Herd mentality not smart during dark times

In this financial crisis, it's probably best not to run with the herd.

When times are uncertain, people are wired to follow the crowd and jump on the wagon. Bank of America Corp bought Merrill Lynch & Co Inc., the U.S. government has taken over Fannie Mae and Freddie Mac, Lehman Brothers Holdings Inc. has gone bankrupt, Washington Mutual failed,and a $700 billion dollar U.S. government bailout was rejected.

With this comes fear and limited information. We see individuals abandoning their own logic and banding together to form one opinion.

All of this is biological and comes with evolution. Gregory Berns, a neuroeconomist at Emory University in Atlanta performed an experiment requiring participants to complete simple tasks of assessing simple shapes. The participants were hired actors and real volunteers. The real volunteer went into a (MRI) scanner. The hired actors would answer confidently and incorrectly. The real volunteers began to change their answers to match the actors'.

Berns explains, "The group changes how you see the world in some way. Our brains are really wired to accept the group opinion of the world." The scanner suggested that the brain's "fear center" is dominant when people are uncertain. "When people are presented with a situation where they don't have information or the information is ambiguous, we see activation of the amygdala and insula," Berns explains.

Paul Zak, of the Center for Neuroeconomics Studies at Claremont Graduate University in California says, "We are really hyper-social apes. We learn almost exclusively from each other."

Of the financial crisis, Zak says, "In this case, running with the herd may not make good sense." Zak continues and makes a good point, "I am not a financial genius. I do know that when you see millions of people in the market essentially freaking out, that spills over into your brain and you get this impulse to do what everyone else is doing."

In this financial crisis, Zak is fighting against the herd. He is buying stocks.

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No surprise that Lehman Brothers went belly up

The 158-year-old financial behemoth Lehman Brothers has closed its operations as of today.

With both Barclay's and Bank of America refusing to play the "good Samaritan" and the Federal government throwing their hands up, the inevitable happened. Lehman Brothers filed for a Chapter 11 bankruptcy petition. One of the most respected firms on Wall Street, just went belly up.

But wasn't bankruptcy supposed to happen to non-descript firms run by inexperienced, non-MBA type managers? Definitely not for Lehman Brothers. They are after all managed by smart Harvard and Wharton educated financial gurus who spent years and years perfecting their trade. So how did such a smart group of people end up making, let's call it an "error of judgment?"

The fabled run on Wall Street had to come to an abrupt end when the debt side of their P&L statement showed $60 billion. I wonder what CEO Richard Fuld was thinking? A 30-year-veteran at Lehman (incidentally he had quipped that it was the only company that he has ever worked for) Fuld has been credited with weathering many a financial storm over the past decade; including Asian Stock Crisis, Dot com bust, September 11 (Lehman rose from the ashes of the attack when its headquarters at Three World Financial Centre had been severely damaged due to falling debris) among others.

But in the end--I guess his luck ran out--he could not bring the rabbit out of the hat this time around.

But, it was not like the signs were never there. The share prices of Lehman Brothers have been steadily spiraling southward since February '08, when its share prices reached a high of $66 (canada.com). Last Friday, it was selling for $3.65 (wsj.com), little more than a cheese burger at your local joint. The sub-prime home loan crisis has just consumed its next victim, this time a company with market capitalization of $250 million as of September 15, 2008 (wikipedia.org).

Just when you were trying to soothe your frazzled nerves, comes the next blow. The other darling on Wall Street, Merrill Lynch just got gobbled up by Bank of America. It was an all-stock deal and cost BOA a whopping $50 Billion. This also means BOA will be burdened with all the losses accrued by Merrill Lynch over the years. An interesting observation is, as of Friday's closing the Merrill shares traded at $17.05, so one wonder's why BOA would pay $29 per share when buying them over.

Hope their CEO Kenneth Lewis has a really good reason for that.

The sub-prime mortgage crises has already taken a big toll on the jittery financial market. The domino effect in a way was spear headed by Bear Stearns, soon the Feds set in to stabilize the market by taking over Freddie Mac & Fannie Mae, now its the turn of Lehman Brothers and Merrill Lynch to take the infamous center stage.

There's no telling what more is in store in the coming weeks. Keep your fingers crossed.

--Editorial by George Lazar