Roger W Ferguson, Jr: September 11, the Federal Reserve, and the financial
system
Speech by Mr Roger W Ferguson, Jr, Vice Chairman of the Board of Governors of the US Federal
Reserve System, at Vanderbilt University, Nashville, Tennessee, 5 February 2003.
* * *
Thank you for the invitation to speak, and thank you all for being here. Certainly most of you have
heard of the Federal Reserve and understand that it plays a role in the maintenance of our domestic
economy. But that is not what I am here to discuss. I was invited here to speak to you about the
actions of the Federal Reserve after the terrorist attacks on September 11, 2001.
As the central bank of the United States, the Federal Reserve seeks to establish through the
implementation of monetary policy, an economic environment that encourages stable prices over time,
a high level of employment, and moderate long-term interest rates. Additionally, the Fed shares, with a
few other regulatory bodies, the duty of overseeing the banking industry. In a broader context, the
Federal Reserve also shares the responsibility of maintaining the stability of the financial system and
containing systemic risks that may arise in financial markets. And in carrying out that responsibility, we
have never been confronted with a situation remotely resembling the grave reality of September 11,
2001.
On that morning, sitting in my office in Washington, I watched television with horror as the second
plane crashed into the World Trade Center. Not long after, I could see thick smoke billowing above the
trees in the direction of the Pentagon.
As events were unfolding, one could easily envision the risks that confronted the United States - and
especially the risks to which the Federal Reserve, as the nation's central bank, would have to respond.
It was clear that the loss of so many key resources at the core of the financial capital of the United
States would strain markets. If allowed to mount, those strains could prompt a chain reaction drying up
liquidity, which, unchecked, could lead to real economic activity seizing-up. The shocks to the financial
system and the economy that were possible could have been disastrous to the confidence of
businesses and households in our country and, to a significant degree, the rest of the world.
Besides these very visible external risks, the Federal Reserve System had to cope effectively in a
threatening environment. The employees of the Federal Reserve Bank of New York, being a few
blocks away from "ground zero," had the exceedingly difficult challenge of maintaining operations in
the midst of terrifying and chaotic surroundings. All parts of the Fed System, wherever located, faced
the challenge of maintaining ongoing operations, including discount window lending and check
clearing, in the period of heightened uncertainty that followed those horrific attacks.
In short, on the morning of September 11, the Fed, as monetary authority, as payment system
operator, as banking supervisor, and as employer, faced an unfolding crisis, and the risks were all to
the downside. The outlook was at best uncertain, and potentially quite bleak.
Against this background, the Federal Reserve System organized a response that emphasized three
objectives. First, as central bank we needed to provide sufficient liquidity through as many means as
possible to maintain stability. In doing so, we would further our obligation to the broader citizenry to
maintain public confidence so that the crisis in New York and Washington, D.C. would not spread
across the country. Second, as operator and overseer of key payment systems we had to ensure that
our systems, as well as those in the private sector, were operational. Third, we worked with critical
public- and private-sector participants to keep markets open or, if circumstances forced them to close,
to return them quickly to normal operations. Obviously, we had to balance the need to perform these
public functions with the need to be a sensitive and responsible employer.
Recognizing these multiple challenges, we responded in several ways. We attempted to maintain
confidence by indicating through our public statement that the Federal Reserve was open and
operating and that we were ready to provide liquidity. We issued this statement after consultation with
the Reserve Bank presidents, so that it represented a statement of the entire System.
Why were we so concerned about maintaining liquidity in the financial system? Liquidity, as you know,
serves as the oil lubricating the engine of capitalism to keep it from burning itself out. The efficiency of
our financial system at maintaining adequate liquidity is often taken for granted. But on September 11,
it could not be taken for granted. The bottlenecks in the pipeline became so severe that the Federal
Reserve stepped in to ensure that the financial system remained adequately liquid. In other words, our
massive provision of reserves made sure that the engine of finance did not run out of oil and seize up.
The massive damage to property and communications systems at the hub of financial activity in this
country made it more difficult, and in some cases impossible, for many banks to execute payments to
one another. The failure of some banks to make payments also disrupted the payments coordination
by which banks use incoming payments to fund their own transfers to other banks. Once a number of
banks began to be short of incoming payments, some became more reluctant to send out payments
themselves. In effect, banks were collectively growing short of liquidity.
We recognized this disturbing trend toward illiquidity in the pattern of funds movement among the
accounts held by commercial banks at the Federal Reserve. Before September 11, banks held
approximately $13 billion in their Fed accounts. In the days after September 11, these balances
ballooned to more than $120 billion because some banks could not move funds out of their accounts.
The large buildup of Federal Reserve account balances was limited to only a few banks, but it meant
that a number of other banks were running huge negative positions in their Federal Reserve accounts
and needed to find other sources of liquidity before the close of business.
Further evidence of disruption in the flow of payments among banks at this time is quite clear from
data for the Federal Reserve's large-value electronic payment system, known as Fedwire. Banks use
Fedwire to make payments to one another to settle their customers' as well as their own transactions.
Just before September 11, the number of transfers sent over Fedwire on a normal day was around
430,000, with a total value of $1.6 trillion. On September 11, the number of transfers was down more
than 40 percent, with fewer than 250,000 transfers being sent over Fedwire, and the total value was
down 25 percent.
If liquidity had continued to dry up, both business and consumer confidence could have been severely
affected. Imagine businesses unable to promptly withdraw funds from checks deposited in their banks,
even though those checks paid for goods or services already provided. Imagine international banks
running out of dollars, a serious impediment to international trade and finance. As we know now, the
situation never reached those extreme conditions because, fortunately, the Federal Reserve System
has numerous means providing liquidity.
One tool used to provide needed liquidity was the discount window, through which the Fed lends in
certain circumstances to help banks maintain smooth day-to-day operations. In essence, in more
normal times the discount window serves a function similar to that of a pressure valve. During the
crisis, as the volume of borrowing requests increased dramatically, the discount window served as
something closer to the floodgates of a great dam. On September 12, lending to banks through the
discount window totaled about $46 billion, more than two hundred times the daily average for the
previous month. The flood of funds released into the banking system reduced the immediate need for
banks to rely on payments from other banks to make the payments they themselves owed others.
Open market operations were a second tool at our disposal for pumping additional liquidity into the
system. Indeed, as you may know, open market operations are the chief tool employed by the Federal
Reserve to affect the global supply of dollars in circulation. In these operations, our trading desk at the
Federal Reserve Bank of New York enters the market daily to buy or sell Treasury securities. Contrary
to one of the early fears, most of our counterparties in these transactions, the community of primary
dealers, were generally functioning starting on September 12. Our trading desk in New York met all
propositions at the intended funds rate from September 12 through September 17, and the System
engaged in a record level of open market operations through overnight repurchase agreements. To
accommodate these demands, the trading desk operated later in the day than normal, giving dealers
an opportunity to assess their financing needs. Also, the Fed's securities lending program expanded
its provision of securities to the marketplace, and those securities in turn could be used as the
collateral for private-sector liquidity arrangements. The staff of the Federal Reserve Bank of New York,
having evacuated its main site and gone to its backup facility, performed heroically in running the open
market operations.
Despite the increased liquidity resulting from discount window lending and open market operations,
some institutions still had difficulty exchanging payments and lending or borrowing funds because of
connectivity problems and the closure of key markets. As a result, many depository institutions
incurred larger-than-usual daylight overdrafts on their accounts at the Federal Reserve. To help in this
situation, the Federal Reserve waived the overdraft fees it normally charges. Between September 11
and September 21, peak and average daylight overdrafts incurred by depository institutions were
approximately 35 percent and 30 percent higher than normal levels, respectively. On September 14,
daylight overdrafts peaked at $150 billion, more than 60 percent higher than usual, despite Federal
Reserve opening account balances of slightly more than $120 billion.
The destruction of infrastructure in Lower Manhattan meant that some foreign financial institutions
might not be able to provide sufficient collateral to underpin funding from their usual counterparties
and correspondent banks. These foreign firms turned to their national central banks for dollar-based
liquidity. The Federal Reserve arranged for the availability of reciprocal currency facilities of up to $50
billion with the European Central Bank and $30 billion with the Bank of England, both in the form of
thirty-day swaps. We also lifted the ceiling of a preexisting swap with the Bank of Canada to $10
billion.
The Federal Reserve's role as a provider of check collection services presented another opportunity
for providing liquidity. Check collection relies on a fleet of airplanes to fly checks all around the country
so that the checks can be presented to their home bank for payment. Though U.S. airspace was
closed for several days after the attacks, the Federal Reserve Banks continued to provide credit for
checks on the usual availability schedules. This accommodation allowed businesses and consumers
that depended on the prompt availability of their check deposits to withdraw the proceeds of these
check deposits as they expected.
With other regulators and supervisors, the Federal Reserve issued a statement on Friday, September
14, encouraging state member banks and bank holding companies to work with customers affected by
the events of September 11. The Board has a long-standing policy of encouraging bankers to work
flexibly with customers affected by disasters. That policy recognizes the need for taking prudent steps
to make credit available to sound borrowers and for adjusting terms and conditions of loans and
transactions to take account of the stresses during a crisis. I am sure that several Reserve Bank
Presidents and Directors of Supervision communicated this message directly to commercial bankers in
their Districts. We also recognized that the banks' balance sheets might expand as businesses and
consumers turned to banks for funding. Through an interagency statement, we invited banks that
experienced such an expansion of their balance sheets to contact their regulator to discuss ways to
respond.
Ultimately, to further increase liquidity, on the morning of September 17, the policymaking body of the
Federal Reserve System, the Federal Open Market Committee, met by teleconference and then
publicly announced a 50 basis point decrease in the intended federal funds rate from 3.5 percent to
3.0 percent.
The Federal Reserve also worked with other regulators through the President's Working Group on
Financial Markets to monitor developments in financial markets. As you know, the government
securities market postponed settlements for a few days, the commercial paper market experienced
significant problems, and the New York Stock Exchange remained closed until September 17. We
supported fully restoring financial markets to normal operations as soon as practical. However, in
working with the Securities and Exchange Commission, the Department of the Treasury, market
participants, and other stakeholders to reopen these markets, we had to balance the benefit of a
prompt return to business against the risk that the supporting infrastructure would be unable to handle
what would certainly be a record volume of trades. Paramount in that consideration was the safety of
the men and women working in Lower Manhattan. The SEC and the New York Federal Reserve Bank,
along with the leaders in these various markets, deserve a great deal of credit for ably managing the
process of reopening, making judgments that allowed all markets to return to normal functioning
quickly and effectively.
As I look back, I am comforted that the financial and monetary effects of the horrible and tragic events
on that day were less severe than one might have imagined. The aftershocks were less sizable than
one might have feared they might be, largely because of the action taken by major market participants
and the regulatory community, including the Federal Reserve System.
The incidents of September 11 taught us many lessons relating to central banking and financial
stability. First and foremost, they reinforced the importance of the Federal Reserve's role as lender of
last resort. Second, we again saw that the multiple roles the Federal Reserve plays - in this instance,
central bank, supervisor and regulator, and payment systems operator - give us many tools to apply
during a crisis. While I have been a member of the Board, I have from time to time heard some
question the wisdom of our central bank's being involved in supervision and regulation and continuing
to provide payment services, particularly retail payment services. To my mind the events of September
11 should put such question to rest. From our experience, we should recognize the benefits of a
central bank that can influence the economy and enhance financial stability through several mutually
reinforcing tools.
A third lesson is that having diversified forms of risk intermediation makes the financial system more
robust. In this instance, having markets and banks that performed similar financial intermediation roles
accounted for much of our financial system's ability to withstand the shock of September 11.
Fourth, the attacks remind us that operational risk, which is hard to quantify with any model, may at
times be the paramount risk. We recognized this in the abstract in our planning for the Y2K
centurydate change. Now we have seen the real results of a massive disruption in infrastructure. Fortunately,
the preparations for Y2K helped the financial system of our country withstand the September 11 crisis.
Even now, financial institutions are working hard to update their contingency plans on the basis of a
new understanding of the risks that confront our country. Having layers of redundancy, each calibrated
to a different level of emergency need, is one potentially successful strategy.
A fifth lesson is the importance of ongoing communication and, when required, coordination among
domestic authorities and across borders. The ability to communicate seamlessly with other members
of the President's Working Group and with fellow central bankers, in both cases on the basis of trust
developed in the course of pre-existing relationships, proved to be very helpful. Obviously, even
without those well-established relationships, we would still have reached decisions. The decisions may
not have come as quickly nor been as well informed, however. The amount of trust needed to
successfully coordinate in the midst of stressful situations is high, and coordinating with familiar
colleagues is much easier than working with relative strangers.
Finally, in the wake of those events, we must address the possibility of major disruptions in areas in
which financial markets or operational centers are concentrated. We will not accomplish our task if one
or two organizations strengthen their resilience and others do not. Instead, we need to work hard to
adopt consistent strategies for reducing risks that together address prevention, management, and
testing.
In conclusion, I must admit that the farther we move away in time from the tragic events of September
11, 2001, the more the lessons come into focus. We in the United States are very fortunate to have
created, through the efforts of private industry at times pushed by regulators, the most robust, most
efficient financial system in the world. But at the same time, it is clear that the events should remind us
to redouble our efforts to make our financial system even stronger.
It has been a pleasure to address you all this afternoon. Thank you.