The Hour Between Dog and Wolf: Risk-taking, Gut Feelings and the Biology of Boom and Bust

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.