TCS Daily


Will High-Tech Bankruptcies Start the Next Recession?

By Kevin Hassett - December 18, 2000 12:00 AM

Last week, I clicked over to Petopia.com to do a little last minute Christmas shopping for my dogs Rusty and Penny. I was rather wistful as I browsed through the Nylabones (liver flavored or chicken?) because I really would have preferred to be shopping at Pets.com. If you type in that address, you are hit with the news that "PETsMART.com has purchased the Pets.com URL." As just about everybody knows by now, Pets.com has failed.

Pets.com was the Internet business of the year for many observers. Their sock puppet advertisement was pure genius, and the optimism created by their clever marketing propelled the share price to $14 last spring. At that point, the company was worth a whopping $478 million. Today, there is nothing left. With a burn rate worthy of a Saturn 5 -- TV is quite costly, after all -- they just ran out of money. And they are not alone. A Who's Who of dot-com failure now includes Mortgage.com, Carorder.com, Furniture.com, Eve.com, and so on.

In my last column, I argued that the information technology revolution has had two significant impacts on our economic structure that have a direct impact on the probability of a recession. First, the chances of a deep recession have been reduced by increased flexibility. No need to hoard inventory when your production facility can turn on a dime. The flipside is, however, that forward-looking investors have created a swarm of companies with no profits. These firms are likely to be less able to withstand weak economic conditions, so an oil shock, for example, might hit the high-tech firms harder than the measles hit Native Americans in the days of the Conquistadors.

The demise of Pets.com and its brethren suggests that a bankruptcy wave is underway. The question is: Will the wave be significant enough to push us into a recession?

The question is important enough that I will deal with it in two parts. This column will discuss how to think about bankruptcies and recessions, and the next will crack open the data.

A recession can come either from the labor side or the financial side. A labor-side recession is started when firms layoff many workers. If the workers spend a long time without jobs, their consumption declines, and a downward spiral begins.

There are no signs that a labor-side recession is on the way. The unemployment rate has stayed relatively low, and details below the surface are very promising. For example, if unemployment remains constant in a month because nobody anywhere in the economy was fired and nobody anywhere was hired, that says one thing. If, on the other hand, the unemployment rate stays constant because a million people were fired and a million people were hired, that says something quite different. In the first case, we would say that the economy might well be suffering from labor sclerosis, with everyone stuck in one place. In the second, which accurately describes our recent experience, we might say that the economy is extremely vibrant, with workers playing musical chairs until they find the most efficient fit.

The increasing number of high-tech bankruptcies and layoffs is not causing trouble because healthy high-tech companies have been sitting on vacancies for some time, and a new wave of qualified workers is exactly what they need. Everybody who lost his or her job when Pets.com closed down likely has a job already.

A financial-side recession is more of a threat. Here is how it would go. Bankruptcies from the Pets.coms of the world ravage lenders, who then would decide not to lend money to quality businesses. Good companies then go under, since they can't find the cash needed to ride out the bad times. Then the cycle begins again. Venture capital may also dry up, and new firm would no longer pop up to replace those that disappear.

Is such a cycle underway? Not as far as I can tell. Things are starting to go severely sour when firms that have obvious healthy profits in their future show up at the funeral parlor. Nothing close to that is happening. Sure there are some losers, but that is always true. I am not concerned that Pets.com went under, because they were attempting to survive in a notably competitive area - retailing -- and they were spending money faster than a trophy wife.

If great firms like Doubleclick or Yahoo! start to have trouble meeting payroll because of cash shortages, and then that impacts Cisco, then we will be looking at a mess.

In my next column, I will gather together the indicators that will help us detect whether a negative financial cycle is beginning.

(Click here to visit Rusty and Penny.)
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