Transcript
Page 2: 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

Page 3: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Extraordinary Popular Delusions and the Madness of Crowds, by Charles MacKay, published in 1841.

Page 4: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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.

Page 5: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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).

Page 6: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Herd behaviour is very often natural and individually rational. But it has the potential to be disastrous for the group.

Page 8: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

On a technical note

To economists and any mathematicians here:

Page 9: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

On a technical note

To economists and any mathematicians here:

I have in mind a class of problem where utility depends on relative actions.

Page 10: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

A general point about the mathematics of imitation

Page 11: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

A general point about the mathematics of imitation

Caring about relative things is not sufficient to give us Keeping-up-with-the-Joneses.

Page 12: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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.

Page 13: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Then if v is concave (convex) in status, it is rational to act similarly to (deviantly from) the herd.

Page 14: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

The main point can be made without any mathematics.

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Subconsciously, humans are frightened of falling behind:

Page 16: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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.

Page 17: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

When rewards depend on your relative position

it will routinely be

Page 18: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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.

Page 19: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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.

Page 20: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Hence the pressures for conformity are strong.

Page 21: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

To students here

These psychological forces are powerful and will come around again, a number of times, in your lifetime.

Page 22: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

• Now to house prices, which started our problems.

Page 23: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Real house prices in the United States over the century

Page 24: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Real house prices in the UK 1975-2006

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So all the historical data suggested that house prices were unsustainable.

Page 26: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Yet -- even two or three years ago near the peak -- few people spoke up about the apparent likelihood of a crash.

Page 27: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Plus continuing propaganda:

13 December 2006

“House prices will continue to rise over the next two years.”

Council of Mortgage Lenders

Page 28: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

One of the simplest principles

Page 29: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

One of the simplest principles

In most systems, including economic ones, there is a tendency to go back to trend.

Page 30: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

The tendency to trend-reversion

Page 31: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

This has a good side to it.

We will bounce back even if we have a few rather bad years after this one.

Page 32: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Excessive gloom can create herd behaviour and over-shooting in the negative direction

Page 33: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Excessive gloom can create herd behaviour and over-shooting in the negative direction (just as it did in the upward direction).

Page 34: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

But we do need some lean years

Page 35: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Trying to sum up

Page 36: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

1. For economists, I believe we will have to integrate herd behaviour into our subject.

Page 37: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

2. For students, it may be helpful to you to remember that the madness of crowds will be back in your lifetime.

Page 38: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

2. For students, it may be helpful to you to remember that the madness of crowds will be back in your lifetime.

Page 39: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

3. For citizens, herd behaviour means more regulation is required.

[because there are spillover ‘externalities’ across people]

Page 40: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

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.

Page 41: Herds, Houses and the Crisis* Andrew Oswald *Many thanks to Danny Blanchflower and Amanda Goodall for valuable ideas

Herds, Houses and the Crisis*

Andrew Oswald

*Many thanks to Danny Blanchflower and Amanda

Goodall for valuable ideas.