As a Wall Street trader named Scott watched the mortgage market crater in late 2007, a switch buried deep in his brain flipped.
What happened next is anatomized, tick by clinical tick, in John Coates’s unsettling book, “The Hour Between Dog and Wolf.”
Scott’s heart rate sped up, to pump extra blood to his arms and thighs, Coates writes. His pupils dilated, to absorb more light. He began to sweat, his breathing accelerated and he got a hit of adrenalin. Then, as his losses surged to $24 million, his bowels liquefied.
Though Scott is a fictional representation, his symptoms are all too real, judging from the observations of Coates, who spent 12 years trading derivatives for Goldman Sachs Group Inc., Merrill Lynch & Co. and Deutsche Bank AG.
“As losses mount on the trading floor, one observes anxious traders marching briskly to the toilets, the men’s room starting to exude the fear and stench of a slaughterhouse,” he writes.
If this book isn’t on Jamie Dimon’s reading list, it should be following the $2 billion trading loss at JPMorgan Chase & Co.
The biological side of financial markets struck Coates during the dot-com bubble in the 1990s, as he watched normally prudent tech-stock traders become overconfident, reckless and euphoric. At the time, he had become fascinated with breakthroughs in neuroscience, notably research into how hormones affect the brain, influencing how we think and behave.
Could it be that testosterone was impairing the judgment of traders, making them feel infallible and propelling markets to unsustainable heights? Then, as tech stocks crashed, were traders overwhelmed by a stress hormone, cortisol?
Fight or Flee
Was human biology, evolved over millennia to help us fight or flee lions and bears, driving booms and busts?
Deciding to test his theory, Coates retired from Wall Street and spent four years studying neuroscience and endocrinology at the University of Cambridge, where he’s now a senior research fellow. He then conducted an experiment with 250 high-frequency traders in the City, London’s financial district. Only three were women.
Over two weeks, he tracked the traders’ testosterone levels and compared them to their daily profits and losses. The conclusion: They scored above-average profits on days when their testosterone was significantly elevated. The reason: The hormone drove them to take more risk, he says.
Another experiment documented how volatile markets and losses triggered traders’ stress hormones, which are sensitive to uncontrollability and uncertainty.
Financial risk-taking, Coates argues, provokes the same physiological responses we feel when taking other risks, be they surfing a pipeline wave, gunning a Ferrari up a twisting mountain road or staring down a grizzly.
As a trader’s testosterone rises, he is being primed like an animal steeling for a fight, Coates says: His risk appetite increases along with his confidence in a moment of metamorphosis alluded to in the book’s title. He has reached what the French call “entre chien et loup,” the hour between dog and wolf.
This is a highly speculative and profoundly unconventional book. It’s also so absorbing that I wound up reading it twice and taking copious notes.
Coates frames the book as the story of a floor of traders caught in a bull market that transmogrifies into the great bear of 2007 and 2008. He describes how they make and lose money, and how their bodies influence their behavior.
Hubris and Nemesis
The narrative arc will be familiar to anyone who has read “Macbeth”: It’s a tragedy tracing the relentless logic of hubris and nemesis, overconfidence and downfall.
From the first page to the last, Coates challenges deep-seated assumptions, arguing that we think with our bodies as well as our brains. Recall that George Soros took the onset of acute back pain as a signal that something was amiss in his portfolio.
Coates also treats us to what he calls “Aha! moments.” Why do you get butterflies in the stomach? Stress makes the blood vessels in your stomach constrict. Goosebumps? That would be the erector pili muscles in your skin trying to make you look bigger by raising your fur, as a cat does when threatened.
If confirmed by more extensive research, Coates’s theory carries profound implications for our understanding of economics and financial market stability. It gives a whole new meaning to John Maynard Keynes’s famous observation that human actions often flow from “animal spirits,” from “a spontaneous urge to action rather than inaction.”
The failure to study the physiology of traders marks “an extraordinary omission,” says Coates. It’s analogous, he says, “to studying animal behavior without looking at an animal in the wild.”
If a testosterone cocktail really does drive irrationally exuberant risk-taking, what can be done about it? Change the market’s biology, Coates suggests.
Banks could, for example, increase the number of women and older men on the trading floor, he says. Women have about 10 percent to 20 percent of the testosterone found in males, he says, while levels of the hormone in men decline as they mature.
Though trading is usually thought of as a young man’s game, most legendary investors are much older, Coates says. Think of Warren Buffett and his mentor, Benjamin Graham.
Sometimes a master of the universe needs an old master around.
“The Hour Between Dog and Wolf: Risk-Taking, Gut Feelings and the Biology of Boom and Bust” is from Fourth Estate in the U.K. and will be published by Penguin Press in the U.S. in June (310 pages, 20 pounds, $27.95). To buy this book in North America, click here.
(James Pressley writes for Muse, the arts and leisure section of Bloomberg News. The opinions expressed are his own.)
Muse highlights include Elin McCoy on wine and Greg Evans on television.