If anyone is qualified to unify the seemingly disparate subjects of financial markets and neurology, it’s John Coates, a senior research fellow in neuroscience and finance at the University of Cambridge. A veteran of Goldman Sachs and Deutsche Bank, he set aside the trader’s life in 2004 to better understand the biological and neurological underpinnings of risk taking in finance. The Hour Between Dog and Wolf: Risk Taking, Gut Feelings, and the Biology of Boom and Bust is a powerful distillation of his work—and an important step in the ongoing struggle to free economics from rational-actor theory.
Coates’s book argues that irrationality rules in times of boom and bust, and that in both cases the “masters of the universe,” as Tom Wolfe put it, whose trades dictate the whims of the market, get caught up in either irrational exuberance or irrational pessimism. That is, “investors during bubbles seem to come equipped with special eyewear that permits them to view all economic news as bullish.” On the other hand, in the wake of a severe downturn, when investors are buffeted by bad news and disastrous trades, they retreat into their shells, unable to take the action necessary to remediate things.
Both of these tendencies put the market—an therefore all of us—at risk, and neither jibes with the long-running theory that investors act rationally, that monetary policy can help steer us away from calamity through monetary policy. Under this view, faced with a bubble or a collapse, the Federal Reserve can alter interest rates to stabilize things, and investors will react rationally to the new resultant prices, putting the markets back on sound footing. But reality isn’t nearly so neat—the human brain and body get in the way. “Under the influence of pathologically elevated hormones,” Coates writes, “the trading community at the peak of a bubble or in the pit of a crash may effectively become a clinical population.”
Coates explains all this via two parallel narrative tracks. In one, he takes us through an endless series of experiments and studies—some his own—explaining the most pernicious hormonal influences of winning and losing and how they can cause us to spiral away from reason and toward maladaptive behavior. In the other, he shows us these mechanisms at work via a series of fictional characters (presumably composites of real-life traders Coates knows or has known) working at a Wall Street investment bank before, during, and after a major financial collapse.
Along the way, Coates also emphasizes the tight connection between brain and body. It’s wrong to think of traders as simply sitting at their desks, thinking through this new piece of information or that trade. Rather, the whole thing is more visceral; every potential opportunity, every glimmer of bad news, registers in primal circuits as a jolt of pleasure or an activation of the fight-or-flight system. In the long run, the stress of prolonged bust times has profound effects on those sitting at the front lines of the markets. Traders, like the rest of us, have bodies, and to ignore them is to greatly oversimplify how the financial markets work.
The Hour Between Dog and Wolf is well executed and makes its argument convincingly, even if a lot of it won’t be new to those who have read the recent spate of popular books on neurology and human decision making. It’s notable not just for the specifics of its subject, but for its place in the broader constellation of books and articles slowly chipping away at rational-actor theory.
“We inhabit a culture dominated by Platonic and Cartesian ideals according to which reason is the ultimate arbiter of our decisions and behavior,” Coates laments. That is, Plato and Descartes argued thousands and hundreds of years ago that mind and body are two distinct entities, and their intellectual legacy—the empirical evidence for which has dwindled to almost nothing—resonates in the rational-choice model, which argues that individuals will rationally seek out that which benefits them the most and which still rules so much of the economic discourse.
Coates is part of a broad, ongoing intellectual process to partially undo Plato, to partially undo Descartes, and to turn us toward Aristotle, who saw mind and body as inextricably linked (which greatly complicates the notion of a separate, dispassionate mind rationally making decisions). Coates and a small army of psychologists and behavioral economists are trying to guide us out of the dark jungle into which the rational-actor model has led us into.
What it comes down to is seeing people as people, not utility-maximizing robots, and that’s part of why Coates’s book is important. One of the most important, difficult aspects of our transition from Plato to Aristotle is seeing those who are unlike us as full-blown human beings. Before this revolution in our view of human decision making, it was easy to dehumanize poor people who made foolish investment decisions, whether via payday loans or subprime mortgages—“they had a choice, just like everyone else, and they made the wrong one. Too bad for them.” Similarly, before Coates’s book it was easy to demonize traders as greed-driven monsters.
But as Coates, having come from that world, points out early in the book, it doesn’t make sense to fully blame the traders for the damage they have done, given the larger cognitive and hormonal forces at work here (though Coates doesn’t entirely absolve them of their responsibility, either). At a time of dire crisis, Scott, one of the traders Coates follows throughout the book, “needs to think clearly about his position and the market, but oddly, inappropriately, his body has atavistically prepared him to fight with or run away from a bear.” What worked in the time of caves and hunting-gathering fails us entirely in the era of lower Manhattan’s towering skyscrapers.
What it comes down to is seeing people as people, not utility-maximizing robots, and that’s part of why Coates’s book is important.
So where does that leave us? Again, Coates turns to the ancient master: “Aristotle looked at the ways we are built, our biological details, and then judged policies and political institutions according to how well they suited our nature, how effectively they brought out the best in us and channeled what was dangerous in harmless directions.”
We need to understand that people, whether poor ones facing a subprime mortgage offer or rich ones flicking a billion dollars this way or that without a second thought, aren’t always great decision makers. We need to have safeguards in place to protect them from their worst tendencies. And, most fundamentally, we need to see people as complicated, flawed, fascinating individuals—not rational, disconnected brains. So Coates is right: we need to heed Aristotle.