Herd Behavior and the Housing Bubble

Herd Behavior and the Housing Bubble
Paper instructions:
Accordingly, case notes will be collected. case notes should include , answers to the questions at the end of the case, and annotations or additional issues you think are pertinent. These analyses should be approximately 1-2 typed pages.
Herd Behavior and the Housing Bubble
It is sometimes easy to forget that humans are not unlike
other animals. Economist John Maynard Keynes recognized
this when he commented, “Most, probably, of our
decisions to do something positive, the full consequences
of which will be drawn out over many days to come, can
only be taken as the result of animal spirits—a spontaneous
urge to action rather than inaction, and not as the
outcome of a weighted average of quantitative benefits
multiplied by quantitative probabilities.”
Such “animal spirits” are particularly dangerous at the
collective level. One animal’s decision to charge over a
cliff is a tragedy for the animal, but it may also lead the
entire herd over the cliff.
You may be wondering how this is applicable to organizational
behavior. Consider the recent housing bubble
and its subsequent and enduring collapse, or the dot-com
implosion of the turn of the century. As housing prices
rose ever higher, people discounted risk. Homeowners
and investors rushed to buy properties because everyone
else was doing it. Banks rushed to provide loans with little
due diligence because, well, everyone else was doing it.
“Banks didn’t want to get left behind. Everybody lowered
their underwriting standards, no matter who they are,”
said Regions Bank executive Michael Menk. “As bankers
that’s who we are; we follow the herd.” Similar problems
led to a run up in prices for internet-based companies
during the early twenty-first century, and some wonder
whether the current valuations of social networking sites
are following a similar trend of overpricing.
Yale Economist Robert Shiller called this “herd behavior”
and cited research showing people often rely heavily
on the behavior of groups in formulating decisions about
what they should do. A recent study in behavioral finance
confirmed herd behavior in investment decisions and
showed that analysts were especially likely to follow other
analysts’ behavior when they had private information that
was less accurate or reliable.
Questions
1. Some research suggests herd behavior increases as
the size of the group increases. Why do you think this
might be the case?
2. One researcher argues that “pack behavior” comes
about because it has benefits. What is the upside of
such behavior?
3. Shiller argues that herd behavior can go both ways: It
explains the housing bubble, but it also explains the
bust. As he notes, “Rational individuals become excessively
pessimistic as they see others bidding down
home prices to abnormally low levels.” Do you agree
with Shiller?
4. How might organizations combat the problems resulting
from herd behavior?


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