What causes markets to panic?

Markets can show the same dysfunctional emotions as the rest of us. They can worry, they can panic, and they can get depressed.

Imagine you hear on the news that petrol is going to be in short supply. You may rush out and buy extra petrol. If everyone does the same thing, the petrol shortage will suddenly get worse, potentially crippling a community's ability to function. What is rational in small doses, becomes self-destructive in large doses. To make matters worse, we all start fighting against each other, and it seems that nothing can restore order. Rumour abounds, and the uncertainty makes everyone unsure what to believe.

Again, imagine that you hear some bad personal news. Your hormones rush out a shot of adrenaline to adjust your system. But if too much of your system joins in, you get overloaded with adrenaline, leading to excessive anxiety, and inability to function. Your system starts behaving counterproductively. Internal rumour starts - in the form of paranoia and excessive worry. The uncertainty undermines our confidence in our own perceptions.

Now look at the current world financial situation. The markets received some bad news about U.S. mortgage debts and their performance. Cash supply was interrupted, and rumours began to circulate of cash shortages in the market. Dealers started to get anxious, and then panicked, rushing out and buying cash - in other words, converting their securities into ready money. This is crippling the financial markets' ability to function. Again, what was rational in small doses (a market adjustment), becomes self-destructive in large doses (a market collapse).

When young children feel threatened, in their panic they often rush into a barrage of self-defensive tactics. They take back their toys. They hit out. They cry. None of this helps, and it is up to adults to restore order by separating everyone for a while, waiting until things calm down, and then clearly administering guidance and discipline. With this in mind, perhaps governments should have simply closed the markets for a while, and told banks that they could have their toys back if they sat down and behaved. Well, it's a thought...!