Jim Jones led 909 people to mass suicide at Jonestown, Guyana in 1978. Since then, the word groupthink has had an extremely negative connotation in our culture. However, we are only beginning to understand its pervasive reach, its neurological and social causes, its symptoms and the resulting bad decisions (including financial decisions) that groupthink causes. “Just go against the herd,” you might say. In reality, overcoming our subconscious tendencies to groupthink is not that simple. Let’s start with a working definition, and then we’ll apply groupthink to finance.
Working Definition of Groupthink. Fortune Magazine’s William H. Whyte, Jr. described groupthink in 1952 as “a coinage” that “is becoming a national philosophy.” He continued, “We are not talking about mere instinctive conformity…what we are talking about is a rationalized conformity—an open, articulate philosophy which holds that group values are not only expedient but right and good as well [emphasis added].” Groupthink is when people in a group seek to avoid conflict so badly that they reach unanimous decisions, overlooking critical thinking and rational alternatives in the process. Irving Janis, an early pioneer on the subject, said it occurs “…when the members’ strivings for unanimity override their motivation to realistically appraise alternative courses of action.”
3 Conditions That Lead To Groupthink. Clark McCauley identified three conditions under which groupthink occurs.
1. Directive leadership
2. Homogeneity of members’ social background and ideology.
3. Isolation of the group from outside sources of information and analysis.
8 Symptoms of Groupthink. Irving Janis came up with the following symptoms indicative of groupthink.
1. Illusions of invulnerability creating excessive optimism and encouraging risk taking.
2. Rationalizing warnings that might challenge the group’s assumptions.
3. Unquestioned belief in the morality of the group, causing members to ignore the consequences of their actions.
4. Stereotyping those who are opposed to the group as weak, evil, biased, spiteful, disfigured, impotent, or stupid.
5. Direct pressure to conform placed on any member who questions the group, couched in terms of “disloyalty.”
6. Self-censorship of ideas that deviate from the apparent group consensus.
7. Illusions of unanimity among group members; silence is viewed as agreement.
8. Mind guards—self-appointed members who shield the group from dissenting information.
Groupthink Sneaks Into Your Brain. Humans are a tribal species, so whether or not you accept it, we are all born with deep, uncontrollable tendencies toward these symptoms. You couldn’t unplug that wiring, even if you wanted to, but you can govern the tendencies. The first step in overcoming them is recognizing what they are so you can catch yourself in the act, engage your reflective brain, and then step away intelligently from the groupthink. It’s equally foolish to just plug in a contrarian “opposite of the herd” mindset on every financial matter, but it pays to know when to go mightily against the grain. Warren Buffett famously warned us to “be greedy when others are nervous, and be nervous when others are greedy.”
Groupthink Sneaks Into Your Finances. Examples of groupthink in the financial world are easy to find. Investment bubbles have fomented around tulip bulbs in Holland in the 1600s, internet stocks in the late 1990s, and U.S. real estate in the past decade. Same song, different verse. They all play out like really bad sequels of the same movie, the kind that makes you mistakenly say “I think I’ve seen this movie before!” Understanding groupthink is the secret to understanding the biggest and most common investment blunders.
Throughout 2005, 2006 and 2007, I was regularly criticized for repeatedly writing and speaking out about what I felt was a “historic bubble” and a “manic frenzy” in the housing market, along with a “drunken stupor” among mortgage lenders. I sounded gloomy in projecting a massive, nationwide, multi-year decline in housing values. It was a lonely and costly position for me to maintain. In hindsight, people who now say they saw the bubble at the time can produce no time-stamped newsletter, email or columns to back up their claim. Virtually no one avoided the feeling of overconfidence, including buyers, builders, bankers, and especially realtors. I didn’t win Miss Congeniality with my colleagues at Smith Barney or my Realtor friends who unknowingly served as the “Mind Guards” to this groupthink, since they were heavily invested emotionally and financially in Real Estate (see symptoms 1,2,4 and 8 above). I ticked off some clients at the time, but my warnings aren’t looking so dumb now. J Ironically, some of my loudest critics during that era are some of my best clients today.
As valuations come down and sentiment goes from excess greed to excess fear in U.S. real estate, the attractiveness of that asset class increases, in my view. Neurological forces that destroy wealth are innately wired into all human brains, mine and yours included. Take a glance at my October 2008 lead article (you can click on it on right hand side of this web newsletter). You’ll recall that YOUR CONDITIONED RESPONSES and YOUR TRAINED REACTIONS to emotional impulses, not the inevitable impulses themselves, are what primarily determine whether you are an Emotional Investor, Disciplined Investor, or a Betweener Investor.
The key to the Disciplined Investor’s success is that his internal emotional impulses are identified quickly, accurately and governed appropriately. The Emotional Investor tries, as an obese person tries to run the Boston Marathon, but he doesn’t have the conditioning he needs to excel. The vast majority of Americans are Emotional Investors. Maybe 10 or 20% can upgrade to the “Betweener” group after years of conditioning—those who are no longer emotional enough to be called Emotional Investors and not yet Disciplined enough to be called Disciplined Investors. Most people can never become Disciplined Investors, even with training or conditioning, just as most people never complete a marathon or triathlon.
Getting into consumer debt is another area in which groupthink can be easily seen at work. No debt addict has ever become a debt addict without the firm belief that somebody else has more debt than he does. “At least I’m not as bad with my money as that lady,” is the comforting phrase that he can give himself as he piles on the credit purchases.
Groupthink financial decision-making is a self-inflicted wound to people and societies. U.S. banks loosened their lending standards during what I have long called The Lending Orgy of 2003-2006. Why did they do it? Because consumers demanded it and The Federal Sow subsidized it! Even if you liked your banker in 2005, you still wouldn’t give him the mortgage unless he agreed to terms to match the loosest of his competitors. Groupthink in the banking business spread like wildfire. Eventually it led to a massive heart attack throughout our entire economy, beginning with the collapse of Lehman Brothers on September 15, 2008. Bankers hurriedly messaged each other things like,“Other banks are doing ‘no document’ (a.k.a ‘liar’) loans, so if we don’t do them then we lose our &#*%$ customers.” Jamie Dimon, one of the very few CEOs who steered clear of excessive risk, scolded his fellow banking CEOs recently in his testimony before Congress. He said in essence that just because your regulator says you can get away with something doesn’t mean you as a CEO should be doing it. He also added, “I want to make it very clear that I do not blame the regulators. The responsibility for a company’s actions rests with the company’s management.”
Mr. Dimon was right. He led his firm, JP Morgan, to largely avoid the icebergs that his peer CEOs slammed into, imploding their once powerful firms such as Merrill Lynch, Citibank, AIG, Washington Mutual, Bear Stearns and Wachovia. We should take away one learning point for future generations of our country: you can never legislate away or regulate away the innate human tendency to groupthink, to act greedily and irrationally. Painfully sharp recessions are the only way to heal the economy; they are the necessary price we pay for our own unavoidable, stupid, human excesses and inability to resist groupthink. My take on capitalism is similar to Winston Churchill’s take on democracy: it’s the worst possible system, except for everything else, which is even worse than capitalism.
