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

Summary of the main promontorys covered in my essay. How did the dotcom sing burst contribute to the scotch crisis of the 2008? Could we expect the similar crisis and how flush toilet it be prevented? What argon the lessons that should accept been learned from the dotcom crisis?When the global monetary crisis occurred in 2008, both(prenominal) experts and general public started heated discussion as everyone was eager to diagnose 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 Chairman of the Federal Reserve System.In that deposition he tried to explicate the causes of the recent financial and sparing crisis to the pecuniary Crisis Inquiry Commission, highlighting the vulnerabilities in different sectors of economics. The idea of inadequate risk-measurement that he focused on is very important for us, as this particular aftermath makes the recent crisis akin to the dot com blab show up we are ab forth to examine in detail. (The equal idea is one of the major issues of the next Ben Bernankes speeches, w here(predicate) he underlines the immensity of conceivable risk management and accomplishable destructive effects of existenceness similarly optimistic about the future of the economic system).To sum up, experts aim that flaws in evaluating the perspectives of crude technologies in the 90ies caused the dotcom house of cards burst in 2000, piece of music the inadequate risk-measurement of the financial instruments connected to mortgages led to the global financial and economic crisis in 2008. Could we require predicted the economic disaster coming in 2008 and which lessons could have been gathered from the dotcom crisis? These are the questions that make the topic urgent and exciting to examine. To receive with, lets define the key term. What is a dotcom?Dotcom is a firm conducting its descent principally over the Internet. They usual ly possess a Web site mean for business use. The term is based on the com that forms the last part of the traverse for roughly commercial Web-sites. Now, what were the reasons for the dotcom blab burst and what actually happened? (We should mention that this phenomenon is as well as makered as the Internet tattle and the Information Technology Bubble in many articles). It all started during the mid 1990is. The Internet was extremely popular those age and the Stock Market soared on engineering and Internet mental strains.Stock termss were travel and it seemed there was to limit for their tax to expand. The masses believed there was a new world coming and the Internet was for sure to flummox the future of business. The smashed confidence took menage that the e-companies would turn future dough and there is no limit for technologies development. These expectations were reflected in the NASDAQ composite mightiness. The NASDAQ composite is a stock mart index of the hone y oil stocks and similar securities, which are listed on the NASDAQ stock trade. 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% add-on, and was influenced principally by prices of high-technology stocks. But these expectations turned out to be far too positive. The grocery store became over apprized. 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 pronounced by the founding of many new weeny Internet-based companies commonly referred to as dotcoms.Many of them geted in 2000. A very specific phenomenon could be find at that magazine the way for a new unknown alliance to become prosperous was just to add an e- prefix to their quote or a . com t o the end. One of the authors called it prefix investing3, as the result of this transparent renaming was the incredible growth of stock prices. I suppose that was one of the offset indicators that some(a)thing was wrong and the calamity was coming. But everyone considered it the steady development of the market that has unfit future.Alan Greenspan (an Ameri apprise economist, the Chairman of the Fed in 1987-2006) in 2005 said, that this vast increase in the market value of asset claims is in part the substantiating 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 acrid 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 it s theoretical sense. What is the bubble in financial markets? In a word, we say that a stock market bubble occurs when there is a rise or boom in the share prices of stocks of a particular industry. Meanwhile, the rise in prices usually bears flyspeck 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 case. 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 imaginary activity. That characteristic describes the dotcom crisis as well, as we already found out. It would be arouse 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 refer to this case as to the dotcom mania.The speculators who represent all the people in the economy that what to get high profits very flying, 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. wherefore the rise happens responding to the high demand for stock and many companies thus become grossly overvalued. When the bubble bursts, the share prices fall dramatically, and many companies are labored to leave the business. In order to be more precise, we can name five stages of any financial bubble5 First. Displacement.When people, especially investors, get enamored by a new paradigm, such as an innovative 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, spare- sequence activity a displacement, but then they gain momentum. More and more participants demean the market. All of them are determined to get prosperous as in short 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 crownwork 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 respective sectors through network effects. However it was clear that all of them wouldnt become successful as the competition was tough. For many of them the get monolithic 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, back up the public to invest in risky companies in the wave of the wide-spread euphoria. As the result, many ordinary people became investors, some of them even gave up their profession to become fill-time traders. Third. Euphoria. During this phase investors as well as the unit of measurement 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 refreshing investors can make fortunes by selling out positions and taking profits. However, it is unequivocal that its very difficult to estimate the exact time when a bubble is due to collapse. John Maynard Keynes once mentioned that the markets c an stay irrational long-lasting 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 panic stage, asset prices change direction and decline as rapidly as they had ascended. Investors and speculators are faced with brink calls, which are demands on an investor using margin to deposit 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 want to liquidate them at any price.The emerge 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 interpretation 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 =Et(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 underlying value of the share (pt * ). The remainder (bt) is a deterministic or the random 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 t he 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 leading 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 play along 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. expectant companies, for example, Amazon. com and eBay, are quite 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 meg in the market value of companies from March 2000 to Oc tober 2002 the market value of NASDAQ companies peaked at $6. 7 cardinal in March 2000 and bottomed out at $1. 6 trillion in October 20029. The economic 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 sick thought-out unsuccessful businesses.Experts claim that dotcom crisis was one of the events that preceded the global financial crisis in 2008. It was var. 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 give 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 prudent and learned a lesson from the 2000 dotcom case. In conclusion, Id worry 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 terms more than a huge transnational 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, despite the companys loss of $ cd 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 eliminate inve stors are optimistic about e-companies, as they survived the recent global crisis, irrelevant huge interconnected firms in other studys, such as financial, machinery 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 just 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.