Of crowds and irrational behaviour


Neuroscientists have uncovered the physiological basis for two of the most basic responses to human behavior, especially when it comes to behavioral economics: greed and fear. These are the two impulses that drive money, markets, and even religion.

According to science, the limbic system, which divides the brain into the right and left hemispheres, is triggered by external stimuli transmitted through the temples on the forehead and behind the eyes.

However, the analysis in the brain very rarely follows rationality. Rather, it follows our own “rationalization” of reality and not reality itself.

That difference will be profound if we just analyzed our answers. The brain is more receptive to stories or narratives than numbers and cold dates, so a story is more likely to be accepted and manipulated than a table of numbers.

In rationalist terms, the latter should guide us more, but the fact is just the opposite.

In a finely written new book, The Delusion of Crowds, William J. Bernstein, author of earlier titles such as Rational Expectations and The Intelligent Asset Allocator, discusses the reasons behind crowd behavior or the herd mentality in a logical analysis of various events in recent history.

Tables versus stories

He does not derive any definitive conclusions, but after reading the book one realizes the need to focus more on data than prints, tables than stories, statistics than stories.

The ideal result is when we can both balance in our brain / mind and then come to conclusions.

Most of the time, however, the crowds that we all belong to – whether in an office conference room or in an economic, political, or religious community – tend to pick up narrative that leads to inadvertent irrational behavior or rationalized behavior that conforms to our intuition.

Herd frenzy

This can be called the herd mentality, but the cases Bernstein cites have repeated so many times in history that it is not just a “mentality” but delusions that the masses suffer from.

Otherwise, healthy people tend to go crazy in groups. This happens with religion as well as with the stock markets.

Booms and busts over the past four centuries and religious waves, benign or malignant, are all due to this characteristic of human behavior.

The subject is not exclusive to the 21st century. In 1841, the Scot Charles Mackey penned Memoirs of Outstanding Popular Delusions which recounted several episodes of mass delusions related to religion or money. It has been popular reading on the subject ever since.

Bernstein states in the Prelude that “people do not use the powerful human intellect to dispassionately analyze the world, but to rationalize how the facts coincide with their emotionally derived perceptions”.

Irrational past

It is stated that Mackey himself was a victim of the UK stock market craze in 1843, when investors saw the railroad lines grow from 2,000 to 5,000 miles and thousands more that were planned but never built in 1848. The shares of thousands of investors went broke. Mackey was one of them !. Those familiar with the stock market would have heard of the Dutch tulip craze of the 1630s (when investors were betting high on tulip bulb prices) and the double stock market bubbles in Paris and London in 1719-20.

Busts and crowds

The dotcom bust at the beginning of the century and the collapse in 2008 are recent examples of the great delusions of crowd behavior. The brightest and best minds lost money even when they appeared to act according to mathematical models based on rational principles. The line between the rational and the rationalized is quite thin indeed, and what is amazing is that this trend tends to repeat itself.

The religious madness of the Crusades and contemporary tendencies in Islam (and in Hinduism on a political level) prove the theory that “rationality” of behavior and thought is, as the author puts it, “a fragile lid, dangerous on the bubbling kettle of balanced is craftsmanship and self-deception ”.

The press (media) and politicians are not too small actors in this drama and are driving the mania to its logical conclusion. Technology and the availability of cheap money are factors that have recently driven these trends. Fiat money (which is where the currency is printed with no reserve) makes it extremely expedient for bubbles to form and flourish. Before the inevitable bust comes.

It is interesting to note that the more the “group” or “crowd” interact, the less rational the individuals in these groups become. Frederich Nietzsche said: “Insanity (not the physiological one) is rare in the individual – but this is the rule with groups, parties, peoples and age groups.”

Accordingly, the accuracy of the overall judgment of a group is that the group does not behave like a crowd.

At a time when cryptocurrency mania and irrational exuberance (famed by Greenspan and recently used by our own RBI Governor Shaktikanta Das) in the markets look like macbethic ambitions that “fall on the other”, the relevance of the mass delusions will remain remain dominate our ex post analysis.

The appraiser is Chief General Manager at SBI. Views are personal.


William J. Bernstein is a neurologist, financial theorist, and historian whose books include A Splendid Exchange, Masters of the Word, The Birth of Abundance, and The Four Pillars of Investing. He is a co-founder of the investment management firm Efficient Frontier Advisors and has written for publications such as the Wall Street Journal and Money Magazine. He was the winner of the 2017 James R Vertin Award from the CFA Institute. He lives in Oregon.