2
Panics and pandemics
‘I of heavenly bodies but not the
madness of people.’ According to legend, Isaac Newton said this
after losing a fortune investing in the South Sea Company. He’d
bought shares in late 1719 and initially seen his investment rise,
which persuaded him to cash in. However, the share price continued
to climb and Newton – regretting his hasty sale – reinvested. When
the bubble burst a few months later, he lost £20,000, equivalent to
around £20 million in today’s money.[1]
Great academic minds have a mixed record when it comes to
financial markets. Some, like mathematicians Edward Thorp and
James Simons, have set up successful investment funds, bringing in
huge profits. Others have succeeded in sending money the opposite
way. Take the hedge fund Long Term Capital Management (LTCM),
which suffered massive losses following the Asian and Russian
Financial Crises in 1997 and 1998. With two Nobel Prize-winning
economists on its board and healthy initial profits, the firm had been
the envy of Wall Street. Investment banks had lent them increasingly
large sums of money to pursue increasingly ambitious trading
strategies, to the point that when the fund went under in 1998, they
had liabilities of over $100 billion.[2]
During the mid-1990s, a new phrase had become popular among
bankers. ‘Financial contagion’ described the spread of economic
problems from one country to another. The Asian Financial Crisis was
a prime example.[3] It wasn’t the crisis itself that hit funds like LTCM;
it was the indirect shockwaves that propagated through other
markets. And because they’d lent so much to LTCM, banks also
found themselves at risk. When some of Wall Street’s most powerful
bankers gathered on the tenth floor of the Federal Reserve Bank of
New York on 23 September 1998, it was this fear of contagion that
brought them there. To avoid LTCM’s woes spreading to other