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 financialsystemandthecommunicationsinfraof 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 operationofasignificantcomponentofourpaypartofthestoryofhowthenationresponded.Still, mentssystem,sincealargeshareofthechecks thewayinwhichthefinancialsystemresponded writtenintheUnitedStatesmovethroughair isataleworthtelling,for,withoutdoubt,aspreadtransporttothepayingbanks. 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. andnottheunderlyingstrengthoffinancialservicesfirms.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. amountonshortnoticewasbasedontheconfidencethattheywerelendingtobanksthatwere 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,whichconbytheFederalReserveSystem—Fedwireand ductsmonetarypolicythroughtransactionswith theautomatedclearinghouse(ACH)—remained governmentsecuritiesdealers,wasabletooperinoperationwithoutinterruption.Operationof ateoutofthemainbuildingforatime,buton thesesystemsfacilitatedtheoperationofother September13relocatedtoaFedbackupfacility segmentsofthepaymentssystemandthesettle- inNewJerseyandconductedopenmarketopermentoftransactionsamongfinancialinstitutions. ationsfromthatofficeforatime. Theattackstemporarilydisruptedmarket Thecreditcard,debitcard,andATMnetworks mechanismsthroughwhichbanksincreasetheir continuedtofunctionaftertheterroristattacks. reserves,includingborrowinginthefederalfunds Theflowofinformationamongparticipantsin marketorsellingfederalgovernmentsecurities thesesystems,includingbanksandmerchants, heldassecondaryreserves.TheFederalReserve occursoverelectroniccommunicationnetworks. madelargeloansthroughthediscountwindow Participantsinthesesystemssettledtheirnet toprovideliquiditytobanksthatcouldnotraise positionsovertheFed’selectronicpaymentsnetadequatefundsthroughnormalmechanisms. works(FedwireandACH)intheusualmanner. Short-termdiscountwindowloans,calledadjust- Ournation’sinfrastructureforelectronicpaymentcredit,were$99milliononSeptember5, mentsnotonlyworkedbutworkedwell. butrosetoover$45billiononSeptember12.By Operationofthenation’scheckcollection September26,adjustmentcredithaddeclinedto systemwasagreaterchallengeduringthefirst $20million;thesystemhadreturnedtonormal weekafterSeptember11.Bankscouldnotcollect operations. checksthroughairtransport.Inthiscrisissitua- Extraliquidityinjectedintothebankingsys- tion,theFedadoptedapolicytominimizepotentemflowedtowhereitwasneeded.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 declinedasthetemporarydisruptionsintheoperforseveraldays.Thecontrastbetweentheunin- ationofthefinancialmarketsended. terruptedoperationofthecreditcardanddebit Oneofthereasonswhypaymentssystems cardsystems,whichoccursprimarilyoverelec- workedinacrisissituationisthatthesesystems troniccommunicationsystems,andthetempo- haveimplementedarrangementsforlimitingthe rarydisruptionsinthecheckcollectionprocess, riskassumedbyeachparticipantthroughcredit illustratesthepotentialbenefitofshiftingcheck extendedtocounterpartiesinthepaymentssyscollectiontoanelectronicsystem. 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.TheexpemarketreopenedThursday,September13,normal rienceoftheUnitedStatessavingsandloanindusmarketfunctioningcouldnotbere-established tryinthe1980s,andofothernations,especially untiltheequitymarketsreopened,whichoccurred Japan,demonstratestheproblemsinherentinthe onMonday,September17.Marketaverages alternativesupervisorypolicyofforbearancewhen declinedwhenthetradingofsharesresumed,but lossesdepletethecapitaloffinancialfirms.An theoperationofthemarketsdidnotshowsigns economycannotgrowifitsmajorfinancialinstiofpanicselling.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- BureauofEconomicResearchannouncedyestermismaboutournation’sabilitytocopewith daythatitsBusinessCycleDatingCommittee futureevents.Thiscapacityrestsonacontinu- hadreachedtheconclusionthatarecessionisin ingcommitmenttosomebasicprinciples. progress;theCommitteedatedthecyclepeakin First,theFedasthecentralbankmustinject Marchofthisyear. additionalreservesintothebankingsystemtem- Thereisnowaytotellnowwhentherecesporarilyduringafinancialcrisis.Thispointisso siontroughwilloccur.Wefacemanyuncertainwellunderstoodinthecountryandcertainly ties,includingthepossibilityoffurtherterrorist withintheFedthatIhavenodoubtthatliquidity attacks.Suchattacks,iftheyoccur,willobviously wouldflowfreelyasneededevenif,horribleto benegativefortheeconomicoutlook.Theuncercontemplate,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.Thefedfirminthecountry,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,thattomyknowledgenoinsurancecompaniesfacetheriskofinsolvencyfrom 4