THE BLOG
01/19/2011 05:00 pm ET Updated May 25, 2011

Be Warned: The Facebook Bubble Is Coming

Whenever Goldman Sachs gets involved with anything, you can rest assured it will end badly. Having played a key role in bankrupting the country through massively risky investments and possibly criminal trading activity, the investment bank Matt Taibbi aptly refers to as a 'Vampire Squid wrapped around the face of humanity' is now getting involved with Facebook.

Goldman Sachs is now offering its clients a way of investing in the social network -- a private company that only trades on secondary markets (where original stakeholders sell their shares in the company) -- after it invested $450 million of its own money, giving it a valuation of $50 billion.

There are a couple of points worth making about this investment.

Firstly, the $50 billion evaluation of the company is completely ridiculous. Facebook generated $1.86 billion in revenue last year, so its price to sales ratio is an astonishing 25. As Stephen Gandel of Time Magazine notes:

NYT's Dealbook says Facebook has $2 billion in revenue. That might be high. Our own reporting at TIME, for Zuck's Person of the Year story, put Facebook's revenue in 2010 anywhere between $1.1 billion to $2 billion. Still, even if you go with the high-end of our scale, as Dealbook seems to have done, the recent Goldman & Co. investment gives Facebook a price-to-sales ratio of 25. Is that high? It appears so. Apple has a price/sales ratio of 4.5. Even Google's price/sales ratio is just under 7

Goldman's investment is basically inflating the price of Facebook to an unprecedented scale. While Facebook certainly has an X-Factor, investors should show a little caution in translating that into untold amounts of money. Simon Johnson writes:
Social networking is a bubble in the sense that email was a bubble.  The technology will without doubt change forever how we communicate with each other, and this may have profound effects on the nature of our society.  But investors will get carried away, valuations will become too high, and some people will lose a lot of money.

Goldman Sachs routinely leads the way in creating new markets for its investors to bet on (and yes, I mean bet), and more often than not, these new markets can either crash spectacularly or have devastating social consequences. If Goldman was using its own money that would be one thing - while it deserves immense amounts of criticism for its risky investments and illegal activities, it would at least reap what it sows.

But Goldman Sachs holds a unique status in America.

As Johnson writes:

It [Facebook] has effectively become a new form of Government Sponsored Enterprise.  Goldman is not a venture capital fund or primarily an equity-financed investment fund.  It is a highly leveraged bank, meaning that it borrows through the capital markets most of the money that it puts to work.

In other words, Goldman Sachs is inflating the price of Facebook using the US tax payer as insurance. It borrows money to invest (or create new bubbles) knowing full well that if anything goes wrong, uncle Sam will be there to clean up the mess.

The likelihood is that we are experiencing another tech bubble akin to the dot-com bubble in the late 90's early 2000's. As DealBook points out:

Dealogic data shows that the number of technology deals -- more than 5,100 so far this year -- is at its highest point since the year 2000. Back then, in the peak year for Internet deal-making, there were 7,007 technology mergers and acquisitions.

We obviously cannot be sure, but the indicators are there, and the warning is worth listening to. And if it is correct, the economic consequences will be as dire as they were 10 years ago, and the human toll no less tragic.

And as usual, Goldman Sachs is right at the helm, herding the cattle to the edge of the cliff knowing full well it can never fall off itself.

Ben Cohen is the founder of BanterMediaGroup.com and Editor of TheDailyBanter.com