an online brokerage, whose advertising slogan, “You don’t have to be a pro to trade like one,” often ran on CNBC. Hertz, a heavy trader on his own account, owed $45 million to four brokerages that had lent him money on margin. To satisfy his debtors, he was forced to pledge more than half his stake in Track Data Corporation. In the grand scheme of things, Hertz was a small player. At the end of April, it emerged that one of the biggest, George Soros’s Quantum Fund, had lost close to $2.5 billion, and the Quota Fund, another Soros operation, had lost several hundred million dollars. Soros had long been warning of a possible crash, and his skepticism with regard to technology issues was common knowledge. But it transpired that in the summer of 1999, Stanley Druckenmiller, the portfolio manager of the Quantum Fund, had persuaded Soros to go along with massive bets on stocks like Qualcomm and Cisco Systems. After the losses were announced, Druckenmiller resigned, as did Nicholas Roditi, the London-based manager of the Quota Fund. A chastened Soros said their successors would follow a more conservative trading strategy.
The majority of the crash’s victims remained anonymous. In all walks of life, there were a few people who had placed their life savings in technology and Internet stocks. For the past few years, these intrepid souls had been the envy of their colleagues and friends, but now they didn’t seem too clever. Most investors had maintained a diverse portfolio, and their losses in technology were cushioned by the resilience of the broader market. After its April slump, the Dow spent most of the next eighteen months trading between 10,000 and 11,000. Gone were the big gains of the late 1990s, but most people who had been in the market for several years were still ahead on their investments.
Partly for this reason, the Nasdaq’s slump had little immediate impact on consumers’ spending patterns. In April, retail spending appeared to strengthen, and the unemployment rate fell to 3.9 percent, a thirty-year low. When Greenspan and his colleagues on the FOMC met on May 16, 2000, their first meeting since March, the economy was still powering ahead. During the first quarter of the year, it had grown at an annual rate of 5.4 percent, down slightly from the 7.3 percent rate recorded in the fourth quarter of 1999, but still much too high for the Fed’s taste. The demand for goods and services was still growing faster than the economy’s capacity to supply them. In view of this, the FOMC voted unanimously to raise the federal funds rate by half a point, from 6.0 percent to 6.5 percent.
The sight of a central bank tightening monetary policy after a stock market crash was unusual. The orthodox reaction is to pump more money into the economy in order to prevent a recession from developing, which is what the Fed did in 1987. In raising interest rates, Greenspan and his colleagues seemed to be following the disastrous precedent of 1929, when their predecessors maintained a tight policy following the stock market’s collapse. Greenspan was well aware of the Fed’s errors following the Great Crash, but on this occasion he didn’t think there was any danger of an economic slump. In a statement, the FOMC defended its decision to raise interest rates “in light of the extraordinary and persisting strength of overall demand.”1 There were few signs that the prosperity of the 1990s had been seriously dented. In May, the average cost of a two-bedroom apartment in Manhattan reached $958,202.
But if the economy as a whole was still growing strongly, the Internet sector was already contracting. The IPO window, which had been open since November 1998, had slammed shut. The investment bankers were forced to call up Internet companies they had been preparing for IPOs, such as Kozmo.com and Petopia.com, to tell them they would have to fend for themselves for the foreseeable future. Firms that had already gone public but needed more cash to survive, such as those on the Barron’s list, were also left stricken.
Boo.com, a wildly ambitious attempt to create a global online retailer catering to fashion-conscious consumers, was the first big casualty. Ernst Malmsten, one of the three Swedes who founded Boo.com in 1998, referred to it as “a gateway to world cool.”2 In 1999, Fortune magazine picked it as one of its “Cool Companies” of the year. Boo.com was headquartered in London, but it also had offices in New York, Paris, Stockholm, and several other trendy locales. Its four hundred employees were highly paid, traveled in style, and had fresh fruit delivered daily. In eighteen months, they ran through about $185 million that had been raised from a variety of investors including Benetton, the Italian fashion house, LVMH, the French fashion conglomerate, J. P. Morgan, Goldman Sachs, and the Lebanese Hariri family. Boo.com’s Web site, when it finally launched in November 1999, was slow, cumbersome, and inaccessible to Apple users. Customers were scarce. Between February and April 2001, total sales were $1.1 million. The Nasdaq crash, which removed any prospect of an IPO, was the final blow. On April 16, J. P. Morgan informed Malmsten that it couldn’t raise any more money. On May 17, Boo.com shut down and filed for bankruptcy.
A few days later, Toysmart.com, whose backers included the Walt Disney Company, bowed out of the brutal battle in the online toys market. EToys, an ambitious California-based start-up that had gone public in May 1999, was the market leader, but ToysRUs.com, Wal-Mart.com, and Amazon.com were all fighting for the same customers. Two smaller companies, RedRocket.com and ToyTime.com, had already folded. Competition in the online pets market was equally intense. On June 13, Pets.com agreed to acquire the assets of Petstore.com, for $10 million in stock. Pets.com had been fortunate enough to go public before the Nasdaq crash, but its stock was now trading at about $2, which meant it would have great difficulty raising any more money. The two other main competitors in the industry—Petopia.com and PetsMart.com—had been forced to cancel their IPOs.
June also saw the collapse of Reel.com, an online video store. The vast majority of online retailers were now struggling to survive. Value America, the Virginia-based firm that styled itself as the “Wal-Mart of the Internet,” had already fired half its staff and ousted its founder, Craig Winn, whom CEO magazine had once dubbed “the prince of e-commerce.” Winn’s vision of having manufacturers send products to customers direct, so Value America wouldn’t have to maintain any costly inventories, had turned out to be as illusory as his plans to run for president. In 1999 alone, Value America lost more than $175 million. It somehow managed to raise another $90 million in March 2000, but this money didn’t last long. On August 11, 2000, Value America closed its Web site and filed for bankruptcy.
The following month, Pseudo.com, the online television network, shut down. The closure came just seven months after founder Josh Harris had boasted that he was trying to put CBS out of business. In May, Harris had defied the post-Nasdaq crash gloom to raise $15 million. In July, Pseudo.com attracted a lot of media attention by providing live online coverage of the Republican National Convention in Philadelphia, but its viewing figures remained dismal. With fewer than 50,000 visitors a day, Pseudo.com didn’t even show up on Media Matrix’s ranking of news and content sites. (Since less than 5 percent of all Internet users had high-speed connections, which were essential for downloading streaming video, this was hardly surprising.) On September 18, Pseudo.com ran out of money. At least Harris could say that his firm had made some programs, lots of them, before going under. Pop.com, a West Coast online network backed by Steven Spielberg and Ron Howard, also went out of business in September, but without producing a single show.
By now, spotting the next dotcom to turn up its toes had turned into a popular spectator sport, with Web sites like Dotcomfailures.com and FuckedCompany.com leading the cheering. Philip Kaplan, a twenty-four-year-old New Yorker, launched FuckedCompany.com over the Memorial Day weekend of 2000 to poke fun at what he called the “ridiculousness” of many Internet business plans. The site quickly developed a cult following, attracting (Kaplan claimed) 300,000 visitors a day. Kaplan encouraged users to submit predictions for the next dotcom demise, and they scored points if they were proved right. Employees of troubled Internet companies used the site to vent their anger at their bosses (and their stock losses), while Kaplan, using the handle “Pud,” kept up a sarcastic running commentary.
III
In August 2000, the National Association of Purchasing Management’s monthly index of manufacturing activity, an economic indicator that is closely watched on Wall Street, dipped significantly. In normal times, this wouldn’t have been too disturbing. Manufacturing currently comprises about a fifth of the economy—the service sector is far bigger—and a fall in manufacturing output doesn’t necessarily cause a recession. But since the middle of the 1990s, spending on high-end computers, software, and networking gear had been growing at an annual rate of 15 percent to 20 percent a year, and the technology sector had accounted for up to a third of overall economic growth. The Fed initially welcomed signs that its efforts to slow down the economy might finally be working. At the central bank’s annual getaway in Jackson Hole in mid-August the atmosphere was almost giddy. Productivity was still rising strongly, which augured well for the economy’s long-term prospects. “In public and in private, the worrywarts, killjoys, and practitioners of the dismal science who inhabit the Fed’s marble halls are sounding like 49ers who have stumbled into a saloon with a sackful of nuggets,” the Washington bureau chief of The Financial Times reported in early September. And he went on: “This autumn the U.S. central bank looks out on an economic landscape that, for the first time in four years, is not pockmarked with potential catastrophes.”3
This was an optimistic prognosis, to say the least. On September 21, Intel, the world’s largest chipmaker, warned that its revenue growth in the third quarter would be half what Wall Street had been expecting. Within two weeks, Intel’s stock had fallen by 40 percent, eviscerating $215 billion in paper wealth. The Nasdaq, which had climbed back above 4,000 during the summer, entered a steep decline that would last through the end of the year and beyond. With public attention focused on the presidential election, the economy was no longer dominating the headlines, but the turndown in investment spending was getting serious. In the second quarter of the year, orders for information technology equipment had risen by 34 percent. Between July and September, they rose by just 1.2 percent. When the fourth quarter started, on October 1, many technology firms found their orders falling at an alarming rate. Some of their customers had gone out of business. Others had simply stopped buying. To many technology company executives, it seemed as if somebody had thrown a bucket of water over the economy. In November, the Nasdaq fell below 3,000.
Meanwhile, the carnage in the Internet sector continued. On November 7, five days after the presidential election and less than nine months after its IPO, Pets.com announced that it was shutting up shop and firing most of its employees. Mortgage.com, a Florida-based dotcom, had already announced its intention to close, but Pets.com was the first publicly traded Internet company actually to go out of business. Merrill Lynch had contacted fifty potential investors on Pets.com’s behalf, but only eight were even willing to meet the company. None was prepared to put up the $20 million or more that Pets.com needed. This was hardly surprising. In the previous quarter, the company had lost $21.7 million on sales of $9.4 million, and its cumulative losses since the start of 1999 amounted to $147 million. In a statement, Julie Wainwright, Pets.com’s chairman and chief executive, said: “It is well known that this is a very, very difficult environment for business-to-consumer Internet companies. With no better offers and avenues effectively exhausted, we felt that the best option was an orderly wind-down with the objective to try to return something to the shareholders.”4
The demise of Pets.com was an embarrassment to all concerned, especially Hummer Winblad, the Silicon Valley venture capital firm that had backed it in the beginning, Amazon.com, which had invested approximately $60 million in the company and ended up as its largest shareholder, and Merrill Lynch, which had touted its stock to the American public. Unsurprisingly, none of these firms had any comment, but Pets.com’s sock puppet did have something to say when he appeared on Good Morning America a few weeks later. After admitting that recent events had left him “bummed a little bit,” the sock puppet was asked by Jack Ford, the show’s cohost, if he had any advice for investors. “Don’t invest in dotcoms,” the puppet replied.5
Many investors were wishing they had heeded that advice. On November 8, TheGlobe.com closed at 63 cents, Quepasa.com at 47 cents, E-Stamp at 59 cents, and eGreetings.com at 34 cents. The market was saying these companies would eventually go out of business. So many Web sites were closing that The New York Post created a “Dead Dotcom of the Day” column, which became a particular favorite of the paper’s proprietor, Rupert Murdoch, who had been widely criticized for turning his back on the Internet boom.
On December 18, the FOMC held its last meeting of the year. Greenspan and his colleagues were divided about what to do. Earlier in the month, the Fed chairman had seemed to hint at a forthcoming interest rate cut when he said that “weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending.”6 Some members of the committee supported an immediate reduction in the federal funds rate, but the majority favored monitoring developments for a while longer. Despite the growing problems in the technology sector, the economy as a whole still appeared to be growing at an annual rate of somewhere between 2 percent and 3 percent. After a debate, the FOMC left interest rates as they were but warned that economic risks were now “weighted mainly toward conditions that may generate economic weakness in the future” and said it would “continue to monitor closely the evolving economic situation.”7
There was more disturbing economic news over Christmas and the New Year, including a slide in December auto sales and disappointing holiday sales for many retailers. This heightened the gloom on Wall Street. On December 29, the last trading day of the year, the Nasdaq fell 87.24 points, closing at 2,470.52, and the Dow fell 81.91 points, to 10,786.75. For 2000 as a whole, the Nasdaq was off 39.3 percent, its biggest fall since its founding in 1971, and the Dow was off 6.2 percent, its worst performance since 1981. Many individual stocks had suffered stunning declines. Lucent Technologies was down 81 percent on the year, Dell Computer down 66 percent, and Microsoft down 63 percent. The Internet stocks had fared worst of all. Priceline.com had dropped 97 percent, Yahoo! 86 percent, and Amazon.com 77 percent.
IV
On Tuesday, January 2, 2001, the National Association of Purchasing Management announced that its index of manufacturing activity had fallen to its lowest level since the last recession ended in 1991. Greenspan had seen enough. The very next day, shortly after 1 P.M., the Fed announced that it was cutting the federal funds rate from 6.5 percent to 6.0 percent. Interest rate changes between FOMC meetings are unusual. The previous one was in October 1998, when the financial markets were in a crisis following the near collapse of Long Term Capital Management. In a statement, the Fed said it had acted “in light of further weakening of sales and production, and the context of lower consumer confidence, tight conditions in some segments of financial markets and high energy prices sapping household and business purchasing power.”8 Investors reacted to the interest rate cut with shock, then delight. The Dow jumped 299.60 points, to 10,945.75. The Nasdaq, after falling for months, posted its biggest ever gain in points and percentages. At the close of trading, the index was at 2,616.69, up 324.83 points, or 14.2 percent.
The celebrations were short-lived. On reflection, investors realized that the Fed’s intervention was evidence of its growing concern about the economy. “They saw the N.A.P.M., and it scared the pants off them,” Ian Richardson, an economist at the consulting firm High Frequency Economics, told The New York Times.9 George W. Bush, the incoming president, seized on the rate cut as evidence that the country needed the tax cuts he had promised during the election campaign, saying: “One of the messages Dr. Greenspan sent was that we need bold action, not only at the Fed, but in the halls of Congress to make sure this economy stays vibrant.”10 At the end of January, the Conference Board reported that consumers’ confidence in the future had suffered its biggest fall since the Gulf War, the clearest evidence yet that the problems in the technology sector were spreading to the economy at large.
One of the factors undermining public confidence was the ongoing wave of job cuts, many of them in the Internet sector. Early in the New Year, Excite/At Home laid off 250 workers and wrote off $4.8 billion in losses related to the precipitous decline in value of its Excite portal. Of all the money-eating Internet companies, the Excite/At Home combine was probably the most ravenous. Since 1995, it had lost almost $10 billion. On January 30, Amazon.com announced plans to shutter two distribution centers and lay off 1,300 people, about 15 percent of its workforce. Although he didn’t concede as much publicly, Jeff Bezos was finally admitting that his “Get Big Fast” strategy was no longer sustainable because investors were no longer willing to accept big losses indefinitely. In the last quarter of 1999, Amazon.com had garnered revenues of almost $1 billion, but it had lost $545 million. Since hitting an intra-day peak of $113 in December 1999, Amazon.com’s stock had fallen to less than $20. Stripped of its Internet glamour, Bezos’s firm looked like any other struggling company that was cutting costs in a desperate attempt to make ends meet. Adding insult to injury, Ravi Suria, a bond analyst at Lehman Brothers, said that the online retailer might run out of working capital later in the year, a claim the company firmly denied.
With the stock market punishing rather than rewarding Internet investments, several big media companies, including CNN, News Corporation, and Walt Disney, slashed their online divisions. CNN, now a part of AOL Time Warner, said it was firing up to 1,000 workers. Disney announced the closure of Go.com because there was no longer any point in trying to compete with America Online and Yahoo! Speaking for many of his fellow moguls, Michael Eisner, the chairman of Disney, said: “We were waiting for something at the end of the rainbow that was looking less and less worth waiting for.”11
On January 31, 2001, the FOMC, citing the risk that “demand and production could remain soft,” reduced the federal funds rate by another half point, from 6.0 percent to 5.5 percent. The economy was still growing, at least according to the official figures, but there was now no doubt that the Greenspan boom had come to an end. The vicious circle started by the Nasdaq crash had already completed one turn, with the slide in the stock market leading to a slowdown in the economy, leading to further falls in stock prices. Another turn was now beginning.
On March 7, eToys went out of business, having run up debts of $274 million. Once valued at $10 billion, the Santa Monica–based retailer was now worthless. When the liquidators tried to sell its Web site and its $80 million warehouse management system to pay off some of its creditors, there were no bids. Even the inventory of toys had to be sold at a 75 percent markdown. Three days after eToys filed for Chapter 11, Cisco Systems, the technology supplier that had benefited most from the growth of the Internet, announced it was firing 11 percent of its workforce because of a slump in demand. Many technology buyers had simply run out of money. NorthPoint Communications, which had built a nationwide network of high-speed Internet connections, was a typical example. When the market was at its peak, NorthPoint had been valued at $5.6 billion. In March, AT&T bought the company for $135 million.
On Friday, March 9, 2001, the anniversary of the Nasdaq first closing above 5,000, the index ended the day at 2,052.78. In twelve months, the total market value of companies listed on the Nasdaq had dropped from $6.7 trillion to $3.2 trillion: $3.5 trillion in stock market wealth had vanished. Cisco Systems, which a year earlier had been the world’s most valuable company, worth $466.5 billion, was now valued at $164.2 billion. Yahoo!’s stock market value had fallen from $93.7 billion to $9.7 billion, Amazon.com’s from $22.8 billion to $4.2 billion. The Dow Jones Composite Internet Index, which on March 10, 2000, closed at 509.84, now stood at 80.74, a fall of 84.2 percent.
On Monday, March 11, the Nasdaq fell another 129.40 points to 1,923.38, the first time it had dropped through 2,000 since November 1998, the month TheGlobe.com went public. Two days later, the Dow fell by 317 points and closed below 10,000. Deflationary forces were buffeting the economy, and the Fed’s actions didn’t seem to be having any effect. On March 20, the FOMC reduced the federal funds rate from 5.5 percent to 5.0 percent, the third half-point rate cut since the start of the year. In a statement explaining its move, the committee referred to the chain reaction that was sending the economy into a downward spiral: “Persistent pressures on profit margins are restraining investment spending, and, through declines in equity wealth, consumption.”12 Wall Street had been hoping for an even bigger move from the Fed. The Nasdaq closed the day at 1,857.44, off 93.74 points, and the Dow closed at 9,720.76, down 238.5 points. The willingness to cast aside old valuation methods was now coming back to haunt investors. Even after the dramatic drops of the last year, many stocks were still expensive on a historical basis. Since March 2000, the average PE ratio for stocks listed on the Nasdaq had fallen from 400 to 154, but that was still almost three times the average PE since 1985, which was 52.
On April 2, Inside.com became the latest Internet company to introduce drastic retrenchments when it merged with Brill Media Holdings, the publisher of Brill’s Content, and announced heavy job cuts. Michael Hirschorn and Kurt Andersen had produced an informative online magazine for media junkies, but from a business perspective Inside.com never made much sense, and once the bubble burst its prospects of survival were minimal. (Later in the year, it would be shut down.) On April 12, Kozmo.com closed shop, having spent more than $250 million making life easier for couch potatoes. Since the cancellation of its IPO, the online delivery service had ousted its founders, instituted a $5 minimum order, and started charging $2 for all orders under $30, but none of these measures had stemmed its losses.
A day later, George Shaheen resigned as chief executive of Webvan. Just six months earlier, Shaheen’s decision to leave Andersen Consulting for the online grocer had been hailed as the ultimate legitimization of e-commerce. But Shaheen had been unable to alter the harsh economics of Webvan’s business. Revenues remained much lower than expected, and neither the acquisition of rival HomeGrocer nor the imposition of a $4.95 delivery fee on orders under $75 had stopped the flow of red ink. Webvan’s stock was trading at 12 cents, and its auditors had recently warned it could go out of business by the end of the year. Shaheen’s signing-on package of stock and options, which had once been worth $280 million, was practically worthless. In a statement, he said he was resigning because Webvan needed a “different kind of executive” as it concentrated on survival.13
Online commerce was turning into a bad joke. In May, Internet.com, a Connecticut-based publishing company, changed its name to INTMedia Group. Since going public in June 1999, its stock had gone from $14 to 72 1/4 to $4. “We have been the whipping boy because of the name,” Alan Meckler, the founder of Internet.com, complained to The Wall Street Journal.14 It now seemed conceivable that the Internet bubble would vanish without a trace. To help save some of it for posterity, Steve Baldwin, a freelance writer, set up a Web site, www.disobey.com/ghostsites, where he preserved the home pages of deceased dotcoms. Having once worked at Time Warner’s Pathfinder site, Baldwin knew a thing or two about troubled online ventures. Whenever an Internet company announced a restructuring, he would take a digital copy of its home page and post it on his site. “I’ve worked on so many Web projects and now they’re all gone,” Baldwin told The New York Times. “I realized there’s no proof I actually did anything.”15
Throughout the summer of 2001, the carnage continued. On July 10, Webvan, arguably the most ambitious e-commerce venture of all, closed down, having spent about $1.2 billion building a nationwide distribution system. “It’s easy to say we could have opened a few less markets,” David Beirne, a partner at Benchmark Capital, who had championed Webvan from the early days, told The New York Times.16 “But we had Catch 22. We had a unique opportunity to raise a lot of capital and build a business faster than Sam Walton rolled out Wal-Mart. But in order to raise the money, we had to promise investors rapid growth.” On August 3, TheGlobe.com closed its online community site, vacated its Manhattan headquarters, and said it would now concentrate on its online games division. Less than three years had passed since the November 1998 IPO that turned Todd Krizelman and Stephen Paternot into instant multimillionaires, but it seemed like an eternity. Krizelman and Paternot had stepped down as co-CEOs during 2000, and Paternot had already written his memoir, A Very Public Offering, when the closure announcement came.
Having invested, intellectually as well as financially, in the Internet, many Americans were now looking around for somebody to blame. The media also fell into this behavior, targeting the VCs, stock analysts, and investment bankers who had promoted Internet stocks. In its issue of May 14, 2001, Fortune pictured Mary Meeker on its front page above the headline “Can We Ever Trust Wall Street Again?”17 The magazine accused Meeker of compromising her position as a stock picker to win investment banking business for Morgan Stanley. Meeker admitted having put her name to some research reports that she hadn’t authored, but she defended her decision to maintain buy ratings on stocks like Amazon.com, Priceline.com, and Yahoo! despite the catastrophic falls of the past year. Sometime during the next two or three years, the “nuclear winter” would give way to a “spring bloom,” she insisted. “Our bet is that the winners that come out of this, the market value of the leaders, are going to make all the things that came before them look like chump change.”18
The days when investors reacted to a favorable mention from Meeker by bidding a company’s stock up ten or twenty points had long gone, and Internet issues continued to languish. In August, a group of investors in Amazon.com and eBay sued Meeker and Morgan Stanley, claiming that Meeker had issued favorable reports on these stocks in order to curry favor with the companies. Meeker “knew that the financial condition and future business prospects of Amazon did not support her positive comments and recommendations, but she nevertheless issued positive reports encouraging investors . . . to purchase shares of Amazon,” one of the suits claimed.19 Meeker wasn’t the first Internet analyst to be sued by angry investors. In July, Merrill Lynch had paid about $400,000 to settle a similar suit brought against Henry Blodget. In the Meeker case, a judge dismissed the initial suits, but more seemed certain to follow. The Securities and Exchange Commission and the U.S. Attorney’s office in Manhattan were investigating allegations that during the Internet boom certain brokerage firms received kickbacks for allowing certain clients to participate in sought-after IPOs. The probe was centered on Frank Quattrone and his colleagues at Credit Suisse First Boston, but it also involved other big Wall Street firms, including Morgan Stanley and Goldman Sachs.
On August 16, 2001, The Industry Standard, the weekly chronicle of the Internet economy, suspended publication after its parent company, Standard Media International, filed for bankruptcy. The demise of The Industry Standard, which during its three and a half years had earned a reputation for spirited and informative journalism, was yet another sign that the dotcom era was passing into history. During early 2000, when the magazine was thriving, its founders had raised $30 million from a group of outside investors, including Morgan Stanley and Chase Manhattan, and launched an aggressive expansion, with the intention of going public. At that juncture, Standard Media International was valuing itself at about $200 million. Like so many others, the company and its backers had mistaken an investing frenzy for permanent prosperity. In the first half of 2001, The Industry Standard’s advertising revenue fell by about 75 percent compared to the previous year. (Other Internet-related magazines, such as Business 2.0 and Red Herring, suffered similar, if slightly less dramatic, falls.) By the summer of 2001, it was on track to lose about $50 million on the year. Attempts to raise more money failed, and The Industry Standard met the same fate that the Railway Standard and many other railway publications had met a century and a half previously: it failed to outlive the speculative bubble that had given it birth. Other publications would have to write the final chapter of the Internet story.
VI
The vicious circle of falling investment and profits was now affecting firms of all kinds. In the second quarter of 2001, the economy grew by just 0.2 percent on an annualized basis: only the resilience of consumer spending, which increased at an annual rate of almost 2 percent, prevented it from contracting. The manufacturing sector was already in a deep slump, and corporate earnings had dropped by $150 billion in twelve months. Even on Wall Street, where analysts had repeatedly insisted that the slowdown would be short-lived, hopes of a rapid recovery were fading. The mighty Fed seemed powerless to arrest the decline. Between April and August, it reduced interest rates another four times, bringing the number of rate cuts in 2001 to seven. Since the start of the year, the federal funds rate had been reduced from 6.5 percent to 3.5 percent, but still the economy failed to respond. In August, the Ford Motor Company announced it was letting go of 5,000 workers because of falling demand.
On Tuesday, September 4, 2001, as Americans returned to their jobs after the Labor Day weekend, The Wall Street Journal published a report from Jackson Hole, Wyoming, where Alan Greenspan and his colleagues had been enjoying their annual policy retreat. The story said senior Fed officials had “expressed great uncertainty” over the course of the economy but also a determination to “continue cutting interest rates, a quarter point at a time, until signs of a recovery emerge.” Such signs were hard to find. On Friday, September 7, the Labor Department announced that 100,000 jobs had been lost in August and that unemployment had risen from 4.5 percent to 4.9 percent, the biggest one-month jump in six years. Such a sharp rise in joblessness strongly suggested that the economy was now shrinking, although confirmation would not come until later in the year, when the third quarter gross domestic product figures were released. The historic economic expansion that had given rise to the greatest speculative bubble the country had ever seen was over. The stock market fell sharply, with the Dow shedding 234.00 points, or 2.4 percent, to close at 9,605.85. The Nasdaq, already in the doldrums for a year and a half, fell another 17.94 points, to 1,687.70. Shortly after the unemployment figures were released, President Bush summoned reporters to the Rose Garden and said he wanted the American people to know “we’re deeply concerned about the unemployment rates and we intend to do something about it.” Four days later, any lingering hopes of an economic recovery were extinguished when terrorists attacked the World Trade Center and the Pentagon.