The Biology of Boom and Bust?

The Montreal Gazette published an excerpt from John Coates' new book, The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and 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.

This is a fascinating excerpt, one that I can relate to as an individual trading in this wolf market dominated by big banks, big hedge funds and high frequency trading platforms.

My stresses are amplified because I suffer from Multiple Sclerosis. But in an odd way, my 15-year battle with MS has helped me deal with unimaginable stress that would make even the most seasoned Wall Street trader crack under pressure.

I remember meeting with Jean Turmel, president of Perseus Capital Inc., and former president of Financial Markets, Treasury and Investment Bank for the National Bank of Canada. He told me trading will make my MS worse and advised me against such a vocation.

He was wrong. MS has made me a better trader precisely because it helps me deal with stress and puts perspective in my life. Sure, hate when I experience a huge loss (love taking huge risk), but the way I deal with those losses is key: just like with MS, if I stumble and fall, I pick myself up, dust myself off and forge ahead. I have MS; MS doesn't have me. No matter what obstacles I face in life, I persevere.

My health is the most important thing in my life. Without your health, you're finished, which is why I tell people to put themselves first. Makes perfect sense but I am shocked to see how people fret over trivial things like a house, a car, their social or even professional status and pay little to no attention to their mental and physical health.

I should be a poster child for people suffering with chronic diseases. After undergoing my liberation treatment, decided to join a gym and get active. I didn't stop there. Have seen numerous physios, a few chiropractors who tortured me (lol), and took the advice of my dad and brother to talk to a psychologist about dealing with MS.

My psychologist is cool. We basically go over communication skills and talk about how to best cope with MS and negative situations. With her help, I realized that I am an imposing and direct individual (also a great guy who got royally screwed and discriminated against!). That's my style but she made me understand that it can be perceived as a negative trait in the workplace or personal relationships. "You are who you are but it's how others perceive you that also matters."

There other things she keeps telling me is "don't focus your energy on negative people" and "acceptance is freedom from hell." Must admit, still can't accept how some prospective employers continuously discriminate against me based on the fact that I have MS or because I write a "controversial" blog (meaning I talk straight and piss off powerful people).

But when I am trading, blogging, analyzing markets, I put all those negative thoughts aside and focus on making links in the big picture to become a better trader and investment analyst. I love looking at trends in the hedge fund, private equity and real estate industry to see where I should be focusing my attention. I love learning through trial and error and have made my share of trading blunders. In trading, your learn the most when losing money. Period.

Making money in markets isn't a science. It's a life-long process where you continuously learn and adapt or else you will get killed. Traders will give you great advice like "cut your losses " but they rarely know when to "average down" or when to go "bottom-fishing" in depressed sectors.

Great traders do know how to take risk but in these schizoid markets which continuously shift like the wind, this isn't always easy and the psychological stress of losing big money on any given day can be overwhelming and put huge stress on one's mental and physical well-being.

That's why I will end off by giving you some wise advice. I take no medication for my MS. Partly by choice, partly because even though my disease has progressed very slowly, I'm considered "secondary progressive" (not relapsing-remitting) and there are no breakthrough therapies for this cohort yet (there will be).

What I do is simple. First, I eat well. Wake up and have a bowl of Nature's Path non-gluten Mesa Sunrise cereal with unsweetened almond milk (avoid dairy) and tons of blueberries. Go the gym three times a week in the morning or in the summer, swim every day. Try to follow a Mediterranean diet which means lots of salads, greens (steam asparagus, broccoli, spinach, or kale), skinless chicken and fish. Portion my meals and eat fruits, veggies and almonds as snacks in between meals (important to lose weight, you must snack in between meals).

Sure, I cheat once in a while and stuff myself with a pizza or a tasty souvlaki gyro, but almost never eat chips, processed foods and junk. I avoid sugar and artificial sweeteners, limit my gluten intake, and drink plenty of water to keep hydrated. And I never smoke cigarettes (the worst possible habit/ addiction!).

As far as supplements, I take large doses of vitamin D drops (cut it to 10,000 IUs a day) and liquid calcium magnesium right after dinner (make sure you have 2:1 ratio of magnesium to calcium or else you will be constipated and have a shitty day!) . Vitamin D and magnesium deficiency are extremely prevalent out there and yet most people are completely unaware they suffer from these deficiencies.

Magnesium helps calm your central nervous system and I guarantee it will give you more energy, maintain regularity and help you sleep like a baby (take a large dose with your vitamin D right after dinner). Adequate sleep and moderate exercise will also help reduce cortisol levels and reduce stress, allowing you to make better decisions.

Don't know why I am sharing all this health information with you but my point is simple: don't take your mental or physical health for granted! Companies also have to do their part to make sure their employees are healthy, especially in the financial sector where nowadays it seems everyone is treated like shit.

It's sad but I have come to accept that the financial industry is a hopelessly shallow and immoral industry full of lying, insecure scumbags that protect their turf at all cost (there are good people too but not enough). Every week I learn about something at some organization but nothing shocks me anymore.

Office politics and the culture at banks, pensions and money management firms is the worst it has ever been which is why many traders want to leave and start their own fund (not easy in this environment). The thinking is if you're going to be fired so easily mind as well go off on your own and enjoy the upside of your blood, sweat and tears.

Below, Stephanie Ruhle reports on Jefferies Group's Sean George. Banker by day, boxer by night, George talks straight on the dismal state of Wall Street where perennial whiners suffering from severe entitlement issues aren't grateful for what they have.