In Case Of Tech Bubble, Do Not Break Glass

Even if bloated valuations of Facebook and Groupon point to another bubble bound to burst, the Fed shouldn't head it off but prepare for the fallout

In Silicon Valley, it's beginning to feel like déjà vu all over again. Much as in the early-to-mid-90s, a euphoria is surrounding new consumer technologies. Then, it was early Internet software, such as Netscape, and such dot-com darlings as eBay (EBAY) and Yahoo! (YHOO). Now the excitement involves mobile devices such as Apple's iPhone and iPad and social network services such as Facebook.

Tech valuations are once again soaring: Apple (AAPL) recently became the second most valuable company in the world, behind ExxonMobil (XOM), with a market cap of $305 billion. Even more striking is the $50 billion valuation that private investors have placed on Facebook. Groupon, a cyber-coupon company, turned down a $6 billion takeover offer from Google (GOOG) last month, and it's now considering an IPO that could reach $15 billion. "We may be on the cusp of another technology-driven boom," says Erik Brynjolfsson, director of the MIT Center for Digital Business.

Or another tech bubble. The last one ended badly—for stockholders, when the tech-heavy Nasdaq index fell from more than 5000 in March 2000 to 1100 in late 2002, and for everyone else in the recession that followed. Now, as investors grow giddy again, odds are the Federal Reserve Board will confront far sooner than expected one of the most difficult and divisive issues in central banking: Should it attempt to deflate an asset price bubble before it grows large enough to threaten the financial system and economy when it pops?

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