Wall Street is not known for self-examination. Colossally bad bets and spectacular losses are more often treated as individual failures than systemic ones; risky behavior is seen as a sign of intestinal fortitude, not foolishness. In the wake of the multibillion-dollar trading loss atJPMorgan Chase (JPM)—considered the best in the business at risk management—the financial industry has focused on who did what, when, and how big the losses might get. But that doesn’t explain why the firm’s traders and executives doubled down on a position that, in hindsight, looked clearly doomed.
What were they thinking? That question, in essence, is what John Coates has devoted his life to answering. Coates once ran a derivatives desk at Deutsche Bank (DB) in New York, until he decided he was more interested in trying to figure out why people are such poor judges of risk than he was in trying to profit from it. Now a senior research fellow at the University of Cambridge, he is employing the tools of neuroscience to identify the biological basis of what John Maynard Keynes called the market’s “animal spirits.”
In particular, Coates focuses on two hormones: testosterone, which increases our appetite for risk, and cortisol, which makes us shy away from it. Drawing on his Wall Street connections, he has been able to treat the trading floors of investment banks as his labs. The answers he’s finding could help financial institutions understand how the banking culture exacerbates the very tendencies companies should be guarding against. There may not have been a way to prevent JPMorgan’s “London Whale” from making his ill-fated bet on corporate bonds. But Coates’s research does suggest that the trader’s bosses should have seen the trouble coming.
Twelve years ago, Coates was flying home to New York from England and found himself sitting next to a young neuroscientist named Linda