by John Coates
Inevitably in these crises, just as night follows dusk, when nerves are close to snapping, rumours spread of impending layoffs, and uncertainty and uncontrollability reach new, debilitating levels. Traders, even former stars, feel vulnerable, and cannot count on job offers from other banks, let alone ones with a large signing bonus. There is even talk of the government shutting down all arb desks at the banks, even preventing flow traders from establishing arbitrage positions. As a result traders are starting to leave the banks for the hedge funds, where their risk appetite can still be fed. Desk managers now take to bullying juniors, hinting at changes to the desk, firing one or two people before the bank even announces layoffs. According to the primatologist Robert Sapolsky, dominant monkeys, when exposed to uncontrollable stressors, take to biting subordinates, an activity that horribly has the effect of lowering their cortisol levels, and managers, appearing to understand this ugly piece of physiology, offload their cortisol onto juniors, even ones who are performing well. In all the mess that goes into making a financial crisis, it is the uncertainty and uncontrollability created by middle managers that could most readily be minimised by upper management.
As December approaches and the days draw in, the stock market continues its plunge, and credit spreads, all of them, remain at historically wide levels. The high spirits of the bull market have now been thoroughly extinguished, and a wintry atmosphere descends on the trading floor. All across Wall Street, and overseas in the City of London and the financial centres of Tokyo, Shanghai, Frankfurt and Paris, the news is equally grim. Reports emerge of many black boxes being unplugged, the algorithms having as little success as humans in figuring out the financial anarchy; and hedge funds, even ones doing well, are seeing a flight of capital as investors shun risk. Scott and most other traders begin to suffer the toxic effects of a stress response that has gone on too long. It is at this point that cortisol has its most noxious impact on both brain and body, warping our thinking and damaging our bodies in ways that can kill us.
CHRONIC STRESS AND RISK-AVERSION
To understand the malevolent influence of stress in the financial world, we have to appreciate the difference between an acute exposure to stress hormones, i.e., moderate levels over a short period of time, and a chronic exposure, i.e., high levels over longer periods of time, for these two types of exposure have very different, and in most cases diametrically opposite, effects. Cortisol displays the same n-shaped dose–response curve we have encountered before, meaning that moderate levels have beneficial effects on cognitive and physical performance, while high levels impair them.
Moderate exposure to cortisol before the analysts’ announcements enhanced the traders’ vigilance, signal detection, metabolic preparedness and motor performance, and improved their mood almost to the point of euphoria. An acute reaction like this gave them a welcome edge. But the chronic exposure they have endured over the past month and a half is slowly poisoning them, wreaking havoc on their cardiovascular and immune systems, and in all likelihood impairing their ability to assess risk. The reason for this difference in effects is that the stress response evolved as a rapid, short-lived, and muscular retaliation; it was designed to switch on quickly, and to switch off after a short period of time. If it fails to do so, widespread medical problems ensue, largely because the stress response is metabolically expensive. The state of heightened readiness it promotes can be maintained over the long term only at the cost of breaking down many tissues in the body, much like burning furniture to keep a house warm.
Unfortunately, stress in the financial markets, and in society more generally, can indeed persist for long periods of time, because the ancient regions of the brain controlling the stress response – the amygdala, hypothalamus and brain stem – cannot distinguish clearly between a physical threat, which is usually brief (one way or the other), and a psychological or work-related one, which can endure for months, even years.
This latter situation is the one in which Scott now finds himself. Prolonged exposure to cortisol has begun to impair his ability to think and take risks almost to the point of making him useless as a trader. Part of the problem comes from a dramatic change that has taken place in the way his memory works. Cortisol affects memory by acting on dense receptor fields in the amygdala and in a neighbouring brain region called the hippocampus. These two brain regions act as a tag team in remembering stressful events. But they encode different aspects of memory: the amygdala the emotional significance of an event, the hippocampus the factual details.
This neural division of labour can be illustrated with the example of a child learning to ride a bicycle. After many false starts, the child finally kicks off, and lo and behold she is hurtling along the street unaided, a wonderful thrill. However, in her excitement she rides straight through an intersection without looking, and narrowly escapes being hit by a car. She dissects the experience and stores pieces of it in widely dispersed parts of the brain, from the cerebral cortex down to the brain stem. The motor control behind the physical feat of riding may be locked up safe from the ravages of time in the cerebellum, a region of the brain that keeps functioning even if a patient suffers a complete amnesia. When referring to something you cannot possibly forget, people commonly say, ‘It’s like riding a bike.’ The conceptual part of the learning experience, perhaps the point at which the girl figured out that the faster you ride the easier it is to remain on two wheels, may be stored away in her rational brain, the neo-cortex. The facts surrounding her first bike ride – the time of day, the location, the weather, who she was with, etc., in short her autobiographical memories – are stored in the hippocampus (although after a period of time they are moved from here to deep storage archives in the neo-cortex). And the fear caused by the near car accident may be stored in the amygdala. If this girl was to return to the same intersection a couple of years later, but with damage to her hippocampus, she might not recall the near accident, but her amygdala would fill her with dread, provoking a reaction with no more discernment than ‘I’m scared, I don’t like it here.’ If on the other hand she returned with an intact hippocampus but a damaged amygdala she might remember every detail of the near accident but have no emotional reaction to the remembered event, the attitude of the hippocampus being, ‘Just the facts, ma’am’.
Of these brain regions, and the types of memory they store, it is the amygdala and the hippocampus that are most affected by stress hormones. Through an extraordinary feat of chemical engineering, the same stress hormones that prepare our bodies to deal physically with a stressful challenge also instruct the amygdala and hippocampus to remember it, so we can avoid this or a similar risk next time. A mugging, a car accident, an encounter with a snake, news reports of 9/11 – tagged by cortisol for special storage, these events are captured for life as ‘ flashbulb memories’. Years later, even in old age, we seem to recall every detail surrounding them. Adrenalin, acting via the vagus nerve, assists cortisol in laying down these memories, and it has been suggested that administering beta-blockers, which inhibit the effects of adrenalin, just after a traumatic event may help prevent the creation of flashbulb memories, and may lower the risk of later panic attacks and post-traumatic stress disorder. At any rate, this week, when the mortgage market collapsed on Scott, wiping out his year, the events were seared into his memory.
Just as high levels of cortisol help us store traumatic events, so too do they later help retrieve memories of them. As cortisol levels rise, and our exposure to the hormone becomes chronic, we increasingly recall the events that were stored under its influence. Scott now finds he recollects mostly disturbing memories. He tends to dwell on nasty events – failing high-school calculus, a locker-room fight, losses during the dot.com crash – rather than pleasant ones, like meeting his girlfriend, vacations in Verbier, or trades he got right. Importantly, when assessing a trade, Scott now increasingly draws on negative precedents in determining the risks, and such a selective recall of things going wrong may promote an irrational ri
sk-aversion.
Chronically elevated levels of cortisol have other effects on our thinking, besides those on memory, most importantly and disturbingly by changing the shape and size of various brain regions. Once again, the amygdala and the hippocampus, because they contain more cortisol receptors than other areas of the brain, are especially affected. If high levels of cortisol continue long enough they can kill neurons in the hippocampus, reducing its volume by up to 15 per cent, as they do in patients with Cushing’s syndrome, a condition in which tumours in the adrenals or pituitary cause chronic overproduction of stress hormones. Fortunately the hippocampus is one of the few brain regions that can regrow neurons, so when the stress finally ends it can regenerate itself. Some neuroscientists, notably Bruce McEwen, believe this temporary loss of hippocampal volume serves to blunt the impact of stress on our brains. The hippocampus effectively hibernates through hard times.
Scott’s hippocampus may shrink under the influence of cortisol, but his amygdala experiences the opposite effect. Neurons in the amygdala are fertilised by cortisol and undergo a rich arborisation (growth of branches), making Scott’s thinking more emotional and less factual, and impairing his ability to engage in rational analysis. Some studies have even suggested that under conditions of extreme stress our pre-frontal cortex is effectively taken offline, impairing analytic thought and leaving our brains to run on stored reactions, largely emotional and impulsive ones.
Shell-shocked traders, under the influence of an overly active amygdala, become prey to rumour and imaginary patterns. In a recent study, two psychologists presented meaningless and random patterns to healthy participants, who appropriately found nothing of significance in them, and then to people exposed to an uncontrollable stressor, who did find patterns in the noise. Under stress we imagine patterns that do not exist. A striking real-life example of this phenomenon is reported by Paul Fussell in his astonishing book The Great War and Modern Memory. Troops living in the trenches during the First World War, under the most unimaginable conditions of fear and uncertainty, were deprived of reliable information about the war because the official army newspaper contained little but inaccurate propaganda. In the absence of reliable information, and in desperate need of it, troops fell prey to rumour in a manner not seen since the Middle Ages – rumours of wraithlike spies conversing with frontline troops before disappearing into the mist; of angels in the sky over the Somme; of a factory behind enemy lines called the Destructor where bodies of Allied soldiers were rendered for their fats; of tribes of feral deserters living in no-man’s land, preying on injured soldiers. Traders during a financial crisis suffer from an equally wretched vulnerability to rumour and suspected conspiracy. Every bank, individually or collectively, at one time or another is going under; hedge funds, huge ones of course, conspiring to push down the markets; the Chinese dumping Treasuries; the UK defaulting on its sovereign debt; broker suicides. Each rumoured catastrophe is now given as much credence, and has as much effect on markets, as hard economic data.
Cortisol’s lethal effects on the brain are compounded by another chemical produced during stress, one produced in the amygdala called CRH (short for corticotropin-releasing hormone). CRH in the brain instils anxiety and what is called ‘anticipatory angst’, a general fear of the world leading to timid behaviour. Together with cortisol, it also suppresses the production of testosterone, the invigorating hormone that powered so much of Scott’s confidence, exploratory behaviour and risk-taking during the bull market. He now scares easily. He develops a selective attention to sad and depressing facts; news comes freighted with ill portent; and he seems to find danger everywhere, even where it does not exist. This paranoia colours his every experience; and when riding home in the taxi at night Scott finds that even his beloved New York City, once sparkling with opportunity and excitement, has lately taken on a menacing silhouette. As a result of chronic stress he, like most of his colleagues, becomes irrationally risk-averse.
By mid-December, the financial industry has endured a month and a half of endless volatility and non-stop losses. The run-up to Christmas is normally one of the most optimistic and playful times of the year, with the holidays and skiing vacations to look forward to, followed by bonus payments in the New Year. But such gaiety as had survived the crash has now been crushed by layoffs, brutally announced just before Christmas, involving almost 15 per cent of the sales and trading staff. Few people will get any bonus at all; and the lucky ones, like Martin and Gwen, who do get a small one, harbour a deep resentment because this year they have made record profits and helped to keep the bank afloat, while traders like Stefan, paid over $25 million last year, have helped blow up the bank and with it their, Martin and Gwen’s, bonuses. Scott will get nothing at all, and does not know how long he will be kept on. Layoffs have been similarly announced all along Wall Street and in the City of London. Many firms, facing bankruptcy, have closed their doors. One by one, the lights are going out all across the financial world.
With their jobs on the line, traders like Scott desperately need to make money, but find themselves oddly unable to initiate a trade, even one that looks attractive, being held back from the phones as if by a force field. They have become, as they say in the business, ‘gun shy’. A reduced risk-taking among traders would be a welcome change under normal conditions, but during a crash it poses a threat to the stability of the financial system. Economists assume economic agents act rationally, and thus respond to price signals such as interest rates, the price of money. In the event of a market crash, so the thinking goes, central banks need only lower interest rates to stimulate the buying of risky assets, which now offer relatively more attractive returns compared to the low interest rates on Treasury bonds. But central banks have met with very limited success in arresting the downward momentum of a collapsing market. One possible reason for this failure could be that the chronically high levels of cortisol among the banking community have powerful cognitive effects. Steroids at levels commonly seen among highly stressed individuals may make traders irrationally risk-averse and even price insensitive. Compared to the Gothic fears now vexing traders to nightmare, lowering interest rates by 1 or 2 per cent has a trivial impact. Central bankers and policy-makers, when considering their response to a financial crisis, have to understand that during a severe bear market the banking and investment community may rapidly develop into a clinical population.
Of the conditions affecting traders, a particularly unfortunate one is known as ‘ learned helplessness’, a state in which a person loses all faith in his or her ability to control their own fate. It has been found that animals exposed repeatedly to uncontrollable stressors may pathetically fail to leave the cage in which this experiment was conducted if the door was left open. Traders, after weeks and months of losses and volatility, may similarly give up, slumping in their chairs and failing to respond to profit opportunities they would only recently have leapt on. In fact there is some evidence suggesting that people like traders might be especially prone to this sort of collapse. Banks and hedge funds commonly select traders for their tough, risk-taking, optimistic attitude. Optimism is generally a valuable trait in a person, especially a trader, for it leads them to welcome risk, and to thrive on it. But not always. Not if they are exposed to long-lasting and unpredictable stressors. Research has suggested that optimistic people, those who are used to things working out, may not handle recurrent failure very well, and may end up with an impaired immune system and increased illness. Bankers, so well suited to the bull market, may be constitutionally ill prepared to handle bear markets.
A telling sign of the onset of learned helplessness is the subsiding of anger on the trading floor, anger being in fact a healthy sign that someone fully expects to be in control. During a crisis, when swearing dies down, fewer phones are smashed, and anger is replaced by resignation, withdrawal and depression, chances are traders have succumbed to learned helplessness. Once stress in the financial world has reached this pathological state, gove
rnments must step in, as they did in 2008–09, and do the job that traders can no longer perform – buy risky assets, reduce credit risk, lead the traders, now reduced to a shellshocked state, out of the slough of despond.
STRESS-RELATED DISEASE IN THE FINANCIAL INDUSTRY
Prolonged and severe stress endangers more than the financial system: it poses a serious threat to the personal health of people working in the financial industry, and indeed in all the industries affected by troubles in the banking sector. In the workplace the difference between acute and chronic effects is most worryingly apparent. A prolonged stress response, by shutting down so many long-term functions of the body, impairs its ability to maintain itself. Blood has been shunted away from the digestive tract, so people become more susceptible to gastric ulcers. The immune system, thrown into overdrive during the early stages of the stress response, has after chronic exposure to cortisol been suppressed (possibly because it draws too much energy), so people find themselves constantly battling upper respiratory diseases, like colds and ’flus, and other recurrent viruses, like herpes. Growth hormone and its effects have been suppressed, as have the reproductive tract and the production of testosterone.
This last effect, in addition to tensed muscles which prevent blood flow into what are called the cavernous cylinders (corpora cavernosa) of the penis, causes bankers like Scott, sexually insatiable during the bull market, to have difficulty maintaining an erection, even mustering any interest in sex, testosterone being the chemical inducement for erotic thoughts. Chronic stress, largely through cortisol’s interaction with the dopamine system, can also make people more susceptible to drug addiction. And all these effects are magnified by the fact that elevated cortisol levels reduce sleep time, especially REM sleep, thereby depriving people of the downtime needed for mental and physical health. Steroids may orchestrate a symphony of physiological effects, but as time passes the music turns into a cacophony.
