The Outlook
PALO ALTO, Calif.
Last week's sell-off in technology shares jangled nerves in Silicon Valley. Elsewhere, economists debate whether falling stock prices could trigger a national recession by damping consumer spending. But when it comes to Silicon Valley, there's little room for dispute these days: Lower stock prices, particularly on the Nasdaq market, could provoke broader economic woes.
In fact, many economists expect the next Silicon Valley recession will come courtesy of Wall Street, not Main Street. That's because "until the mid-1990s, we sold products," says Richard Carlson, an independent Palo Alto economist. "Now, we sell stocks."
In the past five years, the region has indeed shifted from producing goods to incubating ideas, many of which have been richly rewarded in the stock market. Consider Seagate Technology Inc., a maker of disk drives that last week announced a privatization plan to "unlock" the value of its stake in a software company that has revenue equal to only one-tenth of Seagate's but that is valued at many times more than Seagate's core business.
Stock-based rewards have always been part of the Silicon Valley dream. But they have taken on outsize importance amid the flood of Internet-related initial public offerings. Last year, 120 Bay Area companies went public, up from 36 in 1994. On average, their share prices had more than doubled by the end of the year.
The resulting gains have become an important lubricant in the regional economy. Joe Mattey, a researcher with the Federal Reserve Bank of San Francisco, estimates that 80,000 employees of Bay Area companies that went public between 1997 and 1999 gained an average of $700,000 each on stock options.
Mr. Mattey's figures don't include the big run-ups in the stocks of icons such as CiscoSystems Inc. and Intel Corp. Nor do they include the $13.4 billion that venture capitalists lavished on Bay Area entrepreneurs last year, up nearly threefold from 1998 and more than eightfold from 1995.
Add it all up, and the result, in the words of Mr. Carlson, is "a bottomless pit of capital, huge beyond our wildest dreams."
Sales at Allison BMW in Mountain View have risen more than 20% a year for the past five years. But sales manager Rick Gebers frets that two-thirds of his customers pay cash, up from one-third three years ago, cutting into his lucrative leasing business. Mr. Gebers has presold 85% of the cars he expects to be delivered in May. There's an 18-month wait for the $69,000 M5 sedan.
Meanwhile, housing prices have soared beyond the reach of anyone without stock options. The median price for a single-family home in Santa Clara County, the heart of Silicon Valley, reached $467,500 in February, up 32% from a year earlier.
Richard Green, a professor of real estate at the University of Wisconsin, says those prices are nearly dictated by the stock market. In a study published last fall, Mr. Green found that every 1% increase in the Russell 2000 index of small-cap stocks between January 1989 and July 1998 resulted in a 0.88% increase in Silicon Valley housing prices a year later. He found no similar correlation in Southern California.
It wasn't always this way. Hard as it may be to remember, Silicon Valley does have economic cycles. Past downturns were triggered by real slumps in demand for the products made here: a sharp plunge in chip sales in 1985-86 and a general downturn in demand-compounded by the end of the Cold War-in the early 1990s.
In a sense, Silicon Valley has already survived its crucible of falling demand -- in the form of the Asian economic crisis that began in late 1997. As exports declined, some sectors of the region's economy did shrink. Total employment in the valley stagnated between mid-1998 and the end of 1999. But the Internet sector was growing so fast that hardly anyone noticed.
Now, that may be changing. Online retailers report trouble raising money, as venture capitalists warily watch the 80% decline in stocks such as eToys Inc. and CDnow Inc. Even marquee names such as Yahoo! Inc. and Amazon.com Inc. are down more than 30% and 40%, respectively, from their peaks.
Economists worry about the region's economy if the sell-off continues and spreads to the top-tier tech names. Many Silicon Valley workers are paid largely with stock, so falling share prices are akin to shrinking paychecks. Mr. Green says a big downturn in tech stocks "could very well lead to falling house prices in the Bay Area." As homeowners see their equity diminish -- or even disappear -- they would curtail spending and default on some loans.
No one expects a rash of foreclosures as beset Texas in the 1980s and Southern California in the early 1990s. Prices have gone up so quickly that only the most recent buyers would be in jeopardy of losing their homes. And some economists think that lower house prices would actually help the economy by making the region more affordable for more workers. Mr. Mattey, for example, says he isn't worried about the region's economy.
But he concedes that a sustained market downturn would mean "reduced job creation ... and more job destruction."
Surveying his lot of BMWs, Mr. Gebers says he isn't panicking. But he admits to watching the market carefully because "values are inflated," particularly for Internet stocks. "If nothing else," he says, "this is a wake-up call to re-evaluate."
-- Scott Thurm