For mathematics students, an internship in finance was the brightly
lit path that distracted from all others. Everyone I knew on my degree
course, regardless of their eventual career, signed up for one. I was
about a month or so into my internship when I changed my mind, and
decided to pursue a PhD instead of a job offer. A major factor was the
course in epidemiology I’d taken earlier that year. I’d become
fascinated by the idea that disease outbreaks didn’t have to be this
mysterious, unpredictable occurrence. With the right methods, we
could pick them apart, uncover what was really going on, and
hopefully do something about it.
But first, there was the question of what was going on around me
in Canary Wharf. Despite having settled on another career path, I still
wanted to understand what was happening to the banking industry.
Why had rows of trading desks recently been emptied of their
employees? Why were celebrated financial ideas suddenly
crumbling? And how bad could it get?
I was based in equities, analysing company share prices, but in the
preceding years the real money had been in credit-based
investments. One investment stood out in particular: banks had
increasingly bunched together mortgages and other loans into
‘collateralized debt obligations’ (CDOs). These products let investors
take on some of the mortgage lender’s risk and earn money in return.
[4] Such approaches could be extremely lucrative. Sajid Javid, who in
2019 was appointed the UK’s Chancellor of the Exchequer, reportedly
earned around £3m a year trading various credit products before he
left banking in 2009.[5]
CDOs were based on an idea borrowed from the life insurance
industry. Insurers had noticed that people were more likely to die
following the death of a spouse, a social effect known as ‘broken
heart syndrome’. In the mid-1990s, they developed a way to account
for this effect when calculating insurance costs. It didn’t take long for
bankers to borrow the idea and find a new use for it. Rather than
looking at deaths, banks were interested in what happened when
someone defaulted on a mortgage. Would other households follow?
Such borrowing of mathematical models is common in finance, as
well as in other fields. ‘Human beings have limited foresight and great