Complexity and Social Networks Blog

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30 September 2008

Regulating the madness of crowds...

Before there was "crowd sourcing" there was the "madness of crowds." The current economic crisis raises an interesting question: how does one "regulate away" the madness of crowds? While there was likely a degree of moral hazard in the behavior of the financial sector over the last few years (i.e., rationally taking overly risky behavior in the belief that the government will bail them out should things get really bad), my intuition is that the main thing that has created fragility in the system is a convergence in mindset. That is, arguably, there was a convergence in belief about the value of particular assets-- these subprime based securities. Given modern day communication technology, and the generally small world of the financial sector, would it be surprising for there to be a convergence in beliefs about what these securities were worth? and this convergence must create some fragility-- even if it is unbiased-- because if the mean person is wrong, it means everyone is wrong, and that everyone falls off the cliff at the same time.

Of course, the madness of crowds (as the book illustrates) goes back a long ways. And we have built rather robust financial regulatory institutions that have, generally, since the Great Depression, reduced the vulnerability of the financial sector. But it does seem that there has been a paradigm change over the last generation, with the development of more complex (and ambiguously valued) financial instruments, and increased global communication, that perhaps make us more vulnerable now than we have been in 80 years to the madness of crowds. Which raises the question: given an increased systemic tendency to "global groupthink", and given systemic benefits of diversity, how does one regulate the collective mind? (I don't have an answer at this time, but thought I would pose the question.)

Posted by David Lazer at September 30, 2008 9:15 PM

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