by John Coates
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, the faeces being loose and watery. Normally, when undigested waste matter leaves the small intestine it does so in liquid form. As it passes through the large intestine the water is reabsorbed, to maintain the body’s hydration, producing dry stool. But if the colon empties quickly it has no time to complete this process, so the faeces remain mostly liquid. 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.
THE STRESS RESPONSE TO A BEAR MARKET
Scott’s amygdala, registering the severity of the situation, now switches on the big engines of the stress response by flooding his body with cortisol. Cortisol had already been released in small quantities before the news reports, giving Scott and the other traders something of a buzz; but it is now released, pulse after pulse, in such large quantities that it alters the character of the stress response, causing his body and brain to hunker down for a long siege. The effects of Scott’s cortisol are now anything but pleasant. From here on, his attempts to remain cool and rational will encounter the same difficulties as a student trying to finish an exam in the middle of a fire drill.
The biology unfolds in the following way: the amygdala broadcasts a signal to the hypothalamus, a neighbouring brain region which controls the body’s hormones. The hypothalamus tells the pituitary, a gland lying just below it, to secrete a chemical messenger into the blood, where it rushes about looking for receptors in which it fits. The messenger soon finds these in the rim of the adrenal glands, and instructs cells to manufacture cortisol. The cortisol, now pouring out of Scott’s adrenal glands, carries a message to far-flung reaches of his body: the fight-or-flight is taking longer than expected, so to maintain the energy levels needed for this marathon struggle, shut down long-term functions of the body and marshal all available resources, mostly glucose, for immediate use. Adrenalin had initiated this process, but it is short-acting, so now cortisol takes over, maintaining high blood pressure and an accelerated heart rate, and diverting energy away from digestion, reproduction, growth and energy storage.
Fig. 10. The stress response. The initial and rapid phase of the stress response, called the fight-or-flight reaction, is triggered by the amygdala and locus ceruleus. The electrical signals of the fight-or-flight alarm travel down the spinal cord and out into the body, raising heart rate, breathing and blood pressure, and liberating adrenalin from the core of the adrenal glands. The more sustained phase of the stress response involves the hypothalamus, which, through a series of chemical signals carried in the blood, instructs the outer layer of the adrenal glands to produce cortisol. The cortisol then exerts widespread effects on both body and brain, instructing them to hunker down for a long siege by suppressing long-term functions such as digestion, reproduction, growth and immune activation.
Cortisol slows digestion by inhibiting digestive enzymes and shunting blood away from the stomach walls. It further inhibits the production and effects of growth hormone, stunting growth in young adults exposed to stress. Crucially, cortisol also reverses the body’s anabolic processes. While an anabolic process builds up energy reserves, a catabolic process breaks them down for immediate use. Cortisol, as a catabolic steroid, blocks the effects of both testosterone and insulin; and it causes glycogen deposits to be broken down into glucose; fat cells into free fatty acids, an alternative energy source; and muscles into amino acids, which are then shunted to the liver to be converted into glucose. Cortisol has further effects in preparing us for a crisis: it suppresses the reproductive tract by inhibiting the synthesis of testosterone and sperm in men, and oestrogen and ovulation in women.
Finally, in case the crisis ends in injury, cortisol stands by as a powerful anti-inflammatory, one of the most effective known to medicine. In its role of preparing us for injury cortisol is aided by another powerful set of chemicals called endorphins, a type of opiate (responsible, some say, for the fabled runner’s high), which are released in the body and brain during chronic stress as an analgesic, dulling our sense of pain. The effects of these natural painkillers are occasionally observed in battle when wounded soldiers fight on, unaware they have been injured.
Martin hears of Scott’s loss, and glancing down the aisle advises him, ‘This thing’s a freight train; don’t get in the way.’ Scott wisely takes the advice, and over the course of the afternoon, as he tries to sell out the remains of his ill-conceived position, his cortisol levels continue to rise. He and Martin are having very different experiences, Martin thrilling to the volatility, Scott being crushed by it. In fact, across the floor, traders – depending on their physiology, training and exposure to credit markets – display varying physical responses to the volatility. Scott is a wreck, suffering an exaggerated stress response; Gwen is thriving on the flows, and is sustaining a mild fight-or-flight response, with moderate and invigorating levels of both adrenalin and cortisol, just as she used to in mid-tennis match; while Martin, benefiting from a toughened physiology and years of experience, has not needed much cortisol today, nor even much of the fight-or-flight response – his vagus nerve has merely released its brake on his heart and lungs, permitting the naturally powerful idle of his body to carry him through the afternoon without even breaking a sweat. Lucky him.
How does the vagal brake accomplish this miraculous feat? When you are in a relaxed state, reading a book say, your breathing and heart rate idle at a slow speed. But unlike a car, this resting heart rate is not your heart’s default setting: its default setting is considerably faster, somewhere between a slow idle and full throttle. Your heart does not rev up to this natural setting because the vagus nerve applies its brake, slowing down both heart rate and breathing. If you are jarred out of this relaxed state by an emergency, the fight-or-flight nervous system takes over and raises your heart rate to a higher speed. But not for minor stressors. Between a resting heart rate and a fight-or-flight howl, there are intermediate levels of heart activation, and these are controlled by the vagus. In reaction to minor stressors the vagus can merely ease off its brake and allow the heart to accelerate on its own. This is a far more gentle and precise form of control over the heart and it is more efficient metabolically than launching into full fight-or-flight every time we confront a challenge. In fact we rely on these minute vagal adjustments to our heart throughout the day, and reserve the fight-or-flight acceleration for the times when trouble really looms. This is a marvellous trick. What a relief it is to let the vagus, like a trusty assistant, handle these minor hassles without causing us even a moment’s concern. The physiological elite among us enjoy these benefits to an even greater degree: they have such good vagal tone that when faced by a vigorous challenge they do not need much cortisol, nor even much adrenalin, to handle it; they can merely release their vagal brake. Martin is lucky enough to belong to this physiological elite.
But not Scott. The crisis he faces today demands far more physiological resources than his idle can provide, so his body has initiated a powerful stress response. The tidal wave of stress hormones that now overwhelms him has been caused by more than the large amount of money he has lost; it has also been caused by the bewildering volatility of the market. Volatility means uncertainty, and uncertainty can have as large an effect on our bodies as actual harm, a fact of great importance in understanding stress in modern life.
In the early years of stress research, some scientists, such as Hans Selye, a Hungarian working at McGill University in the 1950s, believed the body mounted a defensive stress response largely to actual bodily harm, such as hunger, thirst, hypothermia, injury, low blood sugar, and so on. Others, some of them psychologists such as John Mason from Yale, noticed that the hypothalamus and the adrenal glands reacted more powerfully to the expectation of harm than to harm itself. Since then, resear
chers have found that three types of situation signal threat and elicit a massive physiological stress response – those characterised by novelty, uncertainty and uncontrollability.
Let us consider novelty first. When scientists exposed rats to a novel setting, by placing them in a new cage, the rats experienced an enhanced stress response, with elevated corticosterone (the rodent form of cortisol), even though nothing bad had happened and nothing in the environment presented an overt threat. This observation led scientists to suspect that the stress response was largely preparatory in nature: in novel situations we do not know what to expect, what can happen to us, so our adrenal glands pump out the stress hormones adrenalin and cortisol, which in turn sharpen attention and increase available glucose, just to be ready.
Uncertainty also powerfully affects cortisol secretion. In a series of intriguing experiments conducted in the 1970s, the endocrinologists John Hennessey and Seymour Levine found that an animal’s stress response to a mild shock (nothing dangerous, just enough to make it withdraw its paw) depended more on the timing of the shock than on its magnitude. If a shock was delivered at regular or predictable intervals, or if it was announced by an audible tone, then after the experiment the animal might have normal or just slightly elevated cortisol levels. If, however, the timing of the shocks was altered so that they became less predictable, the animal’s cortisol levels rose. As the timing of the shocks approached complete randomness, meaning they could not be predicted at all, cortisol levels reached a maximum. Animals received the same objective amount of shock in each experiment, yet experienced markedly different stress responses. Uncertainty about when the shock would come provoked more stress than the shock itself. Such a reaction is one we can all recognise, for it is the staple of horror films: we are more scared when uncertain about where the monster lurks than when it finally pops out and snarls at us. More seriously, it is also a pattern of stress that takes a heavy toll during times of war. During the Blitz in the Second World War, for example, the inhabitants of central London were exposed to daily, predictable bombing, while inhabitants of the city’s outer suburbs were exposed to intermittent and unpredictable raids. It was in the suburbs that doctors found a higher incidence of gastric ulcers.
Uncontrollability has also been studied as a potent influence on stress levels. In a series of what are called ‘yoked’ experiments, two animals were given the same amount of shock, but one could push a bar lever to stop the shock for both of them. In other words, one had control, the other did not. At the end of the experiment the two animals had been exposed to identical amounts of shock (in that sense yoked), but the animal with no control displayed a more exaggerated stress response than the one with access to the bar lever. In later experiments it was found that the stress-reducing power of the bar remained even if it was unplugged and did nothing at all. Control, even the illusion of control, can mitigate the stress response, while loss of control in a threatening situation provokes the most terrifying stress response.
Novelty, uncertainty and uncontrollability – the three conditions are similar in that when subjected to them we have no downtime, but are in a constant state of preparedness. They are also the conditions in which traders spend a good part of their day. Do these features of their environment affect traders in the same way they do animals? The answer is, emphatically, yes. That is the conclusion I and my colleagues arrived at after our series of experiments with traders. One of these studies was discussed in the previous chapter, when I described the effects of testosterone on the traders’ P&L. During that study, in addition to testosterone, I also collected cortisol from the traders, and gauged the uncertainty they faced by measuring the volatility of the market. The higher the volatility, we reasoned, the less certain traders would be of where market prices would trade in the coming days. What we found was that their cortisol levels rose substantially with the volatility of the market, demonstrating that their cortisol did indeed increase with uncertainty. In fact, so sensitive were traders’ cortisol levels to volatility that they displayed a remarkably tight relationship with the prices of derivatives, the securities used to hedge volatility, a finding that raises the intriguing possibility that stress hormones form the physiological foundation of the derivatives market.
We also looked at the variability in their P&L, which is an indicator of how much control they have over their trading. This too showed that as the variability of their P&L rose, so too did their cortisol levels. The traders’ hormone fluctuations, moreover, were extraordinarily large. In the normal course of events steroid hormones spike when we wake in the morning, this steroid surge acting much like a breakfast cup of coffee, and then decline over the course of the day. In this experiment we should have observed traders’ cortisol levels dropping by about 50 per cent from morning to afternoon sampling times, but on volatile days they actually increased over the course of the day, some of them by an astonishing 500 per cent, levels normally seen only in clinical patients.
This afternoon, Scott finds himself trapped in a situation that is novel. He has never seen anything like this market – anything remotely like it – in his entire career. In fact, no one has. To find anything comparable, a crisis involving all credit markets and even threatening the solvency of governments themselves, you would have to go back to the Crash of 1929. Scott has furthermore never been so uncertain about the future course of events, an uncertainty he shares with other traders. Evidence of this collective uncertainty is found in the VIX, ‘the Fear Index’, which has risen from a sleepy 11 per cent in the summer to over 25 per cent today, and in the coming months will hit a terrified 80 per cent. Finally, Scott has lost record amounts of money, meaning by definition that he has lost control. The cumulative effect of losses and the novel, uncertain and uncontrollable conditions of the market is a massive upwelling of cortisol in Scott and other traders along Wall Street.
By four o’clock that afternoon Scott has been ordered by Ash to close out his positions, but he has not had much success, and finds it hard to concentrate. Part of the problem stems from a profound change that has taken place in his locus ceruleus. Earlier in the day, in response to the shocking analysts’ reports, it had promoted a focused attention on the market and a heightened awareness of information relevant to predicting what mortgages would do next. But now, under a heavy load of stress, the pattern of neural firing in Scott’s locus ceruleus alters, from short and frequent bursts to sustained firing. When this pattern takes over a person can no longer concentrate, but instead scans the environment, the reason being that when confronted with true novelty we no longer know what is relevant and what to focus on. Our scanning becomes hurried and indiscriminate, almost panicky. Too stressed to think clearly, his attention jumping from one thing to another, Scott sits out the rest of the day, powerless to trade profitably.
Over the next few days the news from the banking sector darkens even more, and traders realise with sinking spirits that the credit market will not recover any time soon. Scott unwinds the last of his mortgage trade only to find that his spread trade, stocks to bonds, is also losing massive amounts of money, as stocks follow mortgages into the abyss and Treasuries enter one of the fastest and most sustained rallies in history. By Friday Scott finds he has not only given back all his year’s P&L, but has also lost an additional $9 million.
Scott had been looking forward to a weekend in the Hamptons with his girlfriend, taking in the late-autumn colours and the chill of sea air. But now he won’t sleep much, or eat. His dreams of his own house on the beach have vanished like a gambler’s lucky streak, and he wonders if he will even be able to afford a rental next summer. He spends most of the weekend on the phone to colleagues, reliving the week, collecting stories of other traders who have reassuringly also lost money. By Sunday his spirits have rallied somewhat. He may have given back his year, but, he reasons, his managers like him; the arb desk, despite losing $125 million last week, is still up $180 million on the year; and the bank as well has had a good yea
r. He may no longer be in line for that $8 million bonus he expected, but he can piggyback off the arb desk’s bonus pool and get, maybe, $1.5 million. After all, his girlfriend reassures him, the bank does not want to lose him to a competitor. Just to be safe, he starts showing up for work earlier than usual, wearing his best suits and ties, and having dinner with the salespeople he used to disdain. If you are not making money, you’d better at least have the sales force on your side.
But in the coming weeks Scott’s optimism proves illusory. The markets have plunged into a financial crisis of historic proportions, and when in this angry state, they inflict maximum pain, searching out and dashing every hope. The Federal Reserve lowers interest rates once again, and will continue to do so in the months ahead, but these moves fail to ignite the expected rally in risky assets. The arbitrage desk, unable to get out of its positions, haemorrhages money at an alarming rate, not only giving back all its year’s profits, but losing an additional $375 million. The bank is not in much better shape, with almost every department registering record losses. Over on the mortgage desk, Logan too has been sucked into the vortex now being called ‘the Credit Crisis’. Despite his best efforts, client flows, all on the sell side, have kept him constantly long the mortgage market, and he has now lost more money this year than he has made in the past five.
