Cecchetti Ohio State University Distinguished Lect

Behind the Scenes on September 11: : 

Behind the Scenes on September 11: How the Federal Reserve Made Sure that Cash Machines and Credit Cards Kept Working

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Imagine what would have happened if on September 11 you had gone to the withdraw cash from your nearest bank machine, and it was out of order?

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What the Federal Reserve Does and Where They Do It? The Payments System: How Money Moves The Financial Disruptions of September 11 What the Federal Reserve Did to Make Sure Your Cash Machine Still Worked

What the Federal Reserve Does?: 

What the Federal Reserve Does? Objectives Low, Stable Inflation High, Stable Growth Financial System Stability

What the Federal Reserve Does?: 

What the Federal Reserve Does? Day-to-Day Functions Bank for the U.S. Government Manages the Government’s Finance Maintains the U.S. Treasury’s bank account Manages the issuance, transfer and redemption of U.S. Treasury debt. Using interest rates, controls availability of money and credit

What the Federal Reserve Does?: 

What the Federal Reserve Does? Day-to-Day Functions Bank for the U.S. Government Bank for Foreign Governments & Central Banks Maintains a bank account for them

What the Federal Reserve Does?: 

What the Federal Reserve Does? Day-to-Day Functions Bank for the U.S. Government Bank for Foreign Governments Bank for the Bankers Maintains a deposit account for commercial banks Make funds available through discount loans Operate a payments system Supervise, regulate financial institutions to ensure safety and soundness

Where They Do It: 

Where They Do It The Federal Reserve System: Board of Governors in Washington Part of the Federal Government Supervisors and Regulators

Where They Do It: 

Where They Do It The Federal Reserve System: Board of Governors in Washington 12 Regional Federal Reserve Banks Private non-profit corporations and chartered banks Overseen by the Board of Governors Conduct Federal Reserve’s Day-to-Day Business

Where They Do It: 

Where They Do It All 12 Regional Banks Cash Check Clearing Electronic Payments, ex. Fedwire Discount Lending Bank Supervision

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New York Only Auction Treasury Securities Foreign Government Services Monetary Policy Operations Fedwire: Large Value Interbank Funds Transfer System

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The Gold Vault 250 million ounces Over $85 billion at current market prices 10% of all the gold that has ever been taken out of the ground One bar weights about 400 ounces

The Federal Reserve’s  Balance Sheet: 

The Federal Reserve’s Balance Sheet Used to control money and credit. Control over the size Unlike you or me, if they want to buy something, they just create liabilities to do it.

Open Market Operations: 

Open Market Operations The Federal Reserve controls the overnight interest rate banks charge each other for reserves – that’s the federal funds rate They do it by buying and selling securities, crediting or debiting commercial bank accounts. This adds or drains reserves from the banking system.

The Payments System: 

The Payments System How We Pay for things: Cash Checks Electronic Payments Credit Cards Debit Cards Automated Clearing House Transactions (ACH) Electronic Funds Transfers

The Federal Reserve’s Role in the Payments System: 

The Federal Reserve’s Role in the Payments System

The Federal Reserve’s Role in the Payments System: 

The Federal Reserve’s Role in the Payments System Supply Cash There is $625 billion out there. $2200 per U.S. resident. 2/3rds of it is in $100 bills 15 $100 bills per U.S. resident. The New York Fed handles $1.5 billion a day.

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The Federal Reserve Bank of New York’s cash vault is the largest in the world. It three stories high and the size of a football field. It holds 5400 pallets of currency.

The Federal Reserve’s Role in the Payments System: 

The Federal Reserve’s Role in the Payments System Checks On an average business day, 170 million move through the economy.

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The New York district handles 6 million a day, with a value of about $10 billion, using check-sorting machines like this one.

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You Write and Mail Payment Recipient Deposits it in Their Bank Step 1

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You Write and Mail Payment Recipient Deposits it in Their Bank Bank Transports it To Federal Reserve Processing Center Step 2

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You Write and Mail Payment Recipient Deposits it in Their Bank Fed flies the check back to your district Bank Transports it To Federal Reserve Processing Center Step 3

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You Write and Mail Payment Recipient Deposits it in Their Bank Fed flies the check back to your district Bank Transports it To Federal Reserve Processing Center Your Bank Pick up the Check from the local processing center Your Bank Returns the Check to You Step 4 Step 5

Checks and Float: 

Checks and Float If Their Bank is in a different Federal Reserve district from Your Bank, Your Bank’s Federal Reserve account is not debited until the check is physically moved to that district! This is done with airplanes.

The Federal Reserve’s Role in the Payments System: 

The Federal Reserve’s Role in the Payments System Electronic Payments 120 million transactions per day, primarily credit and debit cards. The Fed Clears the ACH transactions Fedwire Large-value interbank payments system $2 trillion per day in gross payments

The Fedwire: 

The Fedwire On a typical day there will be 400,000 to 450,000 transactions Valued at $2 trillion Most of it between 2:30pm and 6:30pm And at the end of the day, balances are about $15 billion

Interbank Payments: 

Interbank Payments Banks regularly make payments expecting to be paid by someone else later in the day. System has substantial interdependence Runs on reserves – the balances commercial banks hold at the Federal Reserve Notice that reserve balances are used an average of between 100 and 150 times a day!

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Payments Flows on a Normal Day Bank A Bank B Bank C Opening Balance: $50 $50 $0 Closing Balance: $50 $25 $25

Recap: 

Recap A primary objective of the Federal Reserve is to maintain stability of the financial system Day-to-day this means ensuring that the financial system has the capacity to shift funds around This payments system requires liquidity in the form of commercial bank deposits at the Federal Reserve

Recap: 

Recap Federal Reserve Operations are done in New York The Check Clearing System Requires Airplanes The Interbank Payment System is Highly Interdependent

September 11, 2001: 

September 11, 2001

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* * * * * * * * * * * * * ½ Mile ¼ Mile * *

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Trading pit at the New York Mercantile Exchange in New York City that appeared in the movie “Trading Places” with Eddie Murphy and Dan Ackroyd.

The Disruptions: 

The Disruptions Lower Manhattan became inaccessible No power No communication All nonmilitary aircraft in the U.S. were grounded.

The Federal Reserve Response: 

The Federal Reserve Response At 11:45 am, 3 hours after the attacks began, the Federal Reserve Board issued the following statement:

The Disruption: 

The Disruption Suddenly, banks could not be sure that they were going to receive anticipated payments. Caution meant that they would not make payments if they didn’t have to. Some banks couldn’t make payments at all. The technical problems in securities transfer were particularly severe.

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Bank B Can’t Send Payments Bank A Bank C $75 at 12:00pm Can’t Be Sent $50 at 10:00am $50 at 1:00 pm Can’t Be Sent Payments Flows When Payments are Disrupted Bank A Bank B Bank C Opening Balance: $50 $50 $0 Closing Balance: $0 $100 $0

Payments Flow Disruptions: 

Payments Flow Disruptions Some of the Biggest Banks were unable to send out payments. Small banks use big banks as their bankers. Big banks receive and send out lots of payments. Remember there are 400,000 payments a day just over the Fedwire!

The Risk: 

The Risk A bank that makes payments but doesn’t receive them runs the risk of depleting their reserve account. If a bank runs out of reserves, they can’t operate any more. This would eventually filter down to us! The Federal Reserve knows this, and so they take precautions.

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* * * * * * * * * * * * * ½ Mile ¼ Mile * *

Bank of New York: 

Bank of New York Things were bad enough that on September 14 they issued a statement: The Bank of New York Company, Inc., one of the world's largest securities servicing and cash processing institutions, said today that virtually all of its systems are up and running in the aftermath of the terrorist attacks on New York City. The Bank said that its headquarters as well as some of its operational facilities in lower Manhattan have had to be moved temporarily to alternate locations. The Bank has longstanding contingency plans to carry on business in an emergency and said it is open for business in New York City, across the country and around the world.

Federal Reserve Contingencies: 

Federal Reserve Contingencies Fedwire: Several backup sites. Discount Loans: All 12 banks can do them. Boston took over the New York banks. Open Market operations: New York only! There is a backup site There weren’t back up people The people slept in the building on the night of September 11 so they could be there on September 12.

Federal Reserve Actions: 

Federal Reserve Actions Normal Day Open market operations: Buy $3 to $5 billion in securities Discount loans: Borrowing is virtually zero Float: $500 million No Foreign Exchange Operations

Federal Reserve Reaction: 

Federal Reserve Reaction Liquidity was added by Open market operations: Buy securities, paying with reserves Discount loans: Banks come and asked Float: The planes didn’t fly European Central Bank exchanged euros for dollars (temporarily)

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Overnight RPs Term RPs Outstanding Term and Overnight RPs around September 11 billions of dollars 9/5 9/11 9/17 9/19 10/3 We Tu Mo We We

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Foreign Central Bank Deposits Foreign Exchange Swaps Float Impact of Key Autonomous Factors on the Supply of Fed Balances around September 11 in billions of dollars 9/5 9/11 9/17 9/19 10/3 We Tu Mo We We

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Borrowed Balances Total Fed Balances around September 11 billions of dollars 9/5 9/11 9/17 9/19 10/3 We Tu Mo We We Non Borrowed Balances

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Extraordinary Additions to Banking System Reserves Fed Actions Bank Borrowing Planes Grounded ECB Cooperation

The Results: 

The Results The contingency planning paid off. Everyone knew that liquidity needed to be added, and there were people with the means to do it. Banks were able to make payments If the Federal Reserve hadn’t done it’s job, we all would have noticed.

Slide60: 

I would like to acknowledge the help of my friends at the Federal Reserve Bank of New York, Dino Kos, Spence Hilton and Peter Bakstansky, for explanations, data and photographs.