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Financial manias and panics: a socioeconomic perspective
American Journal of Economics and Sociology, The, Oct, 2002 by Brenda Spotton Visano
IX
The Panic
FINANCIAL PANIC IS THE ILL-ADVISED, confused, and uncoordinated scramble by speculators to dump shares quickly. It is both a personal emotion and a collective action that interferes critically with the preferred adaptive response to distress. The panic occurs in a demoralized environment created by a combination of the prevailing distress plus a specific trigger. Like the mania, the panic is in every way a collective behavioral process. Unlike the mania, however, a clear, identifiable trigger sparks the panic and its hyper-intense life span is short.
Where financial speculation was once a norm of the collective, justified partly by the vague promise of the innovation, its end is unexpected for many. For new and naive speculators, the leveling off and gradual decline in the price of the speculative asset is unfamiliar. The result is demoralization, "the loss of meaningful relationship to the values and activities of some collectivity because changes in the balance of rewards make adherence no longer attractive" (Lang and Lang 1962: 344).
More generally, financial speculation emerged as a norm that created certainty where wider socioeconomic uncertainty from the spreading impact of the innovation had existed. The emergence of financial losses that threatens both investor solvency and reputation shatters these recently created basic understandings and perceptions of the innovation-induced changes. The situation is now panic-prone.
As a collective process, demoralization entails disruption of two elements essential to the functioning of a group: cognitive definitions and affective ties, By cognitive definitions, we mean the patterns of expectations and intellectual schemes by which nature and society are transformed into a meaningful world. Persons become disoriented when the unexpected or unfamiliar shatters their basic understandings. . . . [W]hen external danger that cannot be mastered or internal dissension that cannot be resolved weakens the affective ties that normally weld people into a cohesive unit, it becomes panic-prone because of demoralization. (Lang and Lang 1962:346)
Without a trigger, however, it is possible for the demoralized state to evaporate. As prices stabilize, people readjust their perceptions of the financial situation and come to understand the nature of the changed socioeconomic environment in which they exist; the threat of panic dissolves. Before readjustment is complete, however, if an event occurs to dramatically and adversely alter the tenuous security of the speculator-an event that serves to exaggerate the distress they face- that event will trigger a panic.
In many documented historical instances of panic, the event trigger was something that dramatically decreased the liquidity of the speculative assets. In October 1929, for example, the sheer volume of Ameri- can stock trading activity ran up against a technical trading barrier that when hit prevented the further execution of trades and reporting of price movements. In France, a government decree in May 1720 altered instantly the terms of trade and liquidity characteristics of the speculative asset market. Any dramatic reduction in the liquidity of the speculative asset in a distressed environment will reasonably create heightened anxiety, for it was the liquid nature of the financial equity, in the presence of uncertain future gains, that encouraged the initial speculation. (See Section II, above.) The trigger then may appear as a threshold level of activity that, when reached, dramatically and quickly constrains the asset's market liquidity. Alternatively, it may appear as some externally imposed change such as a government decree altering either the terms of trade between the speculative asset and money or the ability to sell the asset at close to market price.
