From Dot-Com to Dot-Bomb

Anyone reading this blog will most likely either have been sat in Professor John Turners lecture last week, or will in fact be John Turner, and so you should be aware that there are main 3 causes of asset bubbles. Just in case someone who isn’t from the risk management class has stumbled upon this blog and wasn’t in the class, the 3 causes put forward in the lecture were:

1) Agency costs associated with borrowed money
2) Technological Revolutions
3) Investor-Deceiving Frauds

In class I came to the conclusion that there was no single cause for a bubble, but rather it is usually a mixture that contributes. Of the reasons above, the technological revolution jumps out as the obvious answer to the cause of this bubble. The rapid uptake in use of the internet was seen by many as being the start of a “new era”, and this mentality will certainly have contributed to the growth of the bubble. However, another theory I would suggest is that it might have been a form of Investor-Deceiving Fraud.

Hickson and Turner (2006) argued that governments might be responsible for bubbles because of a threat of imminent revolution, or because of a diminished concern for the middle class. It is the second theory here that I think should be considered.

The Private Securities Legislation Reform Act (1995) was designed to restrict the ease with which lawsuits could be brought against firms over claims about performance. The problem this Act created is that it is very difficult to actually prove a company is making an over-hyped statement, and so in effect, this Act may have encouraged firms to make outlandish statements as they were protected from potential litigation. The growing prevalence of the internet made it very easy to hype up stock prices, and with the protection of the PSLRA, many firms did exactly this.

One of the many casualties of the
dot-com bubble bursting

I don’t really think that the government was deliberately trying to defraud investors, or encourage the growth of the dot-com bubble. I do believe, however, that the actions taken by the government in the run up to the dot-com bubble may well have contributed to the growth and size of the bubble.