Taking Stock / Can we quit our addiction to rock-bottom interest rates?
1 Why it's dumb to make predictions. What is the first thing to pop into your head when you read about the starward leap of LinkedIn stock on Wall Street last week? That it's the short play of the year? LinkedIn's company value is $10 billion. Yet it's expected to lose money this year. That value is 40 times its revenues for the year. So you may think the best bet in town is to borrow shares of LinkedIn, sell them while they're still high and then wait for the inevitable fall, six months or so down the line. Then you'll swoop down and scoop up shares for cheap to repay your broker, feathering your nest with the proceeds.
If you did, you weren't being terribly original. Every snot-nosed fledgling trader, from Wall Street to London to Tel Aviv, had the same idea.
No question about it, $10 billion is a wondrously bloated, not to say insane, value for LinkedIn. But good luck finding anyone who willing to lend you the company's shares to sell so you can short it. One of the main reasons for its meteoric leap after the initial public offering was that LinkedIn offered so few shares for sale to the public.
Of course, the outcome of its flotation reawakened the debate over whether another dot.com bubble is developing on Wall Street, a la 2000. One might well think so. The ratio between the market caps of companies such as LinkedIn, Facebook and Twitter and their revenues are reminiscent of the multiples during the maddened Internet bubble days on Nasdaq.
But reality is more complex. 2011 is not 2000. Facebook, Twitter and a few others achieved tremendous valuations because they are dominant players in their field. They have practically no competition. In 2000, there were dozens of companies eating each other's lunches, until nothing but crumbs was left for any of them.
Contributing to the inflated values of many Internet companies is the arms race among the three titans of the Internet: Microsoft Corp., Google Inc. and Apple Inc. Each has war chests with tens of billions of dollars, and does not hesitate to swallow any company they think might give their rivals a technological (or marketing ) edge.
How will all this end? Who will win?
We don't know, and we would do well to avoid the pitfalls of prophesy. Our visit to Silicon Valley in 2007 comes to mind. One day we met three men who had founded social-networking startups: Max Levchin, Mark Pincus and Reid Hoffman. The multiplicity of social-network entrepreneurs led us to suspect a bubble was forming. That was our first mistake.
Levchin was the most impressive and articulate of the three. We predicted great things for him. Two years later he had to sell his startup to Google for a price that was considered downright embarrassing - under $250 million. Pincus, who came off like a jaded serial entrepreneur, is about to float his Facebook games company Zynga at a company value of at least $5 billion.
During the same visit, late in 2007, we also met with the CEO of LinkedIn, to whom we mentioned the rumors that Rupert Murdoch wanted to buy the company for a few hundred million dollars. That seemed a ridiculously high value. Suddenly this sweet guy, very plump, popped up out of nowhere, mumbled something incomprehensible and floated on, smiling in all directions. "That's Reid Hoffman. He's the founder," said the CEO indulgently.
If someone had told me back then that this man's chunk of the company would be worth $2 billion within a few years, we'd have raised an eyebrow. Good thing that no one said anything that odd, and that no eyebrows were raised.Cheap money, the promise and the plague
2 There's another reason for the remarkable leap in LinkedIn stock: the cheap money flooding Wall Street. We received a reminder of just how toxic and addictive that cheap money is last week, when Stanley Fischer, the governor of the Bank of Israel, announced another interest rate hike, from 3% to 3.25%. A few minutes later the Manufacturers Association of Israel responded with howls of protest, noting predictably that interest rates in the United States and in Europe remain close to zero.
The problem, of course, is with the yardstick against which the manufacturers view Fischer and Israeli interest rates. In fact, the latest hike brings the short-term interest rate, adjusted for inflation, to zero. (The 3% rate did not keep pace with inflation, meaning that the real interest rate, after adjustment for inflation, was negative. )
Over the past year, the Bank of Israel interest rate rose from 2% to 3.25%; during that time, inflation in Israel ran at 4%.
Inflation is expected to run anywhere from 3% to 4% over the next 12 months. As a result, the real (inflation-adjusted ) inflation rate will be zero, at best, and it could go into negative territory again.
The leap in local real estate prices in the past two years and the tremendous swelling of asset prices on the stock exchange, both of which propelled the Israeli economy forward, are a function of the low rate of interest. Property values and businesses have become addicted to low interest rates.
Low interest rates have distracted us from the fact that large swaths of the business sector remain mired in debt, in the wake of the credit spree of 2005-2008. We received a sharp reminder of that borrowing extravaganza at the beginning of last week, when Elbit Imaging stock and bonds crashed on reports that owner Moti Zisser and Bank Hapoalim were in disagreement over whether the company was in breach of its covenants.
Not only Elbit Imaging stock tanked. So did shares of a host of real estate and holding companies: Investors suddenly remembered how dependent Israel's tycoons are on enormous credit leverage - borrowed money - and on the low interest rates of recent years.
3 Stanley Fischer is responsible for stable prices, economic growth and full employment. The problems of Israel's over-extended tycoons are not his fief: He doesn't have to, and shouldn't, solve them by keeping interest rates low for their convenience.
In the last Bank of Israel report, Fischer repeated the danger posed to the stability of the entire economy by a handful of gigantic business groups owing tens of billions of shekels. That time bomb can only be defused through profound structural reform of the capital market. Regulation and rules and supervision can only do so much.
And what is the state of the global financial system? Pretty awful, thanks for asking, especially in Europe. For better or worse, as far as the Greeks are concerned, the financial press has been obsessing over the banker who loves women. As the rest of the world, including his wife, focuses on Dominique Strauss-Cohen's extracurricular hobbies and his special marriage with Ann Sinclair, Greece has been relegated to the inside pages.
So what is going on in Greece? Oh, just complete and total bankruptcy, looming larger by the day. The body supposed to lead the way out of the morass is the International Monetary Fund, which, as we said, has more important things on its mind at the moment.
What's our position on DSK? We don't have one, but will settle for those of an international businessman and his wife, who know him. When the lady was cautiously asked for her opinion, she chided the global press for hastening to conclusions. Her husband, asked the same question, had a more technical take on the matter. He said that Dominique was apparently going to be remembered as one of the best managers the IMF ever had, "but he had another side to him, which we didn't know so well." Now we do.