There is a good scene in Men in Black where Will Smith and Tommy Lee Jones talk about aliens living among the humans. The full clip is here, but the notable part is this:
Will Smith: “Why the big secret? People are smart. They can handle it.”
Tommy Lee Jones: “A person is smart. People are dumb, panicky, dangerous animals and you know it. 1,500 years ago, everybody knew the earth was the center of the universe. 500 years ago everybody knew the earth was flat. And 15 minutes ago you knew that people were alone on this planet. Imagine what you’ll know tomorrow.”
I have spent a large part of the last 3 years observing some incredibly volatile and rare events and then thinking about them deeply. Pandemics, lockdowns, vaccine battles, market bubbles, tribalism, mania, paranoia, and now, bank failures. I have tweeted several times about the lessons I’ve learned:
After watching what happened to SVB over the weekend, I think there is one overarching lesson that connects Covid to bubbles to bank runs: group psychology. And I think group psychology is the most powerful (and scariest) thing in the world. After all, if you look at the worst atrocities of the 20th century – I’m talking about the very worst – the pitfalls of group psychology are at the root.
What do I mean by group psychology?
To understand the pitfalls of group psychology, let’s actually invert it and study when and why crowds can be smart. Invert, always invert.
Here’s an example of when group psychology is wise:
Let’s assume you have a jar of jelly beans. You ask every person to guess how many jellybeans are in the jar. If you run this experiment, you find something fascinating: the average guess of the group is almost always one of the best guesses. In other words, the group is very wise. Michael Mauboussin runs this experiment in his class. In one example, the average guess of the class was 1,151 and the actual number was 1,116 – a 3.1% error. Of the 73 students, only 2 were closer than the average of the crowd. Didn’t some people have terrible guesses? Yes! But, as it turns out, those terrible guesses canceled out each other, because the group was large enough, diverse enough (cognitively), and independent. As a result, the group beats the individual.
James Surowiecki is famous for writing a book about the Wisdom of Crowds which teaches the criteria under which crowds are smart. James’ book outlined 3 required criteria for wise groups:
- Diverse + Independent. The group’s viewpoints must be cognitively diverse and independent, meaning they are not determined by the people around them. You must submit your answer to the jelly bean guess without knowing everyone else’s.
- Aggregated. The group’s opinions must be aggregated in some way, like a stock exchange, or a poll.
- Incentives. You must be rewarded for being right, and penalized for being wrong. This incentive makes the group do their best work and get gain if they are right.
You can see why these 3 things lead to group wisdom – and you can quickly see why the inverse leads to crowd madness. When the crowd is wise, you get functioning stock markets, elections, and democracies that are self improving. When the crowd is foolish, you get all the things we’ve talked about, and at the extreme case, genocide and war.
The first requirement for wise crowds is the most important. When thoughts are not diverse nor independent, you get textbook groupthink. Herd mentality. This explains bank runs and it explains bubbles.
This, by the way, is perhaps the best argument for free speech – extremely wrong speech is like the extremely wrong jelly bean guesses that eventually cancel each other out. So you must allow for free, independent, and diverse speech in order to find truth. If you can snuff out diversity of thought, you can convince people to do some atrocious things.
So what does this have to do with bank runs?
In a few hour timeframe, I watched group psychology take hold and bring a $15b bank to its grave. It was like everyone had a guess for the jelly bean amount, but before submitting their guess, they looked at their neighbor’s guess. But their neighbor had also looked at another neighbor’s guess already. It was a textbook prisoner’s dilemma. And at this point, just like the textbook, the prisoners were actually rational! But almost no one had done an independent assessment of the bank’s ability to survive – and it didn’t matter. The group had decided the bank was dead, so it was dead. I’m not even saying the bank didn’t deserve to fail. I’m simply saying that once the group decided it was going to, nothing else mattered.
What made this group of SVB customers unique? Well, most banks have a largely diversified group of customers. But not SVB. It served a very specific type: early stage startups, and their investors. And all those people hang out at the same water cooler. It’s called Twitter. There goes the cognitive diversity required for wisdom of crowds. There goes the independence of judgment required for wisdom of crowds. By the way, the counter argument to this is easy to make – you can say that the crowd actually properly identified a failed bank and acted rationally! And I think that’s a fun argument to have. But in either case the crowd prevailed here, and because of the homogeneity of the customers and the lack of independent thought, I tend to think this is an example of crowd madness.
Last question I’ll explore: so what? What do we do about the scariest thing in the world?
A few things.
We must diversify our cognitive diets. We must recognize the tribes we’re in and try to be members of multiple diverse tribes. Twitter is actually great for both of those if you put in the work. We must seek to disconfirm our deepest held beliefs, rather than confirm them. We must recognize when a crowd is overcome with mania and step back and ask if the crowd is wise or dangerous. And then we must have the courage to stand alone if that’s right. By the way, standing alone is probably wrong when it comes to a bank run, but probably right when it comes to many other things. But the point is we should decide that. Independently.
And if we act independently and deliberately, we do our part to turn crowd psychology from dangerous to wise, which after all is the whole goal: to control the scariest thing in the world.
always happy; never satisfied 