institutions, they agreed a $3.6bn bailout. It was an expensive lesson,
but unfortunately not one that was learned. Almost exactly ten years
later, the same banks would be having the same conversations about
financial contagion. This time it would be much worse.
I of 2008 thinking about how to buy and sell the
statistical concept of correlation. I’d just finished my penultimate year
of university, and was interning with an investment bank in London’s
Canary Wharf. The basic idea was simple enough. Correlation
measures how much things move in line with each other: if a stock
market is highly correlated, stocks will tend to rise or fall together; if
it’s uncorrelated, some stocks might go up while others go down. If
you think stocks are going to behave similarly in future, you’d ideally
want a trading strategy that profited from this correlation. My job was
to help develop such a strategy.
Correlation isn’t just some niche topic to keep a mathematically
minded intern occupied. It turns out to be crucial for understanding
why 2008 would end with a full-blown financial crisis. It can also help
explain how contagion spreads more generally, from social behaviour
to sexually transmitted infections. As we’ll see, it’s a link that would
eventually pull outbreak analysis into the heart of modern finance.
Each morning that summer, I took the Docklands Light Railway to
work. Just before it reached my stop at Canary Wharf, the train would
pass the skyscraper at 25 Bank Street. The building was home to
Lehman Brothers. When I’d applied for internships in late 2007,
Lehman had been one of the coveted destinations for many
applicants. It was part of the elite ‘bulge bracket’ group of banks,
which also included firms like Goldman Sachs, JP Morgan, and
Merrill Lynch. Bear Stearns had been part of the club too, until its
collapse in March 2008.
Bear, as the bankers called it, had gone under because of failed
investments in the mortgage market. Soon after, JP Morgan bought
the carcass for less than a tenth of its earlier value. By the summer,
everyone in the industry was speculating on which firm would go
under next. Lehman seemed to be top of the list.