Herds, Houses and the
Crisis*
Andrew Oswald
*Many thanks to Danny Blanchflower and Amanda
Goodall for valuable ideas.
• "Men … think in herds; they go
mad in herds, … they only
recover their senses slowly,
and one by one."
C. Mackay
Extraordinary Popular Delusions
and the Madness of Crowds, by
Charles MacKay, published in
1841.
Extraordinary Popular Delusions
and the Madness of Crowds, by
Charles MacKay, published in
1841.
Far from the Madding Crowd, by
Thomas Hardy, published in 1874.
Extraordinary Popular Delusions
and the Madness of Crowds, by
Charles MacKay, published in
1841.
Far from the Madding Crowd, by
Thomas Hardy, published in 1874.
(in which a herd of sheep plunge to their doom from a cliff).
Herd behaviour is very often
natural and individually
rational. But it has the potential
to be disastrous for the group.
Herd behaviour is very often
natural and individually
rational. But it has the potential
to be disastrous for the group.
On a technical note
To economists and any
mathematicians here:
On a technical note
To economists and any
mathematicians here:
I have in mind a class of
problem where utility
depends on relative actions.
A general point about the
mathematics of imitation
A general point about the
mathematics of imitation
Caring about relative things is not
sufficient to give us Keeping-upwith-the-Joneses.
Imagine a person is choosing an
action a to solve:
Maximize u(a) + v(a – a*) – c(a)
where a* is what everyone else is
doing.
Then if v is concave (convex) in
status, it is rational to act similarly
to (deviantly from) the herd.
The main point can be
made without any
mathematics.
Subconsciously, humans are
frightened of falling behind:
Subconsciously, humans are
frightened of falling behind:
• Home buyers paid extraordinary prices
in order to keep up.
• Bank lenders and brokers felt they had
to match rivals.
• Money managers -- rewarded on
relative performance against other
managers -- copied what the others did.
When rewards depend on your
relative position
it will routinely be
When rewards depend on your
relative position
it will routinely be
(i) dangerous to question whether the
whole group’s activity is flawed
(ii) rational simply to compete hard
within the rules that govern success.
When rewards depend on your
relative position
it will routinely be
(i) dangerous to question whether the
whole group’s activity is flawed
(ii) rational simply to compete hard
within the rules that govern success.
Before the dotcom crash, the analysts
who got sacked were the ones who
correctly said this bubble cannot last.
Hence the pressures for
conformity are strong.
To students here
These psychological forces are
powerful and will come around
again, a number of times, in
your lifetime.
• Now to house prices, which
started our problems.
Real house prices in the United
States over the century
Real house prices in the UK 1975-2006
So all the historical data
suggested that house prices
were unsustainable.
Yet -- even two or three years
ago near the peak -- few people
spoke up about the apparent
likelihood of a crash.
Plus continuing propaganda:
13 December 2006
“House prices will continue to
rise over the next two years.”
Council of Mortgage Lenders
One of the simplest principles
One of the simplest principles
In most systems, including
economic ones, there is a
tendency to go back to
trend.
The tendency to trend-reversion
This has a good side to it.
We will bounce back even if
we have a few rather bad
years after this one.
Excessive gloom can create
herd behaviour and overshooting in the negative
direction
Excessive gloom can create
herd behaviour and overshooting in the negative
direction (just as it did in the
upward direction).
But we do need some lean years
Trying to sum up
1. For economists, I believe we
will have to integrate herd
behaviour into our subject.
2. For students, it may be
helpful to you to remember that
the madness of crowds will be
back in your lifetime.
2. For students, it may be
helpful to you to remember that
the madness of crowds will be
back in your lifetime.
3. For citizens, herd behaviour
means more regulation is
required.
[because there are spillover
‘externalities’ across people]
Points to take away
We need to integrate herd
behaviour into economics.
The madness of crowds will be
back.
Herd behaviour means that
some regulation is required.
Herds, Houses and the
Crisis*
Andrew Oswald
*Many thanks to Danny Blanchflower and Amanda
Goodall for valuable ideas.