It’s been exactly a dozen years since terrorists crippled markets around the world with a devastating attack aimed at the heart of the American financial system.
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In just hours, the attacks of 9/11 caused thousands of deaths, billions of dollars of destruction and posed a serious and immediate challenge to U.S. policymakers at the Federal Reserve.
The Fed responded in forceful fashion by flooding the system with record-shattering amounts of liquidity and by reassuring market participants, moves that helped limit the financial damage and reinforced the central bank’s critical role as the lender of last resort in times of crisis.
“Only the Fed can create money out of thin air in these crises when everyone panics and liquidity dries up,” said former Fed economist David Jones. “Thanks to the Fed, whose liquidity trumps all in a crisis, we had remarkably little financial instability given how big the 9/11 crisis was.”
Liquidity, the ability to easily buy or sell assets without affecting prices, is crucial to the normal functioning of markets. It’s as important to investors as engine oil is to drivers.
The Fed’s efforts to calm panicked markets and mitigate the financial fallout of the 2001 terrorist attacks would foreshadow similar moves just seven years later during the worst financial crisis since the Great Depression.
The central bank’s response to 9/11 was complicated by countless logistical problems, including communications issues, building evacuations and the absence of its powerful chairman.
Alan Greenspan, arguably the second-most important person in government at the time, had been on his way home from a meeting of central bankers in Switzerland when his flight was turned around due to the unprecedented closure of U.S. airspace.
“He had to fly all the way back to Zurich without knowing what happened in the U.S. to cause all air traffic to be shut down,” said Jones.
Greenspan would return the next morning via a special military transport, but the business of the Fed couldn’t wait.
Under the direction of Roger Ferguson, then vice chairman of the Fed, the first official response from the central bank occurred at 9:44 a.m. ET, just 41 minutes after the second plane hit the World Trade Center. Through a message over Fedwire, the Fed said the fund transfer system was “fully operational” and would remain open until “an orderly closing can be achieved.”
At about noon ET, with the nature of the attacks evident to all, the Federal Open Market Committee issued a carefully-worded statement. The Federal Reserve System is “open and operating,” the FOMC said, and the discount window, which serves as a backstop provider of funds, is “available to meet liquidity needs.”
Reached by reporters in Switzerland, New York Fed President William McDonough said central bankers would “do everything possible to maintain calm and seek to ensure the world economy functions smoothly in the face of this horrendous deed.”
Keeping the System Greased
By using a number of tools, the Fed backed up these reassuring comments with concrete actions that, at the time, were unprecedented.
Due to communications and other issues, the number of Fedwire transactions plunged 40% on 9/11 to less than 250,000.
In a sign of illiquidity, commercial bank balances at the Fed ballooned to more than $120 billion in the days after the attack, compared with just $13 billion pre-9/11.
Banks also incurred huge daylight overdrafts on their accounts at the Fed. Overdraft fees, which the Fed waived, soared 35% through September 21, peaking at $150 billion on September 14.
To help lenders cope with payment problems, the Fed shelled out $46 billion in discount-window lending on the day after 9/11, which was 200 times the daily average for the prior month.
According to the Richmond Fed, at one point the Fed injected more than $100 billion in additional liquidity.
“Our massive provision of reserves made sure that the engine of finance did not run out of oil and seize up,” Ferguson said in a 2003 speech.
The Fed also opened up reciprocal currency facilities with rival central banks, including up to $50 billion with the European Central Bank and $30 billion with the Bank of England.
“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,” Jeffrey Lacker, current president of the Richmond Fed, wrote in a 2003 paper for the regional bank.
Under Greenspan’s guidance, the FOMC also moved to mitigate the impact of the attacks by slashing interest rates by half a percentage point to 3% on September 17 during an emergency meeting. Policymakers “will continue to supply unusually large volumes of liquidity to the financial markets, as needed, until more normal market functioning is restored,” the FOMC said.
Markets Reopen, Quickly Rebound
Much of the Fed building in Washington was evacuated as officials worried about a second plane hitting a high-profile target in the city. Yet Ferguson and a staff of about 100 remained to help coordinate the central bank’s response.
“The key guy that stuck by the battle station was Roger Ferguson,” said Jones.
Ferguson himself said the staff at the NY Fed performed “heroically” from a back-up facility in New Jersey after their fortress-like headquarters in Lower Manhattan was evacuated.
While the Fed was injecting ample liquidity, regulators at the Securities and Exchange Commission and the New York Stock Exchange raced to open markets in a timely and safe basis.
NYSE, then led by Dick Grasso, enjoyed a smooth reopening on September 17, less than a week after the devastating attacks just blocks away.
“That helped confidence. You’ve got to give a lot of credit to Grasso,” said Ernie Patrikis, former general counsel of the NY Fed and now a partner at White & Case. “The worst thing in the world would have been for the market to open and then crash operationally.”
"Our massive provision of reserves made sure that the engine of finance did not run out of oil and seize up."
While the S&P 500 plummeted 4.9% on that first day, the markets bottomed in only five days and returned to pre-9/11 levels just 19 trading days later.
“We may have had a couple of months of weakness because everybody panicked, but there was really a remarkable bounce back to the economy, which I give credit to the Fed for,” said Jones.
The overall response from the Fed further cemented the institution’s intended role as the lender of last resort when a crisis hits.
The central bank flooded the system with liquidity after the 1987 stock-market crash, organized a private-sector bailout in 1998 of imploding hedge fund Long Term Capital Management and rewrote the liquidity playbooks in the wake of the 2008 meltdown.
“They screwed up in the Depression of the ‘30s, but there were a lot of times we had something that could have been worse and the Fed prevented it from getting worse,” said Richard Sylla, a professor and financial historian at NYU.
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