Written by : Radhika Bhattacharyya
In common parlance, Lollapalooza means extraordinary.
However the term, "Lollapalooza effect", coined by Charlie Munger throws light on the psychological phenomena, in which multiple human biases or tendencies synchronize and go hand in hand in creating a larger than life effect . Charlie Munger is an American investor and business man, more famously known for his involvement with Mr. Warren Buffet, as his business partner.
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Imagine a beautiful girl by the name of Sheetal, who is also humble, compassionate, and ethical. Her virtues, in addition to her beauty, all add up in making her irresistible. (Lollapalooza effect).
In a typical real life situation, imagine an inactive student named Ravi, in the Physical Training (P. T.) class. Not only is he lazy, but he also dislikes his fastidious P. T. teacher, who in a bid to make the lazy student more active, makes him run 10 rounds of the field. Say on his 3rd round of the field, Ravi faints in the heat and his class mates end up mocking him. Embarrassed, Ravi vows to miss all his P. T. sessions. Here we see, multiple human biases acting in the same direction and at the same time, in making Ravi want to miss further P. T. sessions.
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The 'Lollapalooza effect' was coined by Munger in his 1995 Harvard speech, in which he reviewed serious instances of human misjudgment.
The 2008 sub-prime crisis is another example of the Lollapalooza effect, on a massive scale. Bankers decided to give prime loans to sub-prime lenders(high rated borrowers) at low interest rates in order to sell off more housing loans with a view to increase their business volumes. The sub-prime lenders started selling off home loans(sub-prime loans) to sub-prime borrowers (unrated borrowers) at higher interest rates, with a view of selling higher volumes of business and receiving higher commissions, without checking into the financial capability of the borrowers. And ultimately the sub-prime borrowers gained the maximum, in being able to fulfill their dreams of buying a home, without giving a thought as to their capacity of repayment of the loan. In a series of chain reactions, what occurred next, as we all know, was the sub-prime crisis.
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Here the mechanism of 'herd-mentality' and the different human tendencies and biases acting together in a synchronized manner, created the massive mortgage crisis leading to the eventual breakdown of the US economy, resulting in large-scale unemployment and recession.
Not a single player thought about the long term consequences(large dose of human misjudgment) leading to an overwhelming mortgage crisis.
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