Bernanke’s Instagram bubble
By James Saft
(Reuters) – Instagram founders Kevin Systrom and Mike Krieger ought to get down on their knees every night and thank Ben Bernanke.
That’s because the Federal Reserve chief has been crucial in creating an atmosphere in which two 20-somethings can sell an 18-month-old company with 13 employees and no significant revenue for $1 billion.
Facebook agreed on Monday to pay $1 billion in cash and stock for Instagram, which develops photo-sharing applications, just a week after the infant company closed a funding deal valuing it at a paltry $500 million.
While Bernanke and the Fed won’t get a cut of the cash, the past 15 years show clearly exactly how much credit for these sorts of bubble valuations they deserve.
Twice since 1997 the Federal Reserve has eased policy in the wake of disruptions to financial markets and twice speculative bubbles have grown up in the aftermath. It is looking increasingly as if social media technology shares are the third in the series.
In 1998, following on from the Asian financial crisis, Long-Term Capital Management came near to failure and required a Fed-orchestrated bailout. While no Fed money was used in the rescue it was followed up shortly with a cut in interest rates intended in part to calm the waters. That sent a clear signal to the market: the Fed has your back.
It should come as no surprise that subsidizing speculation gave rise to more speculation, but this time on a larger scale. The Internet bubble rose rapidly and burst just as rapidly, followed by a sustained campaign by the Fed to lower interest rates. The Fed, led by Alan Greenspan, had already halved rates to 3 percent by the time of the September 11, 2001 attacks and it carried on, ultimately taking them to just 1 percent.
That set the stage for the housing bubble, which, fanned by low rates, duly grew and hugely exceeded in size the manias which came before it. When housing burst the global financial system nearly failed and Bernanke’s Fed took rates to virtually zero before launching a multi-pronged quantitative easing campaign which is still ongoing.
In some ways, if the worst we get this time is a few extra social media billionaires and the pension fund pain that will follow, we should count ourselves lucky. The underlying lesson is that in trying to protect the real economy from Wall Street shocks, the Fed has simply fed Wall Street and caused it and the bubbles which are so good for its business to grow.
In some respects the Fed is trapped. Monetary policy is clearly not too loose by many measures, and certainly too tight if you are an unemployed former construction worker. The issue rather is that the Fed is having, or trying, to do too much of the heavy lifting of getting out of a balance-sheet recession by itself. The Fed has useful tools, but perhaps not the right ones for the job at hand.
None of this is to say that there is nothing to the social media frenzy, or even that the Instagram purchase will definitely turn out to be a bust. Just as the Internet bubble had at its core a world-changing phenomenon, so too this one may have a genuine basis. The issue is price, and the prices now being paid seem highly unlikely to reward investors, at least in aggregate. An ocean of liquidity has been poured on markets worldwide, in a nearly explicit attempt to get investors to take on more risks. Instagram is the result.
It is also probably unfair to criticize Facebook for paying a multiple of infinity for Instagram’s revenues. Facebook is making rational decisions within a context which is fundamentally irrational. Facebook has been awarded a valuation of its own shares and business which is likely hugely in excess of their actual promise. That valuation is predicated, in large part, on their dominant position within social media. They are being paid because they have the best network.
It makes sense, in the early stages of the bubble we are in, for Facebook to pay up for potential competitors because they must become the Amazon of their space to justify their current price. As time passes that valuation may be ratified, but more likely the air will leak and the valuations will collapse. For now though, Facebook is in the game, and the game has said they are very valuable. They must act as if they and their competitors are, or the game will end.
As the South Sea and Tulip bubbles demonstrated, speculative manias predate central banks. Central banks, like the one now led by Bernanke, did not invent bubbles but they certainly seem to be working to perfect them.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(Editing by James Dalgleish)
(At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on)