Payment system disruptions and the federal reserve following September 11, 2001

Abstract

The monetary and payment system consequences of the September 11, 2001, terrorist attacks are reviewed and compared to selected U.S. banking crises. Interbank payment disruptions appear to be the central feature of all the crises reviewed. For some the initial trigger is a credit shock, while for others the initial shock is technological and operational, as in September 11, but for both types the payments system effects are similar. For various reasons, interbank payment disruptions appear likely to recur. Federal Reserve credit extension following September 11 succeeded in massively increasing the supply of banks' balances to satisfy the disruption-induced increase in demand and thereby ameliorate the effects of the shock. Relatively benign banking conditions helped make Fed credit policy manageable. An interbank payment disruption that coincided with less favorable banking conditions could be more difficult to manage, given current daylight credit policies.

Liquidity Risk and Monetary Policy

“…For example, Davis (1994) describes five severe liquidity crises in international markets: The Penn Central Bankruptcy in 1970, the crisis in the floating-rate notes market in the UK in 1986, the failure of the US-High Yield bond market in 1989, the Swedish Commercial Paper crisis in 1990 and the collapse of the ECU bond market in 1992. Greenspan (2004) highlights three crises during his chairmanship at the Federal Reserve (Fed), in which market participants wanted to convert illiquid medium to long-term assets into cash because they favoured safety and liquidity over uncertainty: The stock market crash in 1987, the LTCM-crisis 1998 and the terrorist attacks of September 11, 2001. This section provides a brief review of these three events and the central banks', in particular the Fed's, reactions to them.…”

“…Hence, liquidity problems concentrated in the payment and settlement system and did not affect the stock market immediately. In that sense, the effects were limited and the Fed could quickly withdraw the additional 108 billion US-$ in discount window credits, overnight repos and check floats it had supplied to banks until 13 September already by 20 September (Lacker, 2004, In Europe, the European Central Bank (ECB) immediately issued the following press statement on 11 September:…”

Economically Targeted Terrorism: A Review of the Literature and a Framework for Considering Defensive Approaches

“…The 9/11 attacks caused significant disruption in the nation's financial sector, which affected the functioning of many critical markets and payment operations (reviewed in Lacker, 2004). These disruptions required the Federal Reserve to take action to ensure sufficient liquidity in the financial system.…”

“…The 9/11 attacks also influenced investment behavior and the willingness of individuals or firms to commit their resources to areas they perceived as higher risk. 9 Investors from Middle Eastern nations, for example, reportedly pulled out significant sums of money from investments in 6 Responses of the Federal Reserve and of the payment system to 9/11 are discussed in Lacker (2004), Williamson (2004), andLang (2001). 7 See also Brück (2004, p. 110).…”

“…11 Responses to 9/11 of the Federal Reserve and the payment system are discussed in Lacker (2004), Williamson (2004), andLang (2001).…”