by John Coates
By the end of the 1930s this molecule was already at work in medical clinics, being used to treat depression and what was then called ‘ involutional melancholia’, the ebbing in vitality among men entering middle age, often the result of a perfectly natural decline in testosterone. Today this condition – although if it is natural ageing it should perhaps not be called a condition at all – is marketed by pharmaceutical companies as andropause, the male equivalent to menopause, although the term has yet to achieve medical respectability.
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So, all hype aside, what exactly is testosterone? Testosterone is commonly thought of as a male sex hormone, but it is found in women as well. There are profound differences, however, between the sexes. Men produce it in their testes and to a lesser extent their adrenal glands, and women in their ovaries and adrenals. Importantly, men produce about ten times the amount of testosterone as women, and therefore display more pronounced effects. In fact, so broad and powerful are these effects that it is this molecule, almost on its own, which creates a male. Let me explain.
We each have twenty-three pairs of chromosomes, and it is the twenty-third pair which determines whether a foetus is a boy or girl. This chromosome can be either XX, in which case the foetus develops as a female, or XY, in which case it develops as a male. The default sex of all foetuses is female: unless they have a Y chromosome, they will develop into females. The Y chromosome is a surprisingly simple one, with very few genes on it. One of these is responsible for the bulk of the differences between men and women. This gene is called SRY, standing for Sex Determining Region of the Y chromosome.
What the SRY gene does is simple. It codes for the building of a protein hormone called Testis-Determining Factor, which shunts the primordial gonads off the path leading them to develop into ovaries and onto a path leading them to develop into testes. Once they start to grow, the testes produce testosterone, and this molecule creeps out into the bloodstream and does all the rest of the work, docking in receptors throughout the body and morphing tissues into a male rather than female form. And that is about it. One gene, one protein hormone, growth of testes, then testosterone does almost all the rest, creating a male from Eve’s rib. Recently scientists have found other genes that code for differences between men and women, especially their brains, but testosterone nonetheless does most of the work. That is one potent chemical, just as Brown-Séquard and Butenandt advertised.
Problems lurk in this Y chromosome. Chromosomes normally swap genetic material, a process known as recombination, and this exchange has the felicitous effect of repairing any damaged genetic material, ensuring our continued health. Genetic recombination can be compared to the regular servicing you schedule for your car, in which old parts are replaced by new ones. Our chromosomes do much the same thing when they recombine – they exchange old and broken genetic parts for new ones. An X chromosome can swap material with another X chromosome, thus ensuring that each generation is fitted with new parts. But not so the isolated Y. This lone wolf has nothing it can swap with, so over time, like a car that is never serviced, it compounds problems and accumulates damage until its genes, one by one, die off. Some animals, such as the kangaroo, now have only a few genes remaining on their Y chromosome. This slow death of the Y has been called Adam’s Curse by the Oxford geneticist Bryan Sykes, who predicts that in 5,000 generations men will be extinct.
Testosterone levels fluctuate dramatically over the course of a man’s life. There is a prenatal surge between the eighth and nineteenth week of gestation, and it is at this time that the foetus is masculinised, the testosterone spreading out across the body and brain and creating the tissues, chemical circuits and receptor fields that will influence adult male behaviour. Testosterone levels then subside, spike once more just after birth, for reasons that are not well understood, and then subside again until puberty, this hormonal vacation allowing little boys to be the angels that they are. At puberty testosterone comes flooding back into a boy’s body, coursing along canals, activating tissues that the testosterone itself had created and then left for years to lie dormant, much like sleeper cells in a spy ring. Its effects now are profound, building muscle, manufacturing sperm, lowering the voice, growing facial hair, stimulating sebaceous glands in the skin and frequently causing acne. Later, beginning in his early thirties, a man’s testosterone levels begin to fall, and continue to do so over the rest of his life, these falling hormone levels perhaps calibrating the risks he chooses to take with his body’s declining ability to handle them.
The surge of testosterone at puberty can drive much of the risky behaviour teenage boys are known for. Blame cannot, however, be placed entirely on hormones, because the teenage brain has not finished developing, and there is some evidence that the nucleus accumbens, the thrill centre of the brain, outgrows the more rational prefrontal cortex well into our twenties. Whatever the cause, teenage boys are a menace, and every adult male, myself included, knows deep down that he is lucky to have survived those years.
There is another noticeable effect of these testosterone surges, and that is on sex drive. In animals this hormone prepares a male both to fight and to mate during breeding season, this dual action illustrating yet again how steroids unify body and brain during archetypal moments of life. Among humans testosterone has much the same (albeit muted) effect, on both men and women – it increases desire and sexual fantasy. It should be noted, however, that while testosterone affects a man’s desire, it is not directly involved in the mechanics of erection. Erections are controlled, oddly, by the rest-and-digest nervous system (that is why having sex can be difficult if you are stressed), while ejaculation is controlled by the fight-or-flight nervous system. Sex thus requires a complicated synchronising of hormones and two branches of the nervous system. Testosterone, though, mainly affects a male’s interest in sex, his tendency to think about it every few minutes, to find sexual cues everywhere, and to spin out maddening fantasies.
What determines the amount of testosterone a foetus is exposed to in the womb? These levels are largely the result of genetics, as one would expect, but there is some evidence that birth order also affects them. In animals, the first-born in a clutch of offspring has a distinct advantage over its siblings, a day or two head-start making it larger and stronger, and capable of hogging the food and even pushing the next-born out of the nest. Nature, however, has found a way of evening the odds of survival. A mother’s body, in the words of one research team, ‘appears to “remember” previously carried sons’, possibly because each of them leaves behind a marker, known as the HY antigen. A female, a bird for example, will then deposit higher levels of testosterone in later-born males. These males may be smaller at birth, but they are meaner, and that evens the odds with their bigger siblings. Some reports suggest that the same mechanism exists in humans, with younger sons often proving more aggressive than their older brothers.
What physical advantages do these later-born males enjoy? Developmental biologists distinguish between the anabolic and the masculinising effects of testosterone. Masculinising effects include the growth of facial hair, the lowering of the voice, and the growth of testicles and sperm-producing cells. The anabolic effects include an increase in lean-muscle mass, in haemoglobin, and in bone density. It is the anabolic effects that athletes are after when they illicitly take steroids.
Today vast sums of money are poured into the design and manufacture of synthetic androgens. The result is an extensive menu of anabolic hormones known in the gym as ‘roids’, ‘juice’, ‘hype’, ‘pumpers’, ‘gym candy’ or ‘Arnolds’. A fascinating glimpse into this world of illicit steroid use can be found in the film The Wrestler, in which Mickey Rourke plays an ageing fighter who relies on drugs to keep up his form and strength. Athletes abusing anabolic steroids, frequently raising their levels of testosterone by four to five times those naturally found in their bodies, can suffer some unexpected side-effects. For example, their testicles, interpreting the excessive levels of testoste
rone in the blood as a signal that they do not need to produce any more, shrivel to the size of raisins. Furthermore, in many tissues of the body and brain, testosterone, through a curious twist of evolutionary fate, must be transformed by an enzyme called aromatase into the female sex hormone oestrogen before it can become biologically active. Adipose tissue – fat cells really – are particularly rich in this enzyme, so men who have either a lot of these cells, such as those who are obese, or a lot of testosterone, such as those using anabolic steroids, can end up growing breasts, a condition known as gynaecomastia. At sufficiently high levels, testosterone, the ultimate male molecule, bizarrely starts to feminise weightlifters.
At moderate levels, though, anabolic steroids give an athlete a very clear advantage, and this has led to a high-tech cat-and-mouse game between sports scientists trying to elevate testosterone levels illegally and the policemen of governing bodies like the IOC. The clear advantages testosterone bestows on athletes have also led to a much more controversial form of testing, the testing for an athlete’s sex. It had been suspected in some Olympic Games that gold medals in some women’s events had actually been awarded to men, so the practice began of testing female athletes to see if they were indeed what they claimed to be. At first this seemed a simple case of looking for a Y chromosome. If an athlete tested positive for XY, then he was a male. Simple. As a result of this test a handful of women at both the 1992 Barcelona and the 1996 Atlanta Olympic Games were disqualified.
Unfortunately, the reasoning behind the tests was questionable. If a person has a Y chromosome then they do in fact produce testosterone, starting at the foetal stage. But what if that person has been born with a genetic disorder that makes them insensitive to testosterone? What if their testosterone receptors do not work? Then the testosterone will have no effect. This is precisely what happens in a condition called Androgen Insensitivity Syndrome – people with a Y chromosome produce testosterone, yet it does not masculinise them. Since the default sex of a foetus is female, these people will appear to all the world as women. Are they women? They think so, and who is to tell them otherwise? In the end the issue of establishing sexual identity became intractable and politically fraught. Many women athletes found the tests invasive, far too public, and almost medieval in their humiliation, like displaying the bedsheets of newlyweds. As a result, sex testing was dropped from the 2000 Sydney Olympics.
TAKING THE HEDGE OUT OF HEDGED TRADES
This is a glorious time for the trading desks: the flows are deep, the markets volatile yet optimistic. The Treasury traders find themselves taking larger and larger positions and making more money than ever before. But the risks they take are as nothing compared to those taken on other desks. The real risks to a bank’s capital, and to its solvency, are usually found on the desks trading securities that carry credit risk, securities such as stocks, corporate bonds (ones issued by private companies), junk bonds (ones issued by private companies that are on the verge of bankruptcy), and mortgage-backed bonds.
There is one desk, though, that has a mandate to trade all of these dangerous securities, and not surprisingly it often lies at ground zero of any financial crisis. This desk is located just down the aisle from Martin – the fixed income arb desk. Arb is short for arbitrage, a complicated and supposedly clever type of trading designed to profit from incorrectly priced securities. Arb traders do not provide prices or services for clients, as do flow traders like Martin and Gwen; rather, they trade for the bank’s own account, buying securities that seem cheap and selling ones that seem expensive, sometimes amassing huge leveraged positions, that is, ones financed with borrowed money. The positions can end up being several times larger than the entire value of the bank itself. To put this leverage in perspective, these traders’ positions can be compared to a home-owner who borrows $20 million against the collateral of his $500,000 home, in order to buy some rental properties. Were the rental properties to drop in value by a mere 2.5 per cent, the home-owner’s capital would be wiped out, bankrupting him. It was leverage on this scale that in 2008 bankrupted the investment bank Lehman Brothers.
Arb desks house the so-called rocket scientists, ex-physics or engineering quants who build models designed to spot pricing anomalies in, say, the yield curve or the volatility surface in the options market. Stefan, for example, the head of the desk, has a Ph.D in physics from the University of Moscow and has worked on Superstring Theory, a bewildering branch of quantum physics in which sub-atomic objects vibrate in ten dimensions. Arb traders, being inscrutable geniuses, have a licence to act inappropriately – to go unshaven, dress down, show up for work at noon. Unlike flow traders, who must be clean-cut, well-dressed (but not too flashy – Brooks Brothers rather than Prada) and capable of observing basic table manners when entertaining clients, arb traders are nurtured as the floor’s eccentrics. Whether or not they have the brains and personalities to carry this persona does not matter. Trading floors have a fixed mythology – the funny guy, the sports legend, the brainy eccentric – and people get slotted into one category or other, whether they belong there or not. So it is that arb traders get typecast, tolerated and, tragically, given the benefit of the doubt when management does not understand what they are doing.
One of the arb traders, Scott, has a particularly valuable expertise: spotting discrepancies between the value of a company’s stock and its bonds. The stock of GM or GE or IBM may reflect optimistic expectations of future earnings, while its bonds may reflect worries about the company’s finances. In these cases the stock may be priced too high and the bonds too low, presenting Scott with an arbitrage opportunity. Scott is particularly skilled at this sort of trading because he is a former flow trader from the corporate bond desk, and has extensive experience in assessing credit quality. As a result he is one of the few people in the bond department permitted to trade actively in the stock market. When Scott spots a situation in which two securities are mispriced relative to each other he buys one and shorts the other, establishing what is called a spread or a hedged trade – the terms are mostly synonymous – one of the most common trading strategies pursued by arbitrage desks and hedge funds. They are also used extensively by flow traders such as Martin.
What exactly is a spread trade? What is hedging? What is shorting? Since few people outside banking really understand these trading strategies, it may be worthwhile to explain them. They are also well worth understanding because many of the most toxic positions taken by financial institutions, the positions that frequently lead to crises, are these spread or hedged trades. This fact carries a certain irony: a spread or hedged trade is one that is supposed to minimise market risk. Because a spread trade profits from the mispricing of two securities relative to each other, its profits do not in principle depend on the market going up or down. They depend rather on the price difference between the two securities returning to normal, and this has always been assumed to be a less risky type of trade. To see how a spread trade works, consider an example set in your local fruit market.
Imagine a situation in which an orange is worth on average 10¢ more than an apple. If oranges at the market are priced at, say, 60¢ each, then apples would normally be priced at 50¢. Imagine as well that this 10¢ price difference persists even when the price of fruit goes up or down: it might rise in value with inflation, with oranges increasing to $1, but then apples would also increase, to 90¢. This price relationship is reliable enough to assure you that if the prices of the two fruits diverge from the 10¢ difference to, say, 20¢, then you know with some assurance that eventually they will return to the normal 10¢ difference.
Now imagine you are strolling through the market one day and you notice that oranges are priced at 60¢, yet apples are at 40¢, a difference of 20¢. You fully expect this price difference to revert to normal; and being crafty by nature, you try to figure out how to make money from that prediction. You could buy apples at what seems like a cheap price of 40¢; but if fruit were to fall in value, because of, say, a bumper
harvest, then apples could drop to 20¢. In this case, even if the price difference between apples and oranges reverted to 10¢, with oranges dropping to 30¢, you would have lost 20¢ on your apples. Similarly, you could sell oranges at the seemingly high price of 60¢, but if the fruit market were to rally in price, perhaps because of a frost in the fruit-growing regions, then oranges could rise to $1, and apples to 90¢. Here again the price difference has reverted to normal, but you have lost money on your oranges, in this case 40¢. The only way to profit from the price discrepancy returning to normal is by establishing a spread or a hedged position, one whose profits are determined independently of the market going up or down. A hedged position is therefore said to be market neutral.
How does it work? How could you, as a trader, profit from the mispricing of fruit in a market-neutral manner? You could do it with three separate transactions: First, you buy, say, 100 apples at 40¢ from one fruit stall. Second, you sell 100 oranges at 60¢ to another stall which is looking to buy them. Selling an asset you do not own is called shorting. But how do you deliver 100 oranges to this stall if you do not own them? Selling something you do not own constitutes fraud, so you have to deliver the oranges somehow. To avoid breaking the law you undertake the third transaction: you go to another stall, take its owner to one side and confide in him. ‘Look,’ you say, ‘I need to borrow 100 oranges for a few days. I don’t want to buy them, just borrow them. If you lend me 100 oranges I’ll replace them in a few days, and for your services I’ll also then pay you 5¢ per orange.’ This stall owner, looking at his stock of oranges, thinks the proposal is a reasonable way of making a bit of extra money on fruit that might otherwise just sit there. So he lends you the 100 oranges, which you in turn deliver to your buyer.
