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Dublin: 14 °C Thursday 31 July, 2014

Column: Herd mentality led the UK riots – and it’s also what got us into economic trouble

Former trader Nick Leeson argues that, while it might not seem obvious at first, the psychology behind street rioters is not dissimilar to that which drove the markets, the bankers and property developers into a speculation frenzy.

Nick Leeson

HAVING LIVED AND worked in many of the major cities in the United Kingdom, especially London and its suburbs, I am totally aghast at the most recent goings-on in the country of my birth. Violent rioting and looting of shops have been the daily norm. Whilst the perpetrators represent a small minority of the general public, the extent of their bare-faced abuse of law and order is absolutely astounding.

Some of the individuals are simply opportunistic, many seizing the opportunity to increase their normal levels of criminal activity. But as you read the stories and watch the pictures, it is clear that there are many others being drawn into these behaviours. Normal, respectable people cajoled and coerced into joining in.

Many people of my own particular vintage will have experienced the normal peer pressure that accompanies your path to adulthood. The first cigarette, the first alcoholic drink is pressure that we all face but these are now joined by far bigger challenges.

The outcome of herd behaviour, when unchecked, can be both drastic and tragic

It highlights a behaviour that is becoming frighteningly prevalent in our everyday life – ‘herd behavior’ - how individuals in a group can act together without planned direction. The rioters in the UK displayed this behaviour but it’s not a leap to think of how banks and property developers acted here in Ireland in the recent past. ‘Herd mentality’ describes how people are influenced by their peers to adopt certain behaviours. When either continues, unchecked, the outcome can be both drastic and tragic.

The activities of the rioter has brought groups of law-abiding citizens together to protect their businesses or quite simply do the right thing by confronting the rioters. Pensioner Richard Mannington Bowes had been trying to stamp out a fire lit in a bin by thugs when he was set upon by a group of rioters, receiving serious head injuries. He later died in hospital.

Banks, governments, regulators and the law all usually present an effective buffer to irregular activity by presenting norms and restricting certain types of activity. All are currently failing, most noticeably the law through the sentences that are being handed down.

In the business world, herd behaviour was more often used to highlight trends in the stock market, typically bubbles followed by crashes where market participants pushed markets solely in one direction.

Large financial organisations made the same mistake, time and time again

More recently, and probably most spectacularly in Ireland, it highlights how groups of large individual financial organisations made the same mistake, time and time again. Lending money without any regard for the risk they were undertaking. Decisions made purely for their own financial gain and in the belief that they were missing the boat. Bank of Scotland (Ireland) was one of the most spectacular. Perceiving themselves to be late to a fantastic opportunity, they lent faster, in larger numbers and with scant regard for any of the consequences.

Property developers were no better. Granted, they were aided and abetted by the banks but they bid aggressively for properties and land that have now collapsed in value. Many were far more interested in acquiring the property ahead of one of their rivals rather than assessing whether or not any real value was attached.

Many of the tales are legend and prices paid for land and property in certain areas will never be matched again but as the two herds collided, the property developers and bankers found a common path and fuelled each other further. Throw in a number of politicians who all believed that it was good for the country and you were left with a dangerous cocktail that when spilt as it has been, will take decades to clear up.

This is not the time for herd mentality

For those thinking that now is the time to invest in the stock market, please think again. This is not the time for herd mentality in that area. Volatility is hitting new highs on a daily basis. This in itself increases the entry price for certain forms of investments but is more testament to the fact that wild swings in valuation are the norm. These markets are not for the average investor. Most professionals will sit on the sidelines until some degree of normality prevails, the volatility indicators reduce significantly and then attempt to time their entry once more.

The vast majority of non-institutional investors or market professionals enter and exit the market equally poorly. Most enter the market after it has already rallied 30 per cent and exit equally badly. With volatility at these levels, the successful non-professional investor is rare if indeed they even exist. Success is not totally impossible but is often followed by even greater failure.

Leveraged access to the market through CFDs and spread betting can generate fantastic returns but are generally better left alone in these market conditions. Unless a strong opinion is taken on the medium- to long-term direction of a financial instrument and you simply feel that you must get involved, the best method will be to average your position in slowly and allow the markets to return to a degree of calm.

Some opportunity may be missed – but the risk and the downside is significantly reduced.

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