by Hadley Robinson
Remember when a huge economic recession hit America six years ago, gutting people’s savings and pensions and causing unemployment to soar? Well, if you’re new to San Francisco or Silicon Valley, chances are you don’t.
New skyscrapers are thickening the downtown skyline. Rents are astronomical — the worst in the country, and the thought of buying a house anywhere in the region is a joke to anyone who doesn’t work for Mark Zuckerberg. More people are employed in San Francisco than in any time in the city’s history. This boom is fueled by an influx of new residents — young engineers and others working in the tech sector for big salaries. The tech sector has accounted for 27 percent of job growth in SF since 2010, according to a recent report.
Meanwhile, the rest of the country is struggling to climb out of the recession. U.S. GDP — which accounts for the total value of American goods and services—is trending downward. Los Angeles, Las Vegas, Chicago, NYC all have higher unemployment rates than the Bay Area.
Those two things — a weak national economy, and a booming tech industry — are linked. The economic slowdown is what has allowed tech to boom. Think billion dollar valuations of companies like Instagram, SnapChat and WhatsApp. I’ll explain why.
The nation’s central banking system, the Federal Reserve, controls interest rates to help regulate the economy. After the big crash in 2008, it set interest rates to zero. The idea is that when loans have no interest, it loosens people up to borrow and spend, stimulating the economy. The interest rates hovered around 5 percent before the economy crashed.
“Exactly what the Fed is trying to do is to get people to take on more risks; trying to make safe stuff a bad deal to chase people to do other things with their money,” said Josh Bivens, research and policy director at the Economic Policy Institute.
Those interest rates might be nominal to the average person, with a marginal impact on your ability to secure loans. But for richer companies, hedge funds, and investors, it’s not smart to leave money in savings when there’s no interest. It’s better to invest in something that might have a high payoff. So where can they spend it?
Housing and real estate are not great investments now in most parts of the country because there is still too much inventory, and that overbuilding (and overlending) was a main facilitator of the crash in the first place. Manufacturing is still struggling to make money too. So people have turned to tech. Lots and lots of tech.
Venture capitalist Fred Wilson wrote last year about the impact of having interest rates set at zero — and how that has encouraged risk.
“Valuations are at extreme levels because you cannot get a decent return on your money doing anything else,” Wilson wrote. “It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low.”
Venture capitalists — those lenders who look to invest in an early-stage company in hopes that it will be the next Uber, Airbnb, Facebook — are pouring money into tech companies. Billion-dollar companies, known as “unicorns” for their rare qualities, are springing up more often. In January 2014, there were 42 venture-backed-companies worth more than $1 billion. Now, there’s more than 100, according to the WSJ.
Many tech companies attracting investment are not yielding a profit. And, as another venture capitalist argues, many employees at those companies, the same people buying up real estate across San Francisco and Silicon Valley, may not realize the risk they’re taking.
“An employee’s decision to work for a company that is losing money is an implicit decision to discount risk,” wrote Bill Gurley.
He continued: “And as more and more people make that decision, the risk is constantly increasing. No one makes the implicit decision, ‘I am going to go to work for a money losing company!’ However, slowly over time, a large portion of the employees in the area inherently are. And then, when the bubble bursts, the consequences are far greater.”
So what happens when the economy improves and the Fed raises its interest rates again (as many expect to happen in the near future)? Bivens doesn’t think it will have quite the national effect that the housing bubble caused.
“When I look at a lot of tech companies, they look bubbly and overvalued to me. But it has not reached a point where it’s affecting overall stock market valuations,” he said.
But the local economies where tech is thriving might be another story. A report from SPUR, a San Francisco planning advocacy group, said economists are watching closely the risk of changes to interest rates. “The investment pouring into the Bay Area is partially motivated by historically low federal interest rates,” the report reads.
If rates are increased: “This will certainly have an effect on consumers, businesses and financial markets, as well as on the steam of local investment — increasing the cost of borrowing money for projects and opening up alternatives outside the Bay Area for investors.”
Even if venture capitalists stop investing as much in tech, it is unlikely to gut local economies that have thrived. It just might mean tech companies will take away some of those employee free lunches or other perks, or maybe they’ll trim their number of employees.
If you’re in tech, this might be bad news. But if you’re not, well, an affordable apartment may finally be in your reach. Maybe.
