When used in financial markets, contagion is a term associated with the kind of market turmoil seen in 2007 as well as previous crises such as those of 2001 and 1998. The problem stems from the fact that the global financial markets, and therefore the banks and other institutions that operate in them, are all interlinked- they lend to and trade with each other. So, events which are initially localised and isolated, such as high risk mortgagees defaulting in the subprime US sector, can quickly ripple out and trigger defaults in other institutions all around the world. A good example is Northern Rock's near-collapsewhich resulted from the effective closure of the interbank lending market after rival banks stopped trusting each other to correctly price potentially worthless US-mortgage backed assets.
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