Speech

Financial System Robustness FinancialExecutivesInternational,St.LouisChapter St.Louis,Missouri November27,2001 Eleven weeks ago tonight, we were all September11.KeyoperationslocatedattheWorld in a state of shock. Initial estimates TradeCenterincludedseveraloftheimportant indicated that about 6,000 people had dealerswhomademarketsinfederalgovernment perished in the attacks on the World securities,traderswhomademarketsinforeign Trade Center and Pentagon. U.S. financial mar- exchange,andbrokerswholinkedthebanksthat kets were closed and all civilian aircraft were wantedtoborrowandlendfederalfunds.The grounded. Some banks had closed some offices peoplewhoperformedthesefunctionsinour earlier in the day. No one knew the full extent financialsystemandthecommunicationsinfra- of the damage, and no one knew when the stock structuretheyusedformakingtradesandsettling and bond markets would reopen. Many firms, transactionswerelocatedinoneplace.Inaddition, bothfinancialandnonfinancialones,wereuncer- theNewYorkStockExchangeandtheFederal tain how they could meet their obligations com- ReserveBankofNewYorkarelocatedafew ingdueinthedaysahead,giventheiruncertainty blocksfromtheWorldTradeCenter.Ournational over selling securities to raise funds or even systemforclearingcheckswasalsovulnerable receiving payment on obligations due them. todisruption.Evenatemporarysuspensionof Howthefinancialsystemdealtwiththis airtransportationhadpotentialtodisruptthe unprecedentedsituationisnotthemostimportant operationofasignificantcomponentofourpay- partofthestoryofhowthenationresponded.Still, mentssystem,sincealargeshareofthechecks thewayinwhichthefinancialsystemresponded writtenintheUnitedStatesmovethroughair isataleworthtelling,for,withoutdoubt,aspread- transporttothepayingbanks. ingwaveofdefaultsandfearsofinflationwould Effortsofournation’sfinancialinstitutions haveseverelycomplicatedthenation’seffortsto andtheFedlimitedthedegreeofdisruptioninthe regainequilibriumandgetonwiththenewwar operationofthepaymentssystemandfinancial againstterrorism. institutions.Successinlimitingthedamagetothe Beforeproceeding,Iwanttoemphasizethat paymentssystemandtheoperationoffinancial theviewsIexpressherearemineanddonot marketsandinstitutionsrestsuponthefinancial necessarilyreflectofficialpositionsoftheFederal strengthofourbanksandotherfinancialinstitu- ReserveSystem.Ithankmycolleaguesatthe tionsandthequalityoftheirmanagement. FederalReserveBankofSt.Louis,especially Thevulnerabilityturnedouttobethephysical AltonGilbert,fortheircomments,butIretain infrastructureofpaymentsandtradingsystems, fullresponsibilityforerrors. andnottheunderlyingstrengthoffinancialserv- icesfirms.Thesefirmsandtheirsuppliersproved tohavethecapitalandthetechnicalresourcesto VULNERABILITIES AND restoredamagedinfrastructure.Itisworthreflect- STRENGTHS ingonthispoint,asitisnotatrivialone.Countries Theoperationofournation’sfinancialsys- thathaveseenthesolvencyoftheirfinancial temprovedtobevulnerabletotheattacksof firmsthreatened,suchastheUnitedStatesin 1 FINANCIALMARKETS theearly1930sandseveralAsiancountriesbegin- earlyOctober,interbankloanshaddeclinedto ningin1997,sufferedfarworseeconomicdam- justabove$300billion.Thewillingnessofbanks agethandidtheUnitedStatesinthewakeof toincreasetheirloanstoeachotherbythislarge September11. amountonshortnoticewasbasedontheconfi- dencethattheywerelendingtobanksthatwere strongfinancially.Thestrongcapitalpositions COPING DURING THE FIRST enjoyedbymostbankspermittedthemtodeal successfullywiththedisruptionofthepayments WEEK system. Developmentsduringthefirstweekafter Tradinginthemarketsforforeignexchange September11wereespeciallyimportantforlimit- resumedonSeptember12.Theoperationofthe ingtheimpactoftheattacksontheoperationof federalfundsmarketandthefunctionsofmaking ourpaymentssystemandfinancialinstitutions. marketsingovernmentsecuritiesandsettling Somepartsofthefinancialsystemdidhavetheir thesetransactionsresumedwithinafewdays operationsshutdownbythecollapseoftheTwin afterSeptember11.TheNewYorkFed’smain Towers,butotherpartsofthesystemcontinued building,afewblockswestoftheWorldTrade tofunctionnormally.Thedepthofoperational Center,wasundamagedbutaccesswaslimited resources,thecapacitytocallonbackupsystems, toallbutessentialpersonnelbecauseoffearthat andtheroleoftheFederalReserveinproviding aneighboringbuildingmightcollapse,thelarge massiveamountsofliquidityreflecttherobust- amountofsmokeinlowerManhattan,andthe nessoftheU.S.financialsystem. difficultyofgettingpeopletothebuilding.The Theelectronicpaymentnetworksoperated NewYorkFed’sOpenMarketDesk,whichcon- bytheFederalReserveSystem—Fedwireand ductsmonetarypolicythroughtransactionswith theautomatedclearinghouse(ACH)—remained governmentsecuritiesdealers,wasabletooper- inoperationwithoutinterruption.Operationof ateoutofthemainbuildingforatime,buton thesesystemsfacilitatedtheoperationofother September13relocatedtoaFedbackupfacility segmentsofthepaymentssystemandthesettle- inNewJerseyandconductedopenmarketoper- mentoftransactionsamongfinancialinstitutions. ationsfromthatofficeforatime. Theattackstemporarilydisruptedmarket Thecreditcard,debitcard,andATMnetworks mechanismsthroughwhichbanksincreasetheir continuedtofunctionaftertheterroristattacks. reserves,includingborrowinginthefederalfunds Theflowofinformationamongparticipantsin marketorsellingfederalgovernmentsecurities thesesystems,includingbanksandmerchants, heldassecondaryreserves.TheFederalReserve occursoverelectroniccommunicationnetworks. madelargeloansthroughthediscountwindow Participantsinthesesystemssettledtheirnet toprovideliquiditytobanksthatcouldnotraise positionsovertheFed’selectronicpaymentsnet- adequatefundsthroughnormalmechanisms. works(FedwireandACH)intheusualmanner. Short-termdiscountwindowloans,calledadjust- Ournation’sinfrastructureforelectronicpay- mentcredit,were$99milliononSeptember5, mentsnotonlyworkedbutworkedwell. butrosetoover$45billiononSeptember12.By Operationofthenation’scheckcollection September26,adjustmentcredithaddeclinedto systemwasagreaterchallengeduringthefirst $20million;thesystemhadreturnedtonormal weekafterSeptember11.Bankscouldnotcollect operations. checksthroughairtransport.Inthiscrisissitua- Extraliquidityinjectedintothebankingsys- tion,theFedadoptedapolicytominimizepoten- temflowedtowhereitwasneeded.Banks tialdisruptionstotheuseofchecksintransactions. increasedtheirloanstootherbankssubstantially. TheReserveBanksacceptedchecksfrombanks Interbankloansincreasedfrom$300billionon fordeposittotheirreserveaccountsasusualand September5to$442billiononSeptember12.By creditedtheirreserveaccountsfortheproceeds 2 FinancialSystemRobustness ofthechecksontheusualtimeschedule.Float attacks.Settlementoftradesoccurredinalmost oftheReserveBanksincreasedsubstantially theusualorderlyfashion.Toprovideextratime becausetheFedcouldnotcollectthecheckson forprocessingintheTreasurysecuritiesmarket, theusualschedule.FederalReservefloatadded tradesconductedonSeptember13and14were afairlytypical$2billiontobankreserveson settledthreedaysafterthetrades,andfivedays September5,but$23billiononSeptember12. afterfortradesonSeptember17through TheFed’spolicyofacceptingchecksfordeposit September21;startingMonday,September24, andcreditingtheaccountsofcollectingbankson tradesweresettledonthenormalnext-daybasis. theusualavailabilityschedulefacilitatedtherela- Thelargeincreasesinbankreservesduring tivelysmoothoperationofoneimportantphase thefirstweekafterSeptember11werereversed incheckcollection:banksacceptingchecksfrom duringthesecondweek,asmorechecksreached customersandcreditingtheiraccountsonthe thepayingbanksandbanksrepaidtheirloans basisoftheusualcollectionschedule. fromtheFed’sdiscountwindow.Interbankloans Thecollectionofmanycheckswasdelayed declinedasthetemporarydisruptionsintheoper- forseveraldays.Thecontrastbetweentheunin- ationofthefinancialmarketsended. terruptedoperationofthecreditcardanddebit Oneofthereasonswhypaymentssystems cardsystems,whichoccursprimarilyoverelec- workedinacrisissituationisthatthesesystems troniccommunicationsystems,andthetempo- haveimplementedarrangementsforlimitingthe rarydisruptionsinthecheckcollectionprocess, riskassumedbyeachparticipantthroughcredit illustratesthepotentialbenefitofshiftingcheck extendedtocounterpartiesinthepaymentssys- collectiontoanelectronicsystem. tems.Inaddition,bankshaverelativelyhigh Onlyarelativelyfewpeoplewithdrewmore ratiosofequitytototalassets.Althoughrelatively cashthanusualfromtheirbankaccounts.The largebankshaveexperiencedanincreaseinprob- Fedwasabletohelpbanksmeetthisdemandfor lemloanssince1997,bankcapitalratiosremain substantiallyhigherthanduringthelastperiod cashbyprovidingadditionalcashfromthevaults ofmajorproblemsinthebankingindustry,in oftheReserveBanks.Becausethebanksandthe thelate1980sandearly1990s.Oneofthefactors Fedmadecleartothepublicthatcashwasand thatcouldhavecauseddisruptionsinpayments wouldremainreadilyavailable,theunusual arrangementswouldhavebeenanunwillingness demandforcashneverbecameverylargeand ofparticipantstoextendcredittoeachother.Iam quicklysubsided. notawareofevidencethatthisproblemoccurred. ThesupervisoryauthoritiesintheUnited Statesarecommittedtokeepingourbanking AFTER THE FIRST WEEK industryinsoundfinancialcondition.Banks Ournation’sfinancialsystemreturnedtomore thatsufferlossesthatcompromisetheircapital normaloperationduringthesecondweekafter positionsareclosedorreorganizedunlesstheir September11.Althoughthegovernmentbond shareholdersinjectadditionalequity.Theexpe- marketreopenedThursday,September13,normal rienceoftheUnitedStatessavingsandloanindus- marketfunctioningcouldnotbere-established tryinthe1980s,andofothernations,especially untiltheequitymarketsreopened,whichoccurred Japan,demonstratestheproblemsinherentinthe onMonday,September17.Marketaverages alternativesupervisorypolicyofforbearancewhen declinedwhenthetradingofsharesresumed,but lossesdepletethecapitaloffinancialfirms.An theoperationofthemarketsdidnotshowsigns economycannotgrowifitsmajorfinancialinsti- ofpanicselling.Stockpricestendedtochange tutionsremaininweakfinancialconditionforan inarationalpattern,withthelargestpercentage extendedperiodoftime.Moreover,suchfirms declinesinthepricesofthesharesofcompanies wouldnothavethestrengthtowithstandashock thatappearedtobemostadverselyaffectedbythe ofthemagnitudeofSeptember11. 3 FINANCIALMARKETS IMPLICATIONS OF THIS theselosses.Thatfactisafinetestamenttothe qualityoffinancialmanagementofthesefirms. EXPERIENCE FOR THE FUTURE Peoplearealwaysinterestedinmythoughts Whilewecannotknowwhetherwehave abouttheprobabledirectionoftheeconomyin moreterroristattacksinourfuture,theoperation themonthsahead,andsoI’llofferafewreflections ofourpaymentssystemandfinancialinstitu- onthatsubject.Asyoumayknow,theNational tionsafterSeptember11givesusabasisforopti- BureauofEconomicResearchannouncedyester- mismaboutournation’sabilitytocopewith daythatitsBusinessCycleDatingCommittee futureevents.Thiscapacityrestsonacontinu- hadreachedtheconclusionthatarecessionisin ingcommitmenttosomebasicprinciples. progress;theCommitteedatedthecyclepeakin First,theFedasthecentralbankmustinject Marchofthisyear. additionalreservesintothebankingsystemtem- Thereisnowaytotellnowwhenthereces- porarilyduringafinancialcrisis.Thispointisso siontroughwilloccur.Wefacemanyuncertain- wellunderstoodinthecountryandcertainly ties,includingthepossibilityoffurtherterrorist withintheFedthatIhavenodoubtthatliquidity attacks.Suchattacks,iftheyoccur,willobviously wouldflowfreelyasneededevenif,horribleto benegativefortheeconomicoutlook.Theuncer- contemplate,asignificantfractionoftheFed’s tainties,however,arenotallonthenegativeside. leadershipwerelostinterroristattacks. ThecampaigninAfghanistanseemstobegoing Second,ourgovernmentsupervisoryagencies well,andthereissomeprobabilitythattheFBI mustmaintainacommitmenttopoliciesthat willgettothebottomoftheanthraxattacks. promotethefinancialstrengthofourfinancial Successonthosefrontswouldhelptoclearthe institutions.Thisstrengthincludessoundcapital airandwouldbepositivefortheeconomy. positionsandrobustcontingencyplansformain- AlthoughtheU.S.economyisinarecession, tainingorrestoringoperations.TheFedand Iamcertainlynotpessimisticaboutoureconomic financialfirmsacrossthecountryhadprepared prospects.Indeed,Iamoptimisticbecausewe extensivelyforpossibledisruptionsduringseveral havesuchgreatstrengthsinoursituation.Weare yearsofY2Kpreparations.Thosepreparations aresourcefulpeople,and,becauseoureconomy weresosuccessfulthatthecenturyrollover islargelyorganizedthroughcompetitivemarkets, occurredwithpracticallynoproblemswhatsoever, wearerespondingquicklytothenewsituation. andtheextensivecontingencyplansremained Bankcapitalpositionsarestrong;inflationislow ontheshelf.Thecontingencyplansdidpayoff, andexpectedtoremainlow.Insomepastperiods however,onSeptember11andthedaysthatfol- ofstress,weakbankcapitalandrisinginflation lowed.I’mwillingtospeculatethateveryfinancial considerablycomplicatedthesituation.Thefed- firminthecountry,andmanyothersaswell,are eralgovernmententeredthisperiodinstrongfiscal nowre-examiningandstrengtheningtheircon- condition,whichmeansthattheresourcesare tingencyplans.TheU.S.financialsystemisbeing availabletomeetoursecurityneedswithout madeevenmorerobust. concernthatabudgetdeficitisoutofcontrol. Myremarkshavefocusedimplicitlyonthe Finally,bothmonetarypolicyandfiscalpolicy bankingsystemandtoalesserextentonthesecu- hadturnedexpansionarybeforeSeptember11. ritiestradingsystem.Iwouldberemiss,however, Thereisnowaytoprovideareliableforecast ifIdidnotmentionexplicitlytheinsurance ofhowquicklythesefundamentalstrengthswill industry.InsuredlossesfromSeptember11will showthemselvesinaclearrevivalofeconomic beimmense,andyetinsurancefirmshavemain- growth.Buttheywill,withinamatterofafew tainedsuchstrongcapitalpositionsandsuch monthsorfewcalendarquarters.Ofthat,I’m carefullycontrolledrisks,throughreinsurance confident. andotherdevices,thattomyknowledgenoinsur- ancecompaniesfacetheriskofinsolvencyfrom 4

William Poole (2001, November 26). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_20011127_poole

@misc{wtfs_speech_20011127_poole,
  author = {William Poole},
  title = {Speech},
  year = {2001},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_20011127_poole},
  note = {Retrieved via When the Fed Speaks corpus}
}