[R-G] [BillTottenWeblog] The Next Bubble

[Bill Totten]

Priming the markets for tomorrow's big crash

by Eric Janszen

Harper's Magazine (February 2008)


A financial bubble {1} is a market aberration manufactured by
government, finance, and industry, a shared speculative hallucination
and then a crash, followed by depression. Bubbles were once very rare -
one every hundred years or so was enough to motivate politicians,
bearing the post-bubble ire of their newly destitute citizenry, to enact
legislation that would prevent subsequent occurrences. After the dust
settled from the 1720 crash of the South Sea Bubble, for instance,
British Parliament passed the Bubble Act to forbid "raising or
pretending to raise a transferable stock". For a century this law did
much to prevent the formation of new speculative swellings.

Nowadays we barely pause between such bouts of insanity. The dot-com
crash of the early 2000s should have been followed by decades of
soul-searching; instead, even before the old bubble had fully deflated,
a new mania began to take hold on the foundation of our long-standing
American faith that the wide expansion of home ownership can produce
social harmony and national economic well-being. Spurred by the actions
of the Federal Reserve, financed by exotic credit derivatives and debt
securitization, an already massive real estate sales-and-marketing
program expanded to include the desperate issuance of mortgages to the
poor and feckless, compounding their troubles and ours.

That the Internet and housing hyperinflations transpired within a period
of ten years, each creating trillions of dollars in fake wealth, is, I
believe, only the beginning. There will and must be many more such
booms, for without them the economy of the United States can no longer
function. The bubble cycle has replaced the business cycle.


Such transformations do not take place overnight. After World War One,
Wall Street wrote checks to finance new companies that were trying to
turn wartime inventions, such as refrigeration and radio, into consumer
products. The consumers of the rising middle class were ready to buy but
lacked funds, so the banking system accommodated them with new forms of
credit, notably the installment plan. Following a brief recession in
1921, federal policy accommodated progress by keeping interest rates
below the rate of inflation. Pundits hailed a "new era" of prosperity
until Black Tuesday, October 29 1929.

The crash, the Great Depression, and World War II were a brutal
education for government, academia, corporate America, Wall Street, and
the press. For the next sixty years, that chastened generation managed
to keep the fog of false hopes and bad credit at bay. Economist John
Maynard Keynes emerged as the pied piper of a new school of economics
that promised continuous economic growth without end. Keynes's doctrine:
When a business cycle peaks and starts its downward slide, one must
increase federal spending, cut taxes, and lower short-term interest
rates to increase the money supply and expand credit. The demand
stimulated by deficit spending and cheap money will thereby prevent a
recession. In 1932 this set of economic gambits was dubbed "reflation".

The first Keynesian reflation was botched. To be fair, it was perhaps
impractical under the gold standard, for by the time the Federal Reserve
made its attempt to ameliorate matters, debt was already out of control
{2}. Banks failed, credit contracted, and GDP shrank. The economy was
running in reverse and refused to respond to Keynesian inducements. In
1933, President Franklin D Roosevelt called in gold and repriced it,
hoping to test Keynes's theory that monetary inflation stimulates
demand. The economy began to expand. But it was World War Two that
brought real recovery, as a highly effective, demand-generating,
deficit- and -debt- financed public-works project for the United States.
The war did what a flawed application of Keynes's theories could not.

A few weeks after D-Day, the allies met at the Mount Washington Hotel in
Bretton Woods, New Hampshire, to determine the future of the
international monetary system. It wasn't much of a negotiation. Western
economies were in ruins, and the international monetary system had been
in disarray since the start of the Great Depression. The United States,
now the dominant economic and military power, successfully pushed to peg
the currencies of member nations to the dollar and to make dollars
redeemable in American gold.

Americans could now spend as wisely or foolishly as our government
policy decreed and, regardless of the needs of other nations holding
dollars as reserves, print as many dollars as desired. But by the second
quarter of 1971, the US balance of merchandise trade had run up a
deficit of $3.8 billion (adjusted for inflation) - an admittedly tiny
sum compared with the deficit of $204 billion in the second quarter of
2007, but until that time the United States had run only surpluses.
Members of the Bretton Woods system, most famously French President
General Charles de Gaulle, worried that the United States intended to
repay the money borrowed to cover its trade gap with depreciated
dollars. Opposed to the exercise of such "exorbitant privilege", de
Gaulle demanded payment in gold. With the balance of payments so greatly
out of balance, newly elected President Richard Nixon faced a run on the
US gold supply, and his solution was novel: unilaterally end the US
legal obligation to redeem dollars with gold; in other words, default.

More than a decade of economic and financial-market chaos followed, as
the dollar remained the international currency but traded without an
absolute measure of value. Inflation rose not just in the United States
but around the world, grinding down the worth of many securities and
brokerage firms. The Federal Reserve pushed interest rates into double
digits, setting off two global recessions, and new international
standards and methods for measuring inflation and floating exchange
rates were established to replace the gold standard. After 1975, the
United States would never again post an annual merchandise trade
surplus. Such high-value, finished goods-producing industries as steel
and automobiles were no longer dominant. The new economy belonged to
finance, insurance, and real estate - FIRE.


FIRE is a credit-financed, asset-price-inflation machine organized
around one tenet: that the value of one's assets, which used to
fluctuate in response to the business cycle and the financial markets,
now goes in only one direction, up, with no more than occasional
short-term reversals. With FIRE leading the way, the United States, free
of the international gold standard's limitations, now had great
flexibility to finance its deficits with its own currency. This was
"exorbitant privilege" on steroids. Massive external debts built up as
trade partners to the United States, especially the oil-producing
nations and Japan, balanced their trade surpluses with the purchase of
US financial assets {3}. The process of financing our deficit with
private and public foreign funds became self-reinforcing, for if any of
the largest holders of our debt reduced their holdings, the trade value
of the dollar would fall - and with that, the value of their remaining
holdings would be decreased. Worse, if not enough US financial assets
were purchased, the United States would be less able to finance its
imports. It's the old rule about bank debt, applied to international
deficit finance: if you owe the banks three billion dollars, the bank
owns you. But if you owe the banks ten trillion dollars, you own the banks.

The FIRE sector's power grew unchecked as the old manufacturing economy
declined. The root of the 1920s bubble, it was believed, had been the
conflicts of interest among banks and securities firms, but in the
1990s, under the leadership of Alan Greenspan at the Federal Reserve,
banking and securities markets were deregulated. In 1999, the
Glass-Steagall Act of 1933, which regulated banks and markets, was
repealed, while a servile federal interest-rate policy helped move
things along. As FIRE rose in power, so did a new generation of
politicians, bankers, economists, and journalists willing to invent
creative justifications for the system, as well as for the projects -
ranging from the housing bubble to the Iraq war - that it financed. The
high-water mark of such truckling might be the publication of the Cato
Institute report "America's Record Trade Deficit: A Symbol of Strength".
Freedom had become slavery; persistent deficits had become economic power.


The bubble machine often starts with a new invention or discovery. The
Mosaic graphical Web browser, released in 1993, began to transform the
Internet into a set of linked pages. Suddenly websites were easy to
create and even easier to consume. Industry lobbyists stepped in,
pushing for deregulation and special tax incentives. By 1995, the
Internet had been thrown open to the profiteers; four years later a
sales-tax moratorium was issued, opening the floodgates for e-commerce.
Such legislation does not cause a bubble, but no bubble has ever
occurred in its absence.

I had a front-row seat to the Internet-stock mania of the late 1990s as
managing director of Osborn Capital, a "seed stage" venture-capital him
founded by Jeffrey Qsborn {4}, with positions on the boards of more than
half a dozen technology companies. I observed otherwise rational men and
women fall under the influence of a fast-flowing and, it was widely
believed, risk-free flood of money. Logic and historical precedent were
pushed aside. I remember a managing partner of one firm telling me with
certainty that if the company in which we'd invested failed, at least it
had "hard assets", meaning the notoriously depreciation-prone computer
equipment the company had received in exchange for stock. A year after
the bubble collapsed, of course, the market was flooded with such hard
assets.

Deregulation had built the church, and seed money was needed to grow the
flock. The mechanics of financing vary with each bubble, but what
matters is that the system be able to support astronomical flows of
funds and generate trillions of dollars' worth of new securities. For
the Internet, the seed money came from venture capital. At first,
Internet startups were merely one part of a spectrum of
enterprise-software and other technology industries into which venture
capitalists put their money. Then a few startups like Netscape went
public, netting massive returns. Such liquidity events came faster and
faster. A loop was formed: profits from IPO investments poured back into
new venture funds, then into new startups, then back out again as IPOs,
with the original investment multiplied many times over, then finally
back into new venture-capital funds.

The media stood by cheering, carrying breathless profiles of
wunderkinder in their early twenties who had just made their first
hundred million dollars; business publications grew thick with
advertisements. The media barely questioned the fine points of the new
theology. Skeptics were occasionally interviewed by journalists, but in
general the public was exposed to constant reiterations of the one true
faith. Government stood back - after all, there was little incentive for
lawmakers to intervene. Members of Congress, who influence the agencies
that oversee market-regulation functions, have never been unfriendly to
windfall tax revenues, and the FIRE sector has very deep pockets.
According to the donation-tracking website opensecrets.org, FIRE gave
$146 million in political donations for the 2008 election cycle alone,
and since 1990 more than $1.9 billion - nearly double what lawyers and
lobbyists have donated, and more than triple the donations from
organized labor.

Part of my job was to watch for the end-time, to maximize gains and
guard the firm against sudden losses when the bubble finally popped. In
March 2000, the signal arrived. One of our companies was investigating
the timing of an IPO; the management team was hoping for April 2000. The
representatives of one of the investment banks we talked to gave us a
surprisingly specific recommendation that ran counter to advice offered
by banks during the IPO-driven cycle of the preceding five years: they
warned the company not to go public in April. We took the advice in the
context of other indicators as a clear sign of a top, and over the next
few months we liquidated stocks in public companies that we held as a
result of earlier IPOs. Shortly thereafter, millions of investors with
unrealized gains in mutual funds sold stock to raise enough cash to pay
taxes on their capital gains. The mass selling set off a panic, and the
bubble popped.

In a bubble, fictitious value {5} goes away when market participants
lose faith in the religion - when their false beliefs are destroyed as
quickly as they had been formed. Since the early 1980s, the free-market
orthodoxy of the Chicago School has driven policy on the upward slope of
an economic boom, but we're all Keynesians on the way down: rate cuts by
the Federal Reserve, tax cuts by Congress, deficit spending, and dollar
depreciation are deployed in heroic proportions.

The technology industry represents only a small fraction of the US
economy, but the effects of layoffs, cutbacks, and the collapsing stock
market rippled through the economy and produced a brief national
recession in the early part of 2001, despite a concerted effort by the
Federal Reserve and Congress to avoid it. This left in its wake a
crucial dilemma: how to counter the loss of that seven trillion dollars
in fictitious value built up during the bubble.


The Internet boom had been a matter of abstract electrons and monetized
eyeballs - castles in the sky translated into rising share prices. The
new boom was in McMansions on the ground - wood and nails, granite
countertops. The price-inflation process was traditional as well: there
was way too much mortgage money chasing not enough housing. At the
bubble's peak, twelve trillion dollars in fictitious value had been
created, a sum greater even than the national debt.

We certainly should have known better. Historically, the price of
American homes has risen at a rate similar to the annual rate of
inflation. As the Yale economist Robert Shiller has pointed out, since
1890, discounting the housing boom after World War Two, that rate has
been about 3.3 percent. Why, then, did housing prices suddenly begin to
hyperinflate? Changes in the reserve requirements of US banks, and the
creation in 1994 of special "sweep" accounts, which link commercial
checking and investment accounts, allowed banks greater liquidity -
which meant that they could offer more credit. This was the formative
stage of the bubble. Then, from 2001 to 2002, in the wake of the dot-com
crash, the Federal Reserve Funds Rate was reduced from six percent to
1.24 percent, leading to similar cuts in the London Interbank Offered
Rate that banks use to set some adjustable-rate mortgage (ARM) rates.
These drastically lowered ARM rates meant that in the United States the
monthly cost of a mortgage on a $500,000 home fell to roughly the
monthly cost of a mortgage on a $250,000 home purchased two years
earlier. Demand skyrocketed, though home builders would need years to
gear up their production.

With more credit available than there was housing stock, prices
predictably, and rapidly, rose. All that was needed for hypergrowth was
a supply of new capital. For the Internet boom this money had been
provided by the IPO system and the venture capitalists; for the housing
bubble, starting around 2003; it came from securitized debt.

To "securitize" is to make a new security out of a pool of existing
bonds, bringing together similar financial instruments, like loans or
mortgages, in order to create something more predictable, less
risk-laden, than the sum of its parts. Many such "pass-thru" securities,
backed by mortgages, were set up to allow banks to serve almost purely
as middlemen, so that if a few homeowners defaulted but the rest
continued to pay, the bank that sold the security would itself suffer
little - or at least far less than if it held the mortgages directly. In
theory, risks that used to concentrate on a bank's balance sheet had
been safely spread far and wide across the financial markets among
well-financed and experienced institutional investors {6}.

The US mortgage crisis has been labeled a "subprime mortgage crisis",
but subprime mortgages were only a sideshow that appeared late, as the
housing-bubble credit machine ran out of creditworthy borrowers. The
main event was the hyperinflation of home prices. Risks are embedded in
price and lurk as defaults. Even after the faith that supported a bubble
recedes, false beliefs continue to obscure cause and effect as the
crisis unfolds.

Consider the chemical industry of forty years ago, back when such
pollutants as PCBs were dumped into the air and water with little or no
regulation. For years, the mantra of the industry was "the solution to
pollution is dilution". Mixing toxins with vast quantities of air and
water was supposed to neutralize them. Many decades later, with our
plagues of hermaphrodite frogs, poisoned ground water, and mysterious
cancers, the mistake in that logic is plain. Modern bankers, however,
have carried this mistake into the world of finance. As more and more
loans with a high risk of default were made from the late 1990s to the
summer of 2007, the shared level of credit risk increased throughout the
global financial system.

Think of that enormous risk as economic poison. In theory, those risk
pollutants have been diluted in the oceanic vastness of the world's debt
markets; thanks to the magic of securitization, they are made nontoxic
and so pose no systemic risk. In reality, credit pollutants pose the
same kind of threat to our economy as chemical toxins do to our
environment. Like their chemical counterparts, they tend to concentrate
in the weakest and most vulnerable parts of the financial system, and
that's where the toxic effects show up first: the subprime mortgage
market collapse is essentially the Love Canal of our ongoing
risk-pollution disaster.


Read the front page of any business publication today and you can see
the mess bubbling up. In the United States, Merrill Lynch took a $7.9
billion hit from its mortgage investments and experienced its first
quarterly loss since 2001; Morgan Stanley, Bear Steams, Citigroup, along
with many other US banks, have all suffered major losses. The Royal Bank
of Scotland Group was forced to write down three billion dollars on
credit-related securities and leveraged loans, and Japan's Norinchukin
Bank suffered $357 million in subprime-related losses in the six months
prior to September 2007. Even more of this pollution will become
manifest as home prices continue to fall.

The metaphor is not lost on those touched by debt pollution. In December
2007, Chip Mason of Legg Mason, one of the world's largest money
managers, said that the US Treasury should put twenty billion dollars
into a "structured investment vehicles superfund" to boost investor
confidence.

As more and more risk pollution rises to the surface, credit will
continue to contract, and the FIRE economy - which depends on the free
flow of credit - will experience its first near-death experience since
the sector rose to power in the early 1980s. Because all asset
hyperinflations revert to the mean, we can expect housing prices to
decline roughly 38 percent from their peak as they return to something
closer to the historical rate of monetary inflation. If the rate of
decline stabilizes at between six and seven percent each year, the
correction has about six years to go before things stabilize, leaving
the FIRE economy in need of twelve trillion dollars. Where will that
money be found?


Bubbles are to the industries that host them what clear-cutting is to
forest management. After several years of recession, the affected
industry will eventually grow back, but slowly - the NASDAQ, for
example, at 5,048 in March 2000, had recovered only half of its peak
value going into 2007. When those trillions of dollars first die and go
to money heaven, the whole economy grieves.

The housing bubble has left us in dire shape, worse than after the
technology-stock bubble, when the Federal Reserve Funds Rate was six
percent, the dollar was at a multi-decade peak, the federal government
was running a surplus, and tax rates were relatively high, making
reflation - interest-rate cuts, dollar depreciation, increased
government spending, and tax cuts - relatively painless. Now the Funds
Rate is only 4.5 percent, the dollar is at multi-decade lows, the
federal budget is in deficit, and tax cuts are still in effect. The
chronic trade deficit, the sudden depreciation of our currency, and the
lack of foreign buyers willing to purchase its debt will require the
United States government to print new money simply to fund its own
operations and pay its 22 million employees.

Our economy is in serious trouble. Both the production-consumption
sector and the FIRE sector know that a debt-deflation Armageddon is
nigh, and both are praying for a timely miracle, a new bubble to keep
the economy from slipping into a depression.

We have learned that the industry in any given bubble must support
hundreds or thousands of separate firms financed by not billions but
trillions of dollars in new securities that Wall Street will create and
sell. Like housing in the late 1990s, this sector of the economy must
already be formed and growing even as the previous bubble deflates. For
those investing in that sector, legislation guaranteeing favorable tax
treatment, along with other protections and advantages for investors,
should already be in place or under review. Finally, the industry must
be popular, its name on the lips of government policymakers and
journalists. It should be familiar to those who watch television news or
read newspapers.

There are a number of plausible candidates for the next bubble, but only
a few meet all the criteria. Health care must expand to meet the needs
of the aging baby boomers, but there is as yet no enabling government
legislation to make way for a health-care bubble; the same holds true of
the pharmaceutical industry, which could hyperinflate only if the Food
and Drug Administration was gutted of its power. A second technology
boom - under the rubric "Web 2.0" - is based on improvements to existing
technology rather than any new discovery. The capital-intensive
biotechnology industry will not inflate, as it requires too much
specialized intelligence.

There is one industry that fits the bill: alternative energy, the
development of more energy-efficient products, along with viable
alternatives to oil, including wind, solar, and geothermal power, along
with the use of nuclear energy to produce sustainable oil substitutes,
such as liquefied hydrogen from water. Indeed, the next bubble is
already being branded. Wired magazine, returning to its roots in
boosterism, put ethanol on the cover of its October 2007 issue, advising
its readers to FORGET OIL; NBC had a "Green Week" in November 2007, with
themed shows beating away at an ecological message and Al Gore making a
guest appearance on the sitcom 30 Rock. Improbably, Gore threatens to
become the poster boy for the new new new economy: he has joined the
legendary venture-capital firm Kleiner Perkins Caufield & Byers, which
assisted at the births of Amazon.com and Google, to oversee the "climate
change solutions group", thus providing a massive dose of Nobel
Prize-winning credibility that will be most useful when its first
alternative-energy investments are taken public before a credulous mob.
Other ventures - Lazard Capital Markets, Generation Investment
Management, Nth Power, EnerTech Capital, and Battery Ventures - are
funding an array of startups working on improvements to solar cells, to
biofuels production, to batteries, to "energy management" software, and
so on.

The candidates for the 2008 presidential election, notably Obama,
Clinton, Romney, and McCain, now invoke "energy security" in their stump
speeches and on their websites. Previously, "energy independence" was
more common, and perhaps this change in terminology is a hint that a
portion of the Homeland Security budget will be allocated for
alternative energy, a potential boon for startups and for FIRE.

More valuable than campaign rhetoric, however, is legislation. The
Energy Policy Act of 2005, a massive bill known to morning commuters for
extending daylight savings time, contained provisions guaranteeing loans
for alternative-energy businesses, including nuclear-power technology.
The bill authorizes $200 million annually for clean-coal initiatives,
repeals the current 160-acre cap on coal leases, offers subsidies for
wind energy and other alternative-energy producers, and promises fifty
million dollars annually, over the life of the bill, for a biomass grant
program.

Loan guarantees for "innovative technologies" such as advanced
nuclear-reactor designs are also at hand; a kindler, gentler nuclear
industry appears to be imminent. The Price-Anderson Nuclear Industries
Indemnity Act has been extended through 2025; the secretary of energy
was ordered to implement the 2001 nuclear power "roadmap", and $1.25
billion was set aside by the Department of Energy to develop a nuclear
reactor that will generate both electricity and hydrogen. The future of
transportation may be neither solar- nor ethanol- powered but instead
rely on numerous small nuclear power plants generating electricity and,
for local transportation, hydrogen. At the state and local levels,
related bills have been passed or are under consideration.

Supporting this alternative-energy bubble will be a boom in
infrastructure - transportation and communications systems, water, and
power. In its 2005 report card, the American Society of Civil Engineers
called for $1.6 trillion to be spent over five years to bring the United
States back up to code, giving America a grade of "D". Decades of
neglect have put us trillions of dollars away from an "A". After last
August's bridge collapse in Minnesota, it took only a week for
libertarian Robert Poole, director of transportation studies for the
Reason Foundation, to renew the call for "highway public-private
partnerships funded by tolls", and for Hillary Clinton to put forth a
multibillion-dollar "Rebuild America" plan.

Of course, alternative energy and the improvement of our infrastructure
are both necessary for our national well-being; and therein lies the
danger: hyperinflations, in the long run, are always destructive. Since
the 1970s, US dependence on foreign energy supplies has become a major
economic and security liability, and our superannuated roadways are the
nation's circulatory system. Without the efficient transit of
gasoline-powered trucks laden with goods across our highways there would
be no Wal-Mart, no other big-box stores, no morning FedEx deliveries.
Without "energy security" and repairs to our "crumbling infrastructure",
our very competitiveness is at stake. Luckily, Al Gore will be making
principled venture capital investments on our behalf.

The next bubble must be large enough to recover the losses from the
housing bubble collapse. How bad will it be? Some rough calculations
{7}: the gross market value of all enterprises needed to develop
hydroelectric power, geothermal energy, nuclear energy, wind farms,
solar power, and hydrogen-powered fuel- cell technology - and the
infrastructure to support it - is somewhere between two trillion and
four trillion dollars; assuming the bubble can get started, the
hyperinflated fictitious value could add another twelve trillion
dollars. In a hyperinflation, infrastructure upgrades will accelerate,
with plenty of opportunity for big government contractors fleeing the
declining market in Iraq. Thus, we can expect to see the creation of
another eight trillion dollars in fictitious value, which gives us an
estimate of twenty trillion dollars in speculative wealth, money that
inevitably will be employed to increase share prices rather than to
deliver "energy security". When the bubble finally bursts, we will be
left to mop up after yet another devastated industry. FIRE, meanwhile,
will already be engineering its next opportunity. Given the current
state of our economy, the only thing worse than a new bubble would be
its absence.

Notes:

{1} I will use the familiar term "bubble" as a shorthand, but note that
it confuses cause with effect. A better, if ungainly , descriptor would
be "asset-price hyperinflation" - the huge spike in asset prices that
results from a perverse self-reinforcing belief system, a fog that
clouds the judgment of all but the most aware participants in the
market. Asset hyperinflation starts at a certain stage of market
development under just the right conditions. The bubble is the result of
that financial madness, seen only when the fog rolls away.

{2} Historians argue whether the Federal Reserve and Congress did enough
soon enough to slow the rate of debt liquidation at the time. Most agree
that once the inflation rate turned negative, monetary stimulus via
short-term interest-rate management was ineffective, since the Fed could
not lower short-term rates below zero percent. The Bank of Japan found
itself in a similar predicament sixty years later.

{3} The motivation was in part political: the Saudis, Japanese, and
Taiwanese hold a great portion of US debt; not coincidentally, these
nations receive military protection from the United States.

{4} Venture-Capital firms are defined by when, not where, they place
their investments; a "seed stage" firm usually puts the first money into
very young firms and takes an active role in that investment. Jeffrey
Osborn was a senior executive at commercial Internet provider UUNet
before and after the legislation passed. Prior to the legislation,
bookings were less than four million dollars a year; a few years later
they were greater than two billion dollars.

{5} Fictitious value is the delta between historical-trend growth and
growth brought on by asset hyperinflation. As an anonymous South Sea
Bubble pamphleteer explained: "One added to one, try any rules of vulgar
arithmetic, will never make three and a half; consequently, all the
fictitious value must be a loss to some persons or other, first or last.
The only way to prevent it to oneself must be to sell out betimes, and
so let the Devil take the hindmost."

{6} As happens with most bubbles, a perfectly good idea is taken to an
extreme. In the case of the housing bubble, the new securitized debt
product that drove the final stage - which has come to be known as the
"subprime meltdown" - was the collateralized debt obligation (CDO). A
CDO is a class of instrument called a credit derivative; specifically, a
derivative of a pool of asset-backed securities. Parts of pools of
asset-backed securities that were, for example, rated at a moderately
high risk of default - junk grade, such as BB - were modeled, packaged
into CDOs, and rated at lower risk-investment grades, such as AAA. These
were used to finance the more creative mortgages - stated-income or
"liar loans" - which we now hear are not quite living up to the issuers'
hopes.

{7} To create these valuations, I first examined the necessary market
capitalization of existing companies; then, using the technology and
housing bubbles as precedents, I estimated the number of companies
needed to support the bubble. The model assumes the existence of nascent
credit products that will eventually be deployed to fund the
hyperinflation. While the range of error in this prediction is obviously
huge, the antecedents - and more important, the necessity - for the
bubble remain.
_____

Eric Janszen is the founder and president of iTulip, Inc He formerly
served as managing director of the venture firm Osborn Capital, CEO of
AutoCell, Inc and Bluesocket, Inc, and entrepreneur-in-residence for
Trident Capital.


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