Читать книгу The Hour Between Dog and Wolf: Risk-taking, Gut Feelings and the Biology of Boom and Bust - John Coates, John Coates - Страница 8

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 poloneck 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 Foreign Secretary and one of the founders of the 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 sort 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.

The 1990s were a decade ripe for such research. They gave us the folly of the dot.com bubble as well as the phrase that best described it – ‘irrational exuberance’. This term, first used by Alan Greenspan in a speech delivered in Washington in 1996 and subsequently given wide currency by the Yale economist Robert Shiller, means much the same thing as an older one, ‘animal spirits’, coined in the 1930s by Keynes when he gestured towards some ill-defined and non-rational force animating entrepreneurial and investor risk-taking. But what are animal spirits? What is exuberance?

In the nineties, one or two people did suggest that irrational exuberance might be driven by a chemical. In 1999 Randolph Nesse, a psychiatrist at the University of Michigan, bravely speculated that the dot.com bubble differed from previous ones because the brains of many traders and investors had changed – they were under the influence of now widely prescribed antidepressant drugs, such as Prozac. ‘Human nature has always given rise to booms and bubbles followed by crashes and depressions,’ he argued. ‘But if investor caution is being inhibited by psychotropic drugs, bubbles could grow larger than usual before they pop, with potentially catastrophic economic and political consequences.’ Other observers of Wall Street, following a similar line of thought, pointed the finger at another culprit: the increasing use of cocaine among bankers.

These rumours of cocaine abuse, at least among traders and asset managers, were mostly exaggerated. (Members of the sales force, especially the salesmen responsible for taking clients out to lap-dancing bars till the wee hours of the morning, may have been another matter.) As for Nesse, his comments received some humorous coverage in the media, and when he spoke at a conference organised by the New York Academy of Sciences a year later he seemed to regret making them. But I thought he was on the right track; and to me his suggestion pointed to another possibility – that traders’ bodies were producing a chemical, apparently narcotic, that was causing their manic behaviour. What was this bull-market molecule?

I came across a likely suspect purely by chance. During the later years of the dot.com era I was fortunate enough to observe some fascinating research being conducted in a neuroscience lab at Rockefeller University, a research institution hidden on the Upper East Side of Manhattan, where a friend, Linda Wilbrecht, was doing a Ph.D. I was not at Rockefeller in any formal capacity, but when the markets were slow I would jump in a taxi and run up to the lab to observe the experiments taking place, or to listen to afternoon lectures in Caspary Auditorium, a geodesic dome set in the middle of that vine-clad campus. Scientists in Linda’s lab were working on what is called ‘neurogenesis’, the growth of new neurons. Understanding neurogenesis is in some ways the Holy Grail of the brain sciences, for if neurologists could figure out how to regenerate neurons they could perhaps cure or reverse the damage of neuro-degenerative diseases such as Alzheimer’s and Parkinson’s. Many of the breakthroughs in the study of neurogenesis have taken place at Rockefeller.

There was another area of the neurosciences where Rockefeller had made a historic contribution, and that was in research on hormones, and specifically their effects on the brain. Many of the breakthroughs in this field had been made by scientists addressing very specific issues in neuroscience, but today their results may help us understand irrational exuberance, for the bull-market molecule may in fact be a hormone. And if that is the case, then by a delightful coincidence, at the very moment in the late 1990s when Wall Street was asking the question ‘What is irrational exuberance?’, uptown at Rockefeller scientists were working on the answer.

So what exactly are hormones? Hormones are chemical messengers carried by the blood from one tissue in the body to another. We have dozens of them. We have hormones that stimulate hunger and ones that tell us when we are sated; hormones that stimulate thirst and ones that tell us when it is slaked. Hormones play a central role in what is called our body’s homeostasis, the maintenance of vital signs, like blood pressure, body temperature, glucose levels, etc., within the narrow bands needed for our continued comfort and health. Most of the physiological systems that maintain our internal chemical balance operate pre-consciously, in other words without our being aware of them. For instance, we are all blissfully unaware of the Swiss-watch-like workings of the system controlling the potassium levels in our blood.

But sometimes we cannot maintain our internal balance through these silent, purely chemical reactions. Sometimes we need behaviour; sometimes we have to engage in some sort of physical activity in order to re-establish homeostasis. When glucose levels in our blood fall, for example, our bodies silently liberate glucose deposits from the liver. Soon, however, the glucose reserves burn off, and the low blood sugar communicates itself to our consciousness by means of hunger, a hormonal signal that spurs us to search for food and then to eat. Hunger, thirst, pain, oxygen debt, sodium hunger and the sensations of heat and cold, for example, have accordingly been called ‘homeostatic emotions’. They are called emotions because they are signals from the body that convey more than mere information – they also carry a motivation to do something.

It is enlightening to see our behaviour as an elaborate mechanism designed to maintain homeostasis. However, before we go too far down the path of biological reductionism, I have to point out that hormones do not cause our behaviour. They act more like lobby groups, recommending and pressuring us into certain types of activity. Take the example of ghrelin, one of the hormones regulating hunger and feeding. Produced by cells in the lining of your stomach, ghrelin molecules carry a message to your brain saying in effect, ‘On behalf of your stomach we urge you to eat.’ But your brain does not have to comply. If you are on a diet, or a religious fast, or a hunger strike, you can choose to ignore the message. You can, in other words, choose your actions, and ultimately you take responsibility for them. Nonetheless, with the passing of time the message, at first whispered, becomes more like a foghorned bellow, and can be very hard to resist. So when we look at the effects of hormones on behaviour and on risk-taking – especially financial risk-taking – we will not be contemplating anything like biological determinism. We will be engaged rather in a frank discussion of the pressures, sometimes very powerful, these chemicals bring to bear on us during extreme moments in our lives.

One group of hormones has particularly potent effects on our behaviour – steroid hormones. This group includes testosterone, oestrogen and cortisol, the main hormone of the stress response. Steroids exert particularly widespread effects because they have receptors in almost every cell in our body and brain. Yet it was not until the 1990s that scientists began to understand just how these hormones influence our thinking and behaviour. Much of the work that led to this understanding was conducted in the lab of Bruce McEwen, a renowned professor at Rockefeller. He and his colleagues, including Donald Pfaff and Jay Weiss, were among the first scientists not only to map steroid receptors in the brain but also to study how steroids affect the structure of the brain and the way it works.

Before McEwen began his research, scientists widely believed that hormones and the brain worked in the following way: the hypothalamus, the region of the brain controlling hormones, sends a signal through the blood to the glands producing steroid hormones, be they testes, ovaries or adrenal glands, telling them to increase hormone production. The hormones are then injected into the blood, fan out across the body, and exert their intended effects on tissues such as heart, kidneys, lungs, muscles, etc. They also make their way back to the hypothalamus itself, which senses the higher hormone levels and in response tells the glands to stop producing the hormone. The feedback between hypothalamus and hormone-producing gland works much like a thermostat in a house, which senses cold and turns on the heating, and then senses the warmth and turns it off.

McEwen and his lab found something far more intriguing. Feedback between glands and the hypothalamus does indeed exist, is one of our most important homeostatic mechanisms, but McEwen discovered that there are steroid receptors in brain regions other than the hypothalamus. McEwen’s model of hormones and the brain works in the following way: the hypothalamus sends a message to a gland instructing it to produce a hormone; the hormone fans out across the body, having its physical effects, but it also returns to the brain, changing the very way we think and behave. Now, that is one potent chemical. Indeed, subsequent research by McEwen and others showed that a steroid hormone, because of its widespread receptors, can alter almost every function of our body (its growth, shape, metabolism, immune function) and of our brain (its mood and memory) and of our behaviour.

McEwen’s research was a landmark achievement because it showed how a signal from our body can change the very thoughts we think. And it raised a series of questions that today lie at the heart of our understanding of body and brain. Why does the brain send a signal to the body telling it to produce a chemical which in turn changes the way the brain works? What a strange thing to do. If the brain wants to change the way it thinks, why not keep all the signalling within the brain? Why take such a roundabout route through the body?

And why would a single molecule, like a steroid, be entrusted with such a broad mandate, simultaneously changing both body and brain? I think the answer to these questions goes something like this: steroid hormones evolved to coordinate body, brain and behaviour during archetypal situations, such as fighting, fleeing, feeding, hunting, mating and struggling for status. At important moments like these you need all your tissues cooperating on the task at hand; you do not want to be multi-tasking. It would make little sense to have, say, a cardiovascular system geared up for a fight, a digestive system primed for ingesting a turkey dinner, and a brain in the mood for wandering through fields of daffodils. Steroids, like a drill sergeant, ensure that body and brain fall into line as a single functioning unit.

The ancient Greeks believed that at archetypal moments in our lives we are visited by the gods, that we can feel their presence because these moments – of battle, of love, of childbearing – are especially vivid, are remembered as defining moments in our lives, and during them we seem to enjoy special powers. But alas, it is not one of the Olympian gods, poor creatures of abandoned belief that they are, who touches us at these moments: it is one of our hormones.

During moments of risk-taking, competition and triumph, of exuberance, there is one steroid in particular that makes its presence felt and guides our actions – testosterone. At Rockefeller University I came across a model of testosterone-fuelled behaviour that offered a tantalising explanation of trader behaviour during market bubbles, a model taken from animal behaviour called ‘the winner effect’.

In this model, two males enter a fight for turf or a contest for a mate and, in anticipation of the competition, experience a surge in testosterone, a chemical bracer that increases their blood’s capacity to carry oxygen and, in time, their lean-muscle mass. Testosterone also affects the brain, where it increases the animal’s confidence and appetite for risk. After the battle has been decided the winner emerges with even higher levels of testosterone, the loser with lower levels. The winner, if he proceeds to a next round of competition, does so with already elevated testosterone, and this androgenic priming gives him an edge, helping him win yet again. Scientists have replicated these experiments with athletes, and believe the testosterone feedback loop may explain winning and losing streaks in sports. However, at some point in this winning streak the elevated steroids begin to have the opposite effect on success and survival. Animals experiencing this upward spiral of testosterone and victory have been found after a while to start more fights and to spend more time out in the open, and as a result they suffer an increased mortality. As testosterone levels rise, confidence and risk-taking segue into overconfidence and reckless behaviour.

Could this upward surge of testosterone, cockiness and risky behaviour also occur in the financial markets? This model seemed to describe perfectly how traders behaved as the bull market of the nineties morphed into the tech bubble. When traders, most of whom are young males, make money, their testosterone levels rise, increasing their confidence and appetite for risk, until the extended winning streak of a bull market causes them to become every bit as delusional, overconfident and risk-seeking as those animals venturing into the open, oblivious to all danger. The winner effect seemed to me a plausible explanation for the chemical hit traders receive, one that exaggerates a bull market and turns it into a bubble. The role of testosterone could also explain why women seemed relatively unaffected by the bubble, for they have about 10 to 20 per cent of the testosterone levels of men.

During the dot.com bubble, when considering this possibility, I was particularly swayed by descriptions of the mood-enhancing effects of testosterone voiced by people who had been prescribed it. Patients with cancer, for example, are often given testosterone because, as an anabolic steroid – one that builds up energy stores such as muscle – it helps them put on weight. One brilliant and particularly influential description of its effects was written by Andrew Sullivan and published in the New York Times Magazine in April 2000. He vividly described injecting a golden, oily substance about three inches into his hip, every two weeks: ‘I can actually feel its power on almost a daily basis,’ he reported. ‘Within hours, and at most a day, I feel a deep surge of energy. It is less edgy than a double espresso, but just as powerful. My attention span shortens. In the two or three days after my shot, I find it harder to concentrate on writing and feel the need to exercise more. My wit is quicker, my mind faster, but my judgment is more impulsive. It is not unlike the kind of rush I get before talking in front of a large audience, or going on a first date, or getting on an airplane, but it suffuses me in a less abrupt and more consistent way. In a word, I feel braced. For what? It scarcely seems to matter.’ Sullivan could just as easily have been describing what it feels like to be a trader on a roll.

IRRATIONAL PESSIMISM

If testosterone seemed a likely candidate for the molecule of irrational exuberance, another steroid seemed a likely one for the molecule of irrational pessimism – cortisol.

Cortisol is the main hormone of the stress response, a bodywide response to injury or threat. Cortisol works in tandem with adrenalin, but while adrenalin is a fast-acting hormone, taking effect in seconds and having a half-life in the blood of only two to three minutes, cortisol kicks in to support us during a long siege. If you are hiking in the woods and hear a rustle in the bushes, you may suspect the presence of a grizzly bear, so the shot of adrenalin you receive is designed to carry you clear of danger. If the noise turns out to be nothing but wind in the leaves you settle down, and the adrenalin quickly dissipates. But if you are in fact being stalked by a predator and the chase lasts several hours, then cortisol takes over the management of your body. It orders all long-term and metabolically expensive functions of the body, such as digestion, reproduction, growth, storage of energy, and after a while even immune function, to stop. At the same time, it begins to break down energy stores and flush the liberated glucose into your blood. In short, cortisol has one main and far-reaching command: glucose now! At this crucial moment in your life, cortisol has in effect ordered a complete retooling of your body’s factories, away from leisure and consumption goods to war matériel.

In the brain, cortisol, like testosterone, initially has the beneficial effects of increasing arousal and sharpening attention, even promoting a slight thrill from the challenge, but as levels of the hormone rise and stay elevated, it comes to have opposite effects – the difference between short-term and long-term exposure to a hormone is an important distinction we will look at in this book – promoting feelings of anxiety, a selective recall of disturbing memories, and a tendency to find danger where none exists. Chronic stress and highly elevated stress hormones among traders and asset managers may thus foster a thorough and perhaps irrational risk-aversion.

The research I encountered on steroid hormones thus suggested to me the following hypothesis: testosterone, as predicted by the winner effect, is likely to rise in a bull market, increase risk-taking, and exaggerate the rally, morphing it into a bubble. Cortisol, on the other hand, is likely to rise in a bear market, make traders dramatically and perhaps irrationally risk-averse, and exaggerate the sell-off, morphing it into a crash. Steroid hormones building up in the bodies of traders and investors may thus shift risk preferences systematically across the business cycle, destabilising it.

If this hypothesis of steroid feedback loops is correct, then to understand how financial markets function we need to draw on more than economics and psychology; we need to draw as well on medical research. We need to take seriously the possibility that during bubbles and crashes the financial community, suffering from chronically elevated steroid levels, may develop into a clinical population. And that possibility profoundly changes the way we see the markets, and the way we think about curing their pathologies.

In time, and with the encouragement of several colleagues, I concluded that this hypothesis should be tested. So I retired from Wall Street and returned to the University of Cambridge, where I had previously completed a Ph.D in economics. I spent the next four years retraining in neuroscience and endocrinology, and began designing an experimental protocol to test the hypothesis that the winner effect exists in the financial markets. I then set up a series of studies on a trading floor in the City of London. The results from these experiments provided solid preliminary data supporting the hypothesis that hormones, and signals from the body more generally, influence the risk-taking of traders. We will look at these results later in the book.

MIND AND BODY IN THE FINANCIAL MARKETS

Research on body–brain feedback, even within physiology and neuroscience, is relatively new, and has made only limited inroads into economics. Why is this? Why have we for so long ignored the fact that we have bodies, and that our bodies affect the way we think?

The most likely reason is that our thinking about the mind, the brain and behaviour has been moulded by a powerful philosophical idea we inherited from our culture – that of a categorical divide between mind and body. This ancient notion runs deep in the Western tradition, channelling the riverbed along which all discussion of mind and body has flowed for almost 2,500 years. It originated with the philosopher Pythagoras, who needed the idea of an immortal soul for his doctrine of reincarnation, but the idea of a mind–body split was cast in its most durable form by Plato, who claimed that within our decaying flesh there flickers a spark of divinity, this being an eternal and rational soul. The idea was subsequently taken up by St Paul and enthroned as Christian dogma. It was by that very edict also enthroned as a philosophical conundrum later known as the mind–body problem; and later physicists such as René Descartes, a devout Catholic and committed scientist, wrestled with the problem of how this disembodied mind could interact with a physical body, eventually coming up with the memorable image of a ghost in the machine, watching and giving orders.

Today Platonic dualism, as the doctrine is called, is widely disputed within philosophy and mostly ignored in neuroscience. But there is one unlikely place where a vision of the rational mind as pure as anything contemplated by Plato or Descartes still lingers – and that is in economics.

Many economists, or at any rate those adhering to a widely adopted approach known as neo-classical economics, assume our behaviour is volitional – in other words, we choose our course of behaviour after thinking it through – and guided by a rational mind. According to this school of thought, we are walking computers who can calculate the rewards of each course of action open to us at any given moment, and weight these rewards by the probability of their occurrence. Behind every decision to eat sushi or pasta, to work in aeronautics or banking, to invest in General Electric or Treasury bonds, there purr the optimising calculations of a mainframe computer.

The economists making these claims recognise that most people regularly fall short of this ideal, but justify their austere assumption of rationality by claiming that people behave, on average, ‘as if’ they had performed the actual calculations. These economists also claim that any irrationality we display in our personal lives tends to fall away when we have to deal with something as important as money; for then we are at our most cunning, and come pretty close to behaving as predicted by their models. Besides, they add, if we do not act rationally with our money we will be driven to bankruptcy, leaving the market in the hands of the truly rational. That means economists can continue studying the market with an underlying assumption of rationality.

This economic model is ingenious, at moments quite beautiful, and for good reason has wielded enormous influence on generations of economists, central bankers and policy-makers. Yet despite its elegance, neo-classical economics has come under increasing criticism from experimentally-minded social scientists who have patiently catalogued the myriad ways in which decisions and behaviours of both amateur and professional investors stray from the axioms of rational choice. One reason for its lack of realism is, I believe, that neo-classical economics shares a fundamental assumption with Platonism – that economics should focus on the mind and the thoughts of a purely rational person. Consequently, neo-classical economics has largely ignored the body. It is economics from the neck up.

What I am saying is that something very like the Platonic mind–body split lingers in economics, that it has impaired our ability to understand the financial markets. If we want to understand how people make financial decisions, how traders and investors react to volatile markets, even how markets tend to overshoot sensible levels, we need to recognise that our bodies have a say in our risk-taking. Many economists might reiterate that the importance of money ensures that we act rationally where it is concerned; but perhaps it is this very importance which guarantees a powerful bodily response. Money may be the last thing about which we can remain cool.

Economics is a powerful theoretical science, with a growing body of experimental results. In fact many economists have come to question the assumption of a Spock-like rationality, even as a simplifying assumption, and a noteworthy group among them, beginning with the Chicago economist Richard Thaler and two psychologists, Daniel Kahneman and Amos Tversky, have started a rival school known as behavioural economics. Behavioural economists have succeeded in building up a more realistic picture of how we behave when dealing with money. But their important experimental work could today easily extend to the physiology underlying economic behaviour. And signs are some economists are heading that way. Daniel Kahneman, for one, has conducted research in the physiology of attention and arousal, and has recently pointed out that we think with our body.

He is right. We do. To understand just how our body affects our brain we should first recognise that they evolved together to help us physically pursue an opportunity or run away from a threat. When confronted by an opportunity for gain, such as food or territory or a bull market, or a threat to our well-being, such as a predator or a bear market, our brain sparks a storm of electrical activity in our skeletal muscles and visceral organs, and precipitates a flood of hormones throughout our bodies, altering metabolism and cardiovascular function in order to sustain a physical response. These somatic and visceral signals then feed back on the brain, biasing our thinking – our attention, mood, memory – so that it is in sync with the physical task at hand. In fact, it may be more scientifically accurate, although semantically difficult, to stop speaking in terms of brain and body at all, as if they were separable, and to speak instead of a whole-person response to events.

Were we to start viewing ourselves in this manner we would find economics and the natural sciences beginning to merge. Such a prospect may seem futuristic and strike some people as scary and a touch dehumanising. Scientific progress, admittedly, often heralds an ugly new world, divorced from traditional values, dragging us in a direction we do not want to go. But occasionally science does not do that; occasionally it merely reminds us of something we once knew, but have forgotten. That would be the case here. For the type of economics suggested by recent advances in neuroscience and physiology merely points us back to an ancient, commonsensical and reassuring tradition in Western thought, but one that has been buried under archaeological layers of later ideas – and that is the type of thinking begun by Aristotle. For Aristotle was the first and one of the greatest biologists, perhaps the closest and most encyclopaedic observer of the human condition, and for him, unlike Plato, there was no mind–body split.

In his ethical and political works Aristotle tried to bring thought down to earth, the catchphrase of the Aristotelians being ‘Think mortal thoughts’; and he based his political and ethical thinking on the behaviour of actual humans, not idealised ones. Rather than wagging a finger at us and making us feel shame for our desires and needs and the great gap existing between our actual behaviour and a life of pure reason, he accepted the way we are. His more humane approach to understanding behaviour is today in the process of being rediscovered. In Aristotle we have an ancient blueprint of how to merge nature and nurture, how to design institutions so that they accommodate our biology.

Fig. 1. Detail from Raphael’s School of Athens. Plato, on the left, holds a copy of his dialogue the Timaeus and points to the heavens. Aristotle holds a copy of his Ethics and gestures to the world around him, although with the palm of his hand facing down he also seems to be saying, ‘Plato, my friend, keep your feet on the ground.’

Economics in particular could benefit from this approach, for economics needs to put the body back into the economy. Rather than assuming rationality and an efficient market – the unfortunate upshot of which has been a trading community gone feral – we should study the behaviour of actual traders and investors, much as the behavioural economists do, only we should include in that study the influence of their biology. If it turns out that their biology does indeed exaggerate bull and bear markets then we have to think anew about how to alter training programmes, management practices, even government policies in order to counteract it.

At the moment, though, I fear we have the worst of both worlds – an unstable biology coupled with risk-management practices that increase risk limits during the bubble and decrease them during the crash, plus a bonus scheme that rewards high-variance trading. Today nature and nurture conspire in creating recurrent disasters. More effective policies will have to consider ways of managing the biology of the market. One way to do that may be to encourage a more even balance within the banks between men and women, young and old, for each has a very different biology.

WHAT UNITES US

To begin the story I want to tell, we need to get a better understanding of how brain and body cooperate in producing our thoughts and behaviour, and ultimately our risk-taking. The best way to do that is to look at what might be called the central operation of our brain. What might that be? We may be tempted to answer, given our heritage, that the central, most defining feature of our brain is its capacity for pure thought. But neuroscientists have discovered that conscious, rational thought is a bit player in the drama that is our mental life. Many of these scientists now believe that we are getting closer to the truth if we say that the basic operation of the brain is the organisation of movement.

That statement may come as something of a shock – I know it did for me – even a disappointment. But had I learned its truth earlier than I did, I would have saved myself years of misunderstanding. You see, it is common when starting out in neuroscience to go looking for the computer in the brain, for our awesome reasoning capacities; but if you approach the brain with that goal you inevitably end up disappointed, for what you find is something a lot messier than expected. For the brain regions processing our reasoning skills are inextricably tangled up with motor circuits. You tend to get a bit annoyed at the lack of simplicity in this architecture, and frustrated at the inability to isolate pure thought. But that frustration comes from starting out with the wrong set of assumptions.

If, however, you view your brain and body and behaviour with a robust appreciation of the fact that you are built to move, and if you let that simple fact sink in, then I am willing to bet you will never see yourself in quite the same way again. You will come to understand why you feel so many of the things you do, why your reactions are often so fast as to leave conscious thought behind, why you rely on gut feelings, why it is that during the most powerful moments of your life – satisfying moments of flow, of insight, of love, of risk-taking, and traumatic moments of fear, anger and stress – you lose any awareness of a split between mind and body, and they merge as one. Seeing yourself as an inseparable unity of body and brain may involve a shift in your self-understanding, but it is, I believe, a truly liberating one.