The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust, by John Coates, Fourth Estate RRP£20/Penguin Press RRP$27.95, 310 pages
As JPMorgan Chase joins the list of banks damaged by huge trading losses, the time has come to look beyond the obvious areas of economics and financial regulation for new ways to guard against unnecessarily risky behaviour – whether by individual traders, banks or the whole global system.
People have already found valuable insights from biology: for example, by building on epidemiological models for the spread of infectious disease to show how to reduce the threat of contagion in the financial system.
But John Coates, a Wall Street trader turned Cambridge University neuroscientist, looks at a quite different aspect of the life sciences in The Hour Between Dog and Wolf. This brilliant book shows how human biology contributes to the alternating cycles of irrational exuberance and pessimism that destabilise banks and the global economy – and how the system could be calmed down by applying biological principles.
Financial traders react with their whole being – brain and body – as they make and lose vast sums of money. Their behaviour is governed by a range of biological molecules, including hormones such as testosterone and cortisol, acting over different periods of time.
Many of these are rooted in the “flight or fight” responses of our animal ancestors, which may or may not be appropriate in a high-stress sedentary occupation. John Maynard Keynes got the general idea when he wrote in 1936 about “animal spirits” driving the economy.
In male traders – and most are young men – a run of success creates a testosterone-fuelled “winner effect” in which the trader is biologically driven to take ever greater risks. When he crashes into huge losses, his whole personality changes (a transformation that Coates calls the “hour between dog and wolf”, a phrase apparently popular in medieval times to denote the period of confusion and potential metamorphosis around dusk). The cowed trader becomes apathetic and, for a while at least, excessively risk-averse.
Coates draws on his own experience working for Goldman Sachs and Deutsche Bank to conjure up a fictional Wall Street investment bank. We follow the ups and downs of traders Martin, Ash, Gwen and the superstar Scott as bull market runs into credit crunch between 2006 and 2008.
Coates has a gift for vivid description, as the sights, sounds and (unfortunately) smells of the bank come to life in his prose. For instance, on the afternoon when the reality of the bear market hits home and the traders face up to huge losses, Scott’s bowels liquify.
“When caught in a terrifying event, our bodies assume we need a quick sprint to safety and accordingly jettison excess weight by forcefully expelling urine from the bladder and faeces from the colon,” Coates writes. “As losses mount on the trading floor, one observes anxious traders marching briskly to the toilets, the men’s room starting to exude the fear and stench of a slaughterhouse.”
There are ways to tame excessive displays of animal spirits, however. One is for trading rooms to employ more women and older men, in whom testosterone is less dominant. Their presence would, in the long term, lead to more stable and profitable activity, Coates argues. Another reform could be to change banks’ reward systems so that trading bonuses are based on performance over a whole business cycle of four or five years rather than on annual profits, which encourage short-term risk-taking and volatility.
On an individual level, people could be “toughened up” to react more constructively to the stresses of financial trading by, among other things, taking appropriate physical and mental exercise. But the first step is for bankers to recognise that biology can help us understand and regulate the financial markets. This book should be top of the summer reading list for Jamie Dimon, chief executive of JPMorgan, and anyone else wondering why traders so often get banks into trouble.
Clive Cookson is the FT’s science editor