The Biology of Boom and Bust?
Derivatives trader turned neuroscientist John Coates looks at the biological roots of economic boom and bust in his new book, The Hour Between Dog and Wolf. Here is an excerpt from Chapter 7, Stress Response on Wall Street.
Shell-shocked traders, under the influence of an overly active amygdala, become prey to rumour and imaginary patterns. In a recent study, two psychologists presented meaningless and random patterns to healthy participants, who appropriately found nothing of significance in them, and then to people exposed to an uncontrollable stressor, who did find patterns in the noise.
Under stress we imagine patterns that do not exist. A striking real-life example of this phenomenon is reported by Paul Fussell in his astonishing book The Great War and Modern Memory. Troops living in the trenches during the First World War, under the most unimaginable conditions of fear and uncertainty, were deprived of reliable information about the war because the official army newspaper contained little but inaccurate propaganda.
In the absence of reliable information, and in desperate need of it, troops fell prey to rumour in a manner not seen since the Middle Ages – rumours of wraithlike spies conversing with frontline troops before disappearing into the mist; of angels in the sky over the Somme; of a factory behind enemy lines called the Destructor where bodies of Allied soldiers were rendered for their fats; of tribes of feral deserters living in no-man’s land, preying on injured soldiers.
Traders during a financial crisis suffer from an equally wretched vulnerability to rumour and suspected conspiracy. Every bank, individually or collectively, at one time or another is going under; hedge funds, huge ones of course, conspiring to push down the markets; the Chinese dumping Treasuries; the UK defaulting on its sovereign debt; broker suicides. Each rumoured catastrophe is now given as much credence, and has as much effect on markets, as hard economic data.
Cortisol’s lethal effects on the brain are compounded by another chemical produced during stress, one produced in the amygdala called CRH (short for corticotropin-releasing hormone). CRH in the brain instils anxiety and what is called ‘anticipatory angst’, a general fear of the world leading to timid behaviour.
Together with cortisol, it also suppresses the production of testosterone, the invigorating hormone that powered so much of (Wall Street banker) Scott’s confidence, exploratory behaviour and risk-taking during the bull market. He now scares easily. He develops a selective attention to sad and depressing facts; news comes freighted with ill portent; and he seems to find danger everywhere, even where it does not exist. This paranoia colours his every experience; and when riding home in the taxi at night Scott finds that even his beloved New York City, once sparkling with opportunity and excitement, has lately taken on a menacing silhouette. As a result of chronic stress he, like most of his colleagues, becomes irrationally risk-averse.
By mid-December (2008), the financial industry has endured a month and a half of endless volatility and non-stop losses. The run-up to Christmas is normally one of the most optimistic and playful times of the year, with the holidays and skiing vacations to look forward to, followed by bonus payments in the New Year.
But such gaiety as had survived the crash has now been crushed by layoffs, brutally announced just before Christmas, involving almost 15 per cent of the sales and trading staff. Few people will get any bonus at all; and the lucky ones, like Martin and Gwen, who do get a small one, harbour a deep resentment because this year they have made record profits and helped to keep the bank afloat, while traders like Stefan, paid over $25 million last year, have helped blow up the bank and with it their, Martin and Gwen’s, bonuses. Scott will get nothing at all, and does not know how long he will be kept on. Layoffs have been similarly announced all along Wall Street and in the City of London. Many firms, facing bankruptcy, have closed their doors. One by one, the lights are going out all across the financial world.
With their jobs on the line, traders like Scott desperately need to make money, but find themselves oddly unable to initiate a trade, even one that looks attractive, being held back from the phones as if by a force field. They have become, as they say in the business, ‘gun shy’.
A reduced risk-taking among traders would be a welcome change under normal conditions, but during a crash it poses a threat to the stability of the financial system. Economists assume economic agents act rationally, and thus respond to price signals such as interest rates, the price of money. In the event of a market crash, so the thinking goes, central banks need only lower interest rates to stimulate the buying of risky assets, which now offer relatively more attractive returns compared to the low interest rates on Treasury bonds.
But central banks have met with very limited success in arresting the downward momentum of a collapsing market. One possible reason for this failure could be that the chronically high levels of cortisol among the banking community have powerful cognitive effects. Steroids at levels commonly seen among highly stressed individuals may make traders irrationally risk-averse and even price insensitive. Compared to the Gothic fears now vexing traders to nightmare, lowering interest rates by 1 or 2 per cent has a trivial impact. Central bankers and policy-makers, when considering their response to a financial crisis, have to understand that during a severe bear market the banking and investment community may rapidly develop into a clinical population.
Of the conditions affecting traders, a particularly unfortunate one is known as ‘learned helplessness’, a state in which a person loses all faith in his or her ability to control their own fate. It has been found that animals exposed repeatedly to uncontrollable stressors may pathetically fail to leave the cage in which this experiment was conducted if the door was left open.
Traders, after weeks and months of losses and volatility, may similarly give up, slumping in their chairs and failing to respond to profit opportunities they would only recently have leapt on. In fact there is some evidence suggesting that people like traders might be especially prone to this sort of collapse. Banks and hedge funds commonly select traders for their tough, risk-taking, optimistic attitude. Optimism is generally a valuable trait in a person, especially a trader, for it leads them to welcome risk, and to thrive on it.
But not always. Not if they are exposed to longlasting and unpredictable stressors. Research has suggested that optimistic people, those who are used to things working out, may not handle recurrent failure very well, and may end up with an impaired immune system and increased illness. Bankers, so well suited to the bull market, may be constitutionally ill prepared to handle bear markets.
A telling sign of the onset of learned helplessness is the subsiding of anger on the trading floor, anger being in fact a healthy sign that someone fully expects to be in control. During a crisis, when swearing dies down, fewer phones are smashed, and anger is replaced by resignation, withdrawal and depression, chances are traders have succumbed to learned helplessness. Once stress in the financial world has reached this pathological state, governments must step in, as they did in 2008-09, and do the job that traders can no longer perform – buy risky assets, reduce credit risk, lead the traders, now reduced to a shellshocked state, out of the slough of despond.
Stress-related disease in the financial industry
Prolonged and severe stress endangers more than the financial system: it poses a serious threat to the personal health of people working in the financial industry, and indeed in all the industries affected by troubles in the banking sector. In the workplace the difference between acute and chronic effects is most worryingly apparent. A prolonged stress response, by shutting down so many long-term functions of the body, impairs its ability to maintain itself. Blood has been shunted away from the digestive tract, so people become more susceptible to gastric ulcers.
The immune system, thrown into overdrive during the early stages of the stress response, has after chronic exposure to cortisol been suppressed (possibly because it draws too much energy), so people find themselves constantly battling upper respiratory diseases, like colds and ’flus, and other recurrent viruses, like herpes. Growth hormone and its effects have been suppressed, as have the reproductive tract and the production of testosterone.
This last effect, in addition to tensed muscles which prevent blood flow into what are called the cavernous cylinders (corpora cavernosa) of the penis, causes bankers like Scott, sexually insatiable during the bull market, to have difficulty maintaining an erection, even mustering any interest in sex, testosterone being the chemical inducement for erotic thoughts. Chronic stress, largely through cortisol’s interaction with the dopamine system, can also make people more susceptible to drug addiction.
And all these effects are magnified by the fact that elevated cortisol levels reduce sleep time, especially REM sleep, thereby depriving people of the downtime needed for mental and physical health. Steroids may orchestrate a symphony of physiological effects, but as time passes the music turns into a cacophony.
Perhaps the most harmful effect of prolonged stress is the chronically raised heart rate and blood pressure, a condition known as hypertension. The unceasing pressure on arteries that comes with hypertension can cause small tears in arterial walls, tears which then attract healing agents called macrophages or, more commonly, white blood cells. Mounds of these sticky clotting agents grow over the arterial injuries, and subsequently trap passing molecules, like fats and cholesterol.
Larger and larger plaques form, which can become calcified, a condition known as atherosclerosis, or hardening of the arteries. As the plaques grow and block arteries, they decrease blood flow to the heart itself, causing myocardial ischemia, or angina, a recurring pain in the chest. If the plaques become large enough they may break off, producing a thrombus, or clot, which then travels downstream to smaller and smaller arteries, and ends up blocking an artery to the heart, causing a heart attack, or an artery to the brain, causing a stroke.
As the economic crisis deepens, cortisol’s catabolic effects add to the problems created by high blood pressure. Insulin, which normally withdraws glucose from our blood for storage in cells, has been inhibited for months now, so high levels of glucose and low-density lipoproteins, the so-called bad cholesterol, course through traders’ arteries. Muscles as well get broken down for their nutrients, and the resulting amino acids and glucose circulate needlessly in the blood, looking for an outlet in demanding physical struggle.
Our stress response is designed to fuel a muscular effort, yet the stress most of us now face is largely psychological and social, and we endure it sitting in a chair. The unused glucose ends up being deposited around the waist as fat, the type of fat deposit posing the greatest risk for heart disease. At the extreme, stressed individuals, with elevated glucose and inhibited insulin, can become susceptible to abdominal obesity and type 2 diabetes. Patients suffering from Cushing’s syndrome epitomise the change in body shape, having atrophied arm and leg muscles and fat build-up on the torso, neck and face, making them appear much like an apple on toothpicks. A year into the financial crisis, the testosterone-ripped iron men of the bull market start to look decidedly puffy.
In the myriad ways described here, the stress response, as it builds and ramifies over the course of weeks and months, worsens the credit crisis. The bodily response initiated to handle the stress feeds back on the brain, causing anxiety, fear and a tendency to see danger everywhere. By so doing, this steroid feedback loop, in which market losses and volatility lead to risk-aversion and to a further sell-off in the market, can exaggerate a bear market and turn it into a crash.
Body-brain interactions may thus shift risk preferences systematically across the business cycle, destabilising it. Economists and central bankers, such as Alan Greenspan, refer to an irrational pessimism upsetting the markets, just as John Maynard Keynes once spoke of the dimming of animal spirits. With the development of modern neuroscience and endocrinology we can begin to provide a scientific explanation for these colourful phrases: cortisol is the molecule of irrational pessimism.