On Wednesday, August 8, not long after the markets closed, 200 of the smartest people on Wall Street gathered in a conference room at Four World Financial Center, the 34-story headquarters of ­Merrill Lynch. August is usually a slow month, but the rows of chairs were full, and highly paid financial engineers were standing by the windows at the back, which looked out over black Town Cars below and the Hudson River beyond. They didn't look like Masters of the Universe; they looked like members of a chess club. They were "quants," and they had a lot to talk about, for their work was at the heart of one of the most worrisome summer markets in decades.

The conference was sponsored by the International Association of Financial Engineers (IAFE), and its title asked, "Is Subprime the Canary in the Mine?" "Subprime" borrowers are home buyers whose poor credit history means they don't qualify for market interest rates. Loans to subprime borrowers, which have become more common in recent years, typi­cally have variable interest rates; as those rates rose, many borrowers were failing to meet their mortgage payments. Their defaults, in turn, had triggered unexpected problems in the market for financial instruments known as derivatives.