Tim Adams: How to fix Wall St: Hire women

For the past few weeks I've had two books by my bed, both of which offer a first draft of what history may well judge the most significant event of our times: the 2008 financial crash. Read together, they are about as close as we might come to a closing chapter of The Rise and Fall of the American Empire.

As literature, one of them - the final report of the Financial Crisis Inquiry Commission of the US Treasury - doesn't always make for easy reading: there are far too many nameless villains for a start. And, quite pointedly, there is not a heroine in sight. Reading the report I became preoccupied by, among other things - the fairy steps from millions to billions to trillions, say - the overwhelming maleness of the world described.

The words "she", "woman" or "her" do not appear once in its 662 pages. It is a book, like most historical tragedies, written about the follies and hubris of men.

The other book, an entirely compulsive companion volume, is Michael Lewis' bestselling The Big Short, which Google Earths you into the crisis.

Rather than looking at a global picture, it lets you into the bedrooms and boardrooms of the individual corporate men who catastrophically lost billions of dollars and, on the other side of those bets, the extraordinary ragtag of obsessive individuals who saw what was coming and made eye-watering fortunes. It gives the crash a human face, and once again that face is universally male.

The books are linked by more than subject matter, though. Lewis, a one-time bond trader himself - he left, 20-odd years ago, in incredulity and disgust to write his insider's account, Liar's Poker - gave evidence to the Crisis Inquiry Commission over the course of its 18-month sitting. In the end, however, he refused to sign off the report; and not only did he refuse to sign it, he also refused to put his name to the dissenters' addenda to the report, which three of the committee insisted upon. And not only that, he did not add his name to that of the single individual who insisted on a further addendum stating that he dissented from the dissenters' view. Lewis was not a fan of the report.

The reason for this was simple, he suggested. He felt that the committee, for all its considered judgment, had not understood, from the outset, a single, pivotal word. That word was "unprecedented".

Though the inquiry had set out in the belief that the crash was an event different in kind to anything that had gone before, it nevertheless proceeded to judge it in the terms of previous crashes.

What it failed to do, in Lewis' eyes, was this: it neglected to look for the things that might have changed in Wall Street or the City, the things that might have made individuals on the trading floors act in ways that were seen to be entirely, unprecedentedly, reckless.

When he came to consider these things himself, Lewis felt that perhaps chief among the unprecedented novelties was this one: women.

"Of course," he observed, with tongue firmly in cheek, "the women who flooded into Wall Street firms before the crisis weren't typically permitted to take big financial risks. As a rule they remained in the background, as 'helpmates'. But their presence clearly distorted the judgment of male bond traders - though the mechanics of their influence remains unexplored by the commission. They may have compelled the male risk-takers to 'show off for the ladies', for instance, or perhaps they merely asked annoying questions and undermined the risk-takers' confidence.

"At any rate, one sure sign of the importance of women in the crisis is the market's subsequent response: to purge women from senior Wall Street roles."

When I first read those remarks it was not clear how much in earnest Lewis had been when he made them. Subsequently, though, I heard him speak at the London School of Economics, and he took this idea in a slightly different direction. When asked what single thing he would do to reform the markets and prevent such a catastrophe happening again, he said: "I would take steps to have 50 per cent of women in risk positions in banks.

You don't have to look too far into the science to realise that Lewis's claim, in broad terms, stands up. The first definitive study in this area appeared in 2001 in a celebrated paper that broke down the investment decisions made with a brokerage firm by 35,000 households in America.

The study, called, inevitably, "Boys will be Boys", found that while men were confident in making multiple changes to investments, their annual returns were, on average, a full percentage point below those of women who invested the family finances, and nearly half as much again inferior to single women.

A more recent study of 2.7 million personal investors found that during the financial crisis of 2008 and 2009, men were much more likely than women to sell any shares they owned at stock market lows. Male investors, as a group, appeared to be overconfident, the author of this study suggested.

"There's been a lot of academic research suggesting that men think they know what they're doing, even when they really don't know what they're doing."

A fact that will come as a surprise to few of us. Men, it seemed, typically believed they could make sense of every piece of short-term financial news. Women, never embarrassed to ask directions, were on the whole far more likely to acknowledge when they didn't know something. As a consequence, women shifted their positions far less frequently, and made significantly more money as a result.

Naturally, if these findings were widely applicable, then it would be hard not to agree with Lewis' suggestion for reforming the sharpest end of capitalism. Rather than ring-fencing casino investment banks or demanding that high street banks hold vastly greater capital wouldn't a safer model just be to hire more women?

To argue this case, you would probably need more than just behavioural evidence; you might need to understand some of the mechanisms which produced the trillion-dollar bad decision-making that led to what happened in 2008. In recent years, and particularly since the crash, a new science of such decision-making - neuroeconomics - has become fashionable in universities and beyond.

It proposes the idea that you will create a better understanding of how people make economic choices if you bring to bear advances in neurobiology and brain chemistry and behavioural psychology alongside traditional economic maths models. Not surprisingly, neuroeconomics has plenty to say about the question of whether decision-making, in high-pressure situations, divides on gender lines.

The problem is that most of the scenarios used to investigate this divide are artificial. It is one thing attaching someone to an MRI scanner and telling him or her that a million pounds rests on their decision in a game; it is another when that person actually stands to lose a million pounds.

Only one study, as far as I could discover, has had access to the brain chemistry, the neural biology, of young men actually working on trading floors. But the results it produced were nonetheless startling.

The study was led by a pair of Cambridge researchers. One, Joe Herbert, is a professor of endocrinology, and the other, John Coates, a research fellow in neuroscience and finance.

Herbert, a specialist in the effect of hormones on depression, was fascinated to put some of his theories about the role of chemicals on decision-making into practice. Coates used to be a bond trader himself.

He started off at Goldman Sachs and went on to Deutsche Bank. After some years trading, and making a lot of money out of a lot of money, he became increasingly fascinated by the way, during the dotcom years, the traders he worked alongside radically changed behaviour. They became, he says, "euphoric and delusional. They were taking far more risks, and were putting up trades with terrible risk-reward profiles".

Coates was a relatively cautious trader himself, but there had been times when he too felt this surge, this euphoria: "When I had been making a lot of money myself, I felt unbelievably powerful," he recalls. "You carry yourself like a strutting rooster, and you can't help it.

"Michael Lewis talked about 'Big Swinging Dicks', Tom Wolfe talked about 'Masters of the Universe' - they were right. A trader on a winning streak acts exactly that way."

The second thing that Coates noticed was even more revelatory to him. "I noticed that women did not buy into the dotcom bubble at all."

Coates began splitting his time between his trading desk and the Rockefeller University in Manhattan, which is perhaps the world's leading institute for the study of brain chemicals. There he started to become interested in steroids, and in particular something called "the winner effect".

This occurs when two males enter a competition and their testosterone levels rise, increasing their muscle mass and the ability of the blood to carry oxygen. It also enhances their appetite for risk. Much of this testosterone stays in the system of the winner of a competition, while the loser's testosterone melts away fast; in evolutionary terms, the loser retires to the woods to lick his wounds.

Coates became convinced that this winner effect was what he observed in bullish trading markets, and what ended up dramatically distorting them. It also explained why women were mostly immune to the euphoria, because they had only 10 per cent of the testosterone of men.

What struck him most, though, was that, for all the literature about financial instability, economics, psychology, game theory, no one had ever clinically looked at a trader who was caught up in a bubble.

Coates wrote a research proposal. He came back to Cambridge where he had done his first degree, and because of his background eventually gained access, with Herbert, to a City bond-dealing floor in London. They tested the traders for two hormones in particular, testosterone and cortisol (the anxiety induced, depressive "stress hormone"), and mapped their levels over a period of weeks against the success or failure of trades, individual profit and loss. Coates had imagined the experiment to be a preliminary study but the correlations he found - for evidence of irrationality produced by the winner effect and its converse - was "an absolute dream".

They not only discovered that a trader's morning testosterone level could be used to predict his day's profitability. They also found that a trader's cortisol rose with both the variance of his trading results and the volatility of the market. The results pointed to a further possibility: as volatility increased, the hormones seemed to shift risk preferences and even affect a trader's ability to engage in rational choice.

Though the sample was limited, and suitable caution was needed in claiming too much, the correlations suggested that over a certain peak, testosterone impaired the risk assessment of traders. "The stress hormones were switching over to emergency states all the time," he said. "There was an optimal level but these stress hormones can linger for months. Then you get all sorts of really pathological behaviours. If you are constantly prepared for high tension it affects your brain, and it causes you to recall stressful memories and become exaggeratedly risk-averse and kind of helpless."

Unfortunately this particular study ended in June 2007, before the full effect of the crisis, but its implications account, Coates believes, for some of what he subsequently heard from the trading floor.

"If cortisol goes beyond a certain point, then it may become very difficult for traders to assess any risk at all. These guys are not built to handle adversity that well. There is an observable condition called 'learned helplessness', which if you are submitting to great stress over a long period of time makes you give up suddenly. They just slump in their chairs. In the crisis there were classic arbitrage opportunities as the markets were falling. Free money. But traders would sit there staring at the numbers and not touching it."

Since then, Coates has partly been working on the other strand of his original hypothesis, looking at the brain chemistry of women working in the markets. Because of the small sample sizes he has to work with - there were only three women out of 250 traders on the floor he first tested - the detail of that is far from complete, and he is properly reluctant to draw conclusions. What he will go so far as to say, though, is this. "Central bankers, often brilliant people, spend their life trying to stop a bubble or prevent a crash, and they are spectacularly unsuccessful at it. And I think it is because, at the centre of the market, you have these guys either ripped on testosterone or overwhelmed by cortisol so that they become completely price insensitive."

To most experienced, male, investment bankers, of course, this sounds like fighting talk. An old friend of mine, who traded his Cambridge English degree for an extremely lucrative life as a bond dealer, offered this, when I presented Coates' evidence to him. "It would be nice to think that having more female traders on the floor would make for less volatility," he said, "but that's wishful thinking. Financial markets are now global, so while we in the West might decide not to chase trends or react instinctively to breaking news because there are mature mothering types in boardrooms and sitting on risk committees, the rest of the world will, and our banks would lose out."

And that's not all. "Many of the women I know who have managed money or have put capital at risk for banks have tended to be even more aggressive with risk than their male counterparts, as if perhaps to compensate for their supposed diffidence. Fighting their way through a male-dominated environment to a position in which they can invest/punt/risk-manage, many women develop an ultra-masculine persona so as to be thought of as ballsy ..."

Books and blogs written by young women seem to support this observation. Melanie Berliet, who worked as one of the only female traders in Wall Street, set the tone in her confessional blog: "If anything," she observed, "my token status gave me an extra thrill. I enjoyed being called a dullard or being instructed, patronisingly, to 'remove head from ass', because my reaction - to grin rather than cry - impressed the guys. I loved their attention and the daily opportunities to prove that I fitted in.

"What separated me from my colleagues was physical: my 1.5m, 55kg frame, my long, blondish hair . I had two options with my boss: trade sexual banter or resist. Typically, I chose the former."

Her base salary wasn't terribly high, and the bonus "was all" and she said getting the right number rested on one thing, her willingness to promote her boss' fantasies about her.

The figures

* A 2001 US study found annual returns for male investors were a percentage point below those of women who invested the family finances, and nearly half as much again inferior to single women.

* Another study of 2.7 million personal investors found that during the financial crisis of 2008 and 2009, men were much more likely than women to sell any shares they owned at stock market lows.

* Male investors, as a group, appeared to be overconfident, the author of this study suggested.

* Traders' high levels of testosterone and the stress hormone cortisol can make them less effective.

- Observer