Behavioral economics and standing in line outside indymac

Since the Great Depression, the U.S. government has insured bank deposits up to $100,000 per account. So why, last week, were so many people standing in line at IndyMac, the California bank that failed under the crush of bad subprime loans? Fear, uncertainty, loss aversion, a propensity for herd behavior – behavioral economists have seen this all this before. A seminal paper on herd behavior in non-market contexts (Banerjee 1992) argued that herd behavior can occur when private information is not shared publicly. Individuals with private information act, leading to information cascades as others follow their lead, with the result being a socially suboptimal outcome.

In the case of IndyMac, no one had – or has – any private inside information about the collapse of the Federal Deposit Insurance Corporation, and yet public notices about bank deposit insurance did not keep people at home. Of course, everyone in line might have simply wanted enough money to pay a mortgage and food for a month, or had assets greater than $100,000, which meant all of their money wouldn’t have been insured. But what are the odds?

The Washington Post points out an interesting distinction between how people see the failures of human institutions like IndyMac versus the physical destruction caused by natural events like hurricanes.

People are often more fearful of man-made events than they are of natural ones. “We are rather blase about nature,” said Paul Slovic, the founder of Decision Research, an Oregon nonprofit group that studies human behavior and advises governments. “We think it’s generally benign even though we get clobbered by it over and over again. That’s why after a big storm we go back and rebuild on the spot.”

He continued: “But we are quite the opposite for certain types of risk that are human-caused, particularly if they involve something new or mysterious. We react very strongly to that. . . . If people see signs of incompetence or that the system is not being regulated or controlled, that is very worrisome.”

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