by John Coates
Despite the traders’ frequent successes, the story follows the narrative arc of tragedy, with its grim and unstoppable logic of overconfidence and downfall, what the ancient Greeks called hubris and nemesis. For human biology obeys seasons of its own, and as traders make and lose money they are led almost irresistibly into recurrent cycles of euphoria, excessive risk-taking and crash. This dangerous pattern repeats itself in the financial markets every few years. Alan Greenspan, former chairman of the US Federal Reserve, puzzled over this periodic folly, and wrote of ‘innate human responses that result in swings between euphoria and fear that repeat themselves generation after generation’. Much the same pattern occurs in sport, politics and war, where larger-than-life characters, believing themselves exempt from the laws of nature and morality, overreach their abilities. Extraordinary success seems inevitably to breed excess.
Why is this? Recent research in physiology and neuroscience can, I believe, help us explain this ancient, delusional and tragic behaviour. Human biology can today help us understand overconfidence and irrational exuberance, and it can contribute to a more scientific understanding of financial market instability.
A simpler reason for bringing biology into the story is that it is, quite simply, fascinating. A story of human behaviour spiked with biology can lead to particularly vivid moments of recognition. The term ‘recognition’ is commonly used to describe the point in a story when all of a sudden we understand what is going on, and by that very process understand ourselves. It was Aristotle who coined this term, and since his day recognition moments have been largely the preserve of philosophy and literature. But today they are increasingly provided, for me at any rate, by human biology. For when we understand what is going on inside our bodies, and why, we are met with repeated Aha! moments. These range from the fun: ‘Oh, so that’s why I get butterflies in my stomach when excited!’ or ‘So that’s why I get goosebumps when scared!’ (The erector pili muscles in your skin try to raise your fur, to make you look bigger, just as a cat does when threatened. Most of your fur no longer exists, so you get goosebumps instead, but where it does you have a ‘hair-raising’ experience) – to the deadly serious: ‘So that’s why stress is so tormenting, why it contributes to gastric ulcers, hypertension, even heart disease and stroke!’
Today human biology, perhaps more than any other subject, throws a light into the dark corners of our lives. So by mixing biology into the story I can more accurately describe what it feels like to take large financial risks; and I can do so moreover in a way that provides recognition moments for people who have never set foot on a trading floor. In fact, the physiology I describe is not confined to traders at all. It is the universal biology of risk-taking. As such it has been experienced by anyone who plays a sport, runs for political office, or fights in a war. But I focus on financial risk-taking, and do so for good reason: first, because finance is a world I know, having spent twelve years on Wall Street; second, and more importantly, because finance is the nerve centre of the world economy. If athletes succumb to overconfidence, they lose a match, but if traders get carried away on a flood of hormones, global markets founder. The financial system, as we have recently discovered to our dismay, balances precariously on the mental health of these risk-takers.
I begin by looking at the physiology that produces our risk-taking, filling in the background story for what follows. I then show, through a story set on a trading floor, how this physiology can mix with lax risk-management systems and a bonus system that rewards excessive gambling to produce a volatile and explosive bank. We watch as nature and nurture conspire to produce an awful train wreck, leaving behind mangled careers, damaged bodies and a devastated financial system. We then linger in the wreckage and observe the resulting fatigue and chronic stress, two medical conditions that blight the workplace. Finally we look at some tentative yet hopeful research into the physiology of toughness, in other words training regimes designed by sports scientists and stress physiologists to immunise our bodies against an overactive stress response. Such training could help calm the unstable physiology of risk-takers.
ONE
The Biology of a Market Bubble
THE FEELING OF A BUBBLE
My interest in the biological side of the financial markets dates back to the 1990s. I was then working on Wall Street, trading derivatives for Goldman Sachs, then Merrill Lynch, and finally running a desk for Deutsche Bank. This was a fascinating time to trade the markets, because New York, and indeed America as a whole, was caught up in the dot.com bubble. And what a bubble that was. The markets had not seen anything quite like it since the great bull market of the 1920s. In 1991 the Nasdaq (the electronic stock exchange where many new-tech ventures are listed) traded below 600, and had meandered around that level for a few years. It then began a gradual yet persistent bull run, reaching a level of 2,000 in 1998. The Nasdaq’s rise was checked for a year or so by the Asian Financial Crisis, which reined it back about 500 points, but then the market recovered and took to the skies. In little more than a year and a half the Nasdaq shot up from 1,500 to a peak just over 5,000, for a total return in excess of 300 per cent.
The rally was almost unprecedented in its speed and magnitude. It was completely unprecedented in the paucity of hard financial data supporting the dot.com and high-tech ventures powering the bull run. In fact, so large was the gap between stock prices and the underlying fundamentals that many legendary investors, betting unsuccessfully against the trend, retired from Wall Street in disgust. Julian Robertson, for instance, founder of the hedge fund Tiger Capital, threw in the towel, saying in effect that the market may have gone crazy but he had not. Robertson and others were right that the market was due for a dreadful day of reckoning, but they also fully understood a point made by the great economist John Maynard Keynes back in the 1930s: that the markets could remain irrational longer than they, the investors, could remain solvent. So Robertson retired from the field, his reputation and capital largely intact. Then, early in 2000, the Nasdaq collapsed, giving back over 3,000 points in little more than a year, eventually bottoming out at the 1,000 level where it had begun a few short years before. Volatility of this magnitude normally makes a few people rich, but I know of no one who made money calling the top of this market’s explosive trajectory.
Besides the scale of the run-up and subsequent crash, another feature of the Bubble was noteworthy, and reminiscent of the 1920s, at least the 1920s I knew from novels, black-and-white movies and grainy documentaries – that was how its energy and excitement overflowed the stock exchange, permeated the culture and intoxicated people. For the fact is, while they last, bubbles are fun; and the widespread silliness attending them is often remembered with a certain amount of humour and fondness. I imagine anyone who lived through the bull market of the Roaring Twenties retained an abiding nostalgia for that heroic and madcap time, when futuristic technology, blithe spirits and easy wealth seemed to herald a new era of boundless possibility. Of course, life in its aftermath must have been even more formative, and those born and raised during the Great Depression are said to carry, even into old age, what the historian Caroline Bird calls an ‘invisible scar’, a pathological distrust of banks and stock markets, and a morbid fear of unemployment.
My recollections of the 1990s are of a decade every bit as hopeful and every bit as screwball as the 1920s. During the nineties we were entertained by middle-aged CEOs in black turtleneck sweaters trying to ‘think outside the box’; by kids in their twenties wearing toques and yellow sunglasses, backed by apparently limitless amounts of capital, throwing lavish parties in midtown lofts and talking wacky internet schemes few of us could understand – and even fewer questioned. To do so meant you ‘just didn’t get it’, one of the worst insults of the time, indicating that you were a dinosaur incapable of lateral thought. One thing I definitely didn’t get was how the internet was supposed to overcome the constraints of time and space. Sure, ordering online was easy, but then delivery took place in the
real world of rising oil prices and road congestion. The internet company that made the most heroic attempt to defy this brute fact was Kozmo.com, a New York-based start-up that promised free delivery within Manhattan and about a dozen other cities within an hour. The people who paid the price for this act of folly, besides the investors, were the scores of bicycle messengers breathlessly running red lights to meet a deadline. You would see groups of these haggard youngsters outside coffee bars (with appropriate names like Jet Fuel) catching their breath. Not surprisingly the company went bankrupt, leaving behind a question asked about this and countless similar ventures: what on earth were the investors thinking?
Perhaps the right question should have been, were they thinking at all? Were investors engaged in a rational assessment of information, as many economists might – and did – argue? If not, then were they perhaps engaged in a different form of reasoning, something closer to a game theoretic calculation: ‘I know this thing is a bubble,’ they may have schemed, ‘but I’ll buy on the way up and then sell before everyone else.’ Yet when talking to people who were investing their savings in newly listed internet shares I found little evidence for either of these thought processes. Most investors I spoke to had difficulty employing anything like linear and disciplined reasoning, the excitement and boundless potential of the markets apparently being enough to validate their harebrained ideas. It was almost impossible to engage them in a reasoned discussion: history was irrelevant, statistics counted for little, and when pressed they shot off starbursts of trendy concepts like ‘convergence’, the exact meaning of which I never discerned, although I think it had something to do with everything in the world becoming the same – TVs turning into phones, cars into offices, Greek bonds yielding the same as German, and so on.
If investors who had bought into this runaway market displayed little of the thought processes described by either rational choice or game theory, they also displayed little of the behaviour implied by a more common and clichéd account – the fear and greed account of investor folly. According to this piece of folk wisdom a bull market, as it picks up steam, churns out extraordinary profits, and these cause the better judgement of investors to become warped by the distemper of greed. The implication is that investors know full well that the market is a bubble, yet greed, rather than cunning, causes them to linger before selling.
Greed certainly can and does cause investors to run with their profits too long. By itself, though, the account misses something important about bubbles like the dot.com era and perhaps the Roaring Twenties – that investors naïvely and fervently believe they are buying into the future. Cynicism and cunning are not on display. Furthermore, as a bull market starts to validate investors’ beliefs, the profits they make translate into a lot more than mere greed: they bring on powerful feelings of euphoria and omnipotence. It is at this point that traders and investors feel the bonds of terrestrial life slip from their shoulders and they begin to flex their muscles like a newborn superhero. Assessment of risk is replaced by judgements of certainty – they just know what is going to happen: extreme sports seem like child’s play, sex becomes a competitive activity. They even walk differently: more erect, more purposeful, their very bearing carrying a hint of danger: ‘Don’t mess with me,’ their bodies seem to say. ‘I can handle anything.’ Tom Wolfe nailed this delusional behaviour when he described the stars of Wall Street as ‘Masters of the Universe’.
It was this behaviour more than anything else that struck me during the dot.com era. For the undeniable fact was, people were changing. The change showed itself not only among the untrained public but also, perhaps even more, among professional traders all along Wall Street. Normally a sober and prudent lot, these traders were becoming by small steps euphoric and delusional. Their minds were frequently troubled by racing thoughts, and their personal habits were changing: they were making do with less sleep – clubbing till 4 a.m. – and seemed to be horny all the time, more than usual at any rate, judging by their lewd comments and the increased amount of porn on their computer screens. More troubling still, they were becoming overconfident in their risk-taking, placing bets of ever-increasing size and with ever worsening risk–reward trade-offs. I was later to learn that the behaviour I was witnessing showed all the symptoms of a clinical condition known as mania (but now I am getting ahead of the story).
These symptoms are not unique to Wall Street: other worlds also manifest them, politics for example. One particularly insightful account of political mania has been provided by David Owen, now Lord Owen. Owen, a former British Foreign Secretary and one of the founders of the UK Social Democratic Party, has spent most of his life at the very top of British politics. But he is by training a neurologist, and has lately taken to writing about a personality disorder he has observed among political and business leaders, a disorder he calls the Hubris Syndrome. This syndrome is characterised by recklessness, an inattention to detail, overwhelming self-confidence and contempt for others; all of which, he observes, ‘can result in disastrous leadership and cause damage on a large scale’. The syndrome, he continues, ‘is a disorder of the possession of power, particularly power which has been associated with overwhelming success, held for a period of years and with minimal constraint on the leader’. The symptoms Owen describes sound strikingly similar to those I observed on Wall Street, and his account further suggests an important point – that the manic behaviour displayed by many traders when on a winning streak comes from more than their newly acquired wealth. It comes equally, perhaps more, from a feeling of consummate power.
During the dot.com years I was in a good position to observe this manic behaviour among traders. On the one hand I was immune to the siren call of both Silicon Valley and Silicon Alley. I never had a deep understanding of high tech, so I did not invest in it, and could watch the comedy with a sceptical eye. On the other, I understood the traders’ feelings because I had in previous years been completely caught up in one or two bull markets myself, ones you probably did not hear about unless you read the financial pages, as they were isolated in either the bond or the currency market. And during these periods I too enjoyed above-average profits, felt euphoria and a sense of omnipotence, and became the picture of cockiness. Frankly, I cringe when I think about it.
So during the dot.com bubble I knew what the traders were going through. And the point I want to make is this: the overconfidence and hubris that traders experience during a bubble or a winning streak just does not feel as if it is driven by a rational assessment of opportunities, nor by greed – it feels as if it is driven by a chemical.
When traders enjoy an extended winning streak they experience a high that is powerfully narcotic. This feeling, as overwhelming as passionate desire or wall-banging anger, is very difficult to control. Any trader knows the feeling, and we all fear its consequences. Under its influence we tend to feel invincible, and to put on such stupid trades, in such large size, that we end up losing more money on them than we made on the winning streak that kindled this feeling of omnipotence in the first place. It has to be understood that traders on a roll are traders under the influence of a drug that has the power to transform them into different people.
Perhaps this chemical, whatever it is, accounts for much of the silliness and extreme behaviour that accompany bubbles, making them unfold much like a midsummer night’s dream, with people losing themselves in ill-fated delusions, mixed identities and swapped partners, until the cold light of dawn brings the world back into focus and the laws of nature and morality reassert themselves. After the dot.com bubble burst, traders were like revellers with a hangover, heads cradled in hands, stunned that they could have blown their savings on such ridiculous schemes. The shocked disbelief that the reality sustaining them for so long had turned out to be an illusion has nowhere been better described than on the front page of the New York Times the day after the Great Crash of 1929: ‘Wall St.,’ it reported, ‘was a street of vanished hopes, of curiously silent apprehension and a s
ort of paralyzed hypnosis.’
IS THERE AN IRRATIONAL EXUBERANCE MOLECULE?
As I say, the overconfident behaviour I describe is one that most traders will recognise and most have experienced at one point or another in their careers. I should add, however, that in addition to the changed behaviour among traders, another remarkable fact struck me during the dot.com years – that women were relatively immune to the frenzy surrounding internet and high-tech stocks. In fact, most of the women I knew, both on Wall Street and off, were quite cynical about the excitement, and as a result were often dismissed as ‘not getting it’, or worse, resented as perennial killjoys.
I have a special reason for relating these stories of Wall Street excess. I am not presenting them as items of front-line reportage, but rather as overlooked pieces of scientific data. Scientific research often begins with fieldwork. Fieldwork turns up curious phenomena or observations that prove to be anomalies for existing theory. The behaviour I am describing constitutes precisely this sort of field data for economics, yet it is rarely recognised as such. Indeed, out of all the research devoted to explaining financial market instability, very little has involved looking at what happens physiologically to traders when caught up in a bubble or a crash. This is an extraordinary omission, comparable to studying animal behaviour without looking at an animal in the wild, or practising medicine without ever looking at a patient. I am, however, convinced we should be looking at traders’ biology. I think we should take seriously the possibility that the extreme overconfidence and risk-taking displayed by traders during a bubble may be pathological behaviour calling for biological, even clinical, study.