Herd mentality rules in financial crisis

WASHINGTON Tue Sep 30, 2008 10:28am EDT

Traders gather at the Bank of America kiosk on the floor of the New York Stock Exchange in New York, September 24, 2008. REUTERS/Brendan McDermid

Traders gather at the Bank of America kiosk on the floor of the New York Stock Exchange in New York, September 24, 2008.

Credit: Reuters/Brendan McDermid

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WASHINGTON (Reuters) - Herd mentality rules during a financial crisis because people are wired to follow the crowd when times are uncertain, experts say.

Brain and behavior studies clearly show that when information is scarce and threats seem imminent, people often stop listening to their own logic and look to see what others are doing.

"People are afraid, and the reason they are afraid is there tremendous uncertainty right now in the markets," Gregory Berns, a neuroeconomist at Emory University in Atlanta who studies the biology of economic behavior, said in a telephone interview.

Berns puts people in magnetic resonance imaging or MRI scanners while he tests their responses to various scenarios, and studies patterns of their brain activation.

One clear pattern -- the brain's "fear center" lights up when people are uncertain.

"When people are presented with a situation where they don't have information or the information is ambiguous, we see activation of the amygdala and insula," Berns said in a telephone interview.

And people begin to doubt their own judgment.

Bern's team did an experiment in which they recruited actors and true volunteers. "One real subject went into a (MRI) scanner," he said.

They were asked to do a simple task, assessing shapes.

"We had the group (of actors) tell them the wrong answer sometimes," Berns said.

The volunteers began to change their answers to match what the group said. Perhaps they were merely overriding their own judgments for the sake of getting along, Berns said. But the scanner suggested another explanation.

RUNNING WITH THE HERD

"The group changes how you see the world in some way," he said.

"Our brains are really wired to accept the group opinion of the world."

In this case, running with the herd may not make good sense, said Paul Zak of the Center for Neuroeconomics Studies at Claremont Graduate University in California.

"There is this sort of herd mentality over-reaction," Zak said in a telephone interview.

"One of my colleagues actually pulled his money out of Washington Mutual a few weeks ago. He ought to know better."

The U.S. government has taken over mortgage finance companies Fannie Mae and Freddie Mac, Lehman Brothers Holdings Inc has gone bankrupt, giant savings and loan Washington Mutual failed and Bank of America Corp bought Merrill Lynch & Co Inc.

The U.S. House of Representatives rejected a $700 billion bailout on Monday, sending stock markets crashing globally.

Zak said the reactions are illogical. "I see no evidence that a depression is coming but it seems like people are behaving that way," he said.

The reason is evolution, Zak said. "We are really hyper-social apes. We learn almost exclusively from each other," he said. "Gossip is really important because it is another way that we learn socially. Separating out rumor from fact is difficult, particularly in these complex markets."

Berns, whose book "Iconoclast" comes out this week and aims to teach people how to avoid this herd behavior, declined to dispense advice on weathering the current market.

"I am not a financial genius. I do know that when you see millions of people in the market essentially freaking out, that spills over into your brain and you get this impulse to do what everyone else is doing," he said.

Zak knows what he is doing. "I am buying stocks," he said.

(Editing by Will Dunham and Jackie Frank)

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