Economic Policy Review Executive Summary
Liquidity Effects of the Events of September 11, 2001
Recapping an article from the November 2002 issue
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of the Economic Policy Review, Volume 8, Number 2 View full article PDF


21 pages / 260 kb

Authors: James J. McAndrews and Simon M. Potter

Index of executive summaries

McAndrews and Potter investigate the disruption to the flow of payments among banks on September 11 and assess the steps taken by the Federal Reserve to remedy the problem. They find that the Fed’s moves to supply extraordinary amounts of liquidity to the banking system were important in restoring normal payments flow.
Because of the severe damage to property and communications systems on September 11, some banks were unable to execute payments through the Federal Reserve System’s large-value payments system, Fedwire. As a result, other banks received fewer payments than expected. Since banks rely heavily on a strategy of payments coordination—using incoming payments to fund their own transfers—those banks that found themselves short of liquidity were less likely to send payments to other banks in the normal pattern.
Argument and Methodology
The authors begin their analysis by tracking changes in the value and volume of Fedwire transfers on September 11 and the days following. Payments fell off sharply on the day of the attack: Instead of the usual $10 billion per minute that flows over the wire near the end of most days, the end-of-day flow on September 11 was less than $2 billion per minute (chart). Although the value of funds sent returned to normal levels on September 12, the volume of payments remained low until September 14. The authors also show that the timing of payments deviated markedly from the customary patterns. The variability of payments timing rose sharply—almost doubling to about four hours from two—and payments were delayed by roughly two hours on average (chart). In this environment, banks were unsure when they would receive expected payments and whether they would be able to synchronize their outgoing payments with incoming funds from other banks. Banks responded to the uncertainty, the authors argue, by increasing their precautionary demand for liquidity. To test this interpretation, the authors estimate banks’ payments reactions to the receipt of payments from other banks. Using data on the Fedwire activity of twenty large banks, they assess banks’ propensity to send out payments in response to incoming payments both before and after September 11. They find a distinct shift after September 11, with the typical bank requiring more of a liquidity cushion in advance of sending out payments than it had in the preceding period. The authors then show how the Federal Reserve’s actions to meet banks’ demand for liquidity helped to reestablish payments coordination. Specifically, the Fed lent billions of dollars through the discount window—more than two hundred times the daily average amount of lending in the prior month—and temporarily suspended penalties on intraday and overnight overdrafts. These actions reduced banks’ reliance on payments from other banks and encouraged banks to resume sending their payments in more normal patterns. In the week of September 17-21, the Fed injected additional liquidity into banks’ accounts through open market operations, bringing payments coordination to higher than normal levels (chart).
The breakdown in the coordination of payments on September 11 caused the demand for liquidity to balloon. McAndrews and Potter argue that the Fed’s moves to meet this demand through discount window loans and open market operations helped to reestablish the coordinating equilibrium. According to the authors, the discount window proved to be a particularly effective means of channeling liquidity to those institutions that needed funds in order to send payments.            

The authors conclude their analysis with a brief look at long-run reforms that could mitigate the impact of future disruptions to the payments system. They discuss current proposals for safeguarding the physical infrastructure of the system and examine possible changes in the protocols for submitting and settling payments.

The value and volume of Fedwire funds transfers dropped far below customary levels on September11.

Value and Volume of Funds Sent per Minute
Ten-Minute Moving Average

Source: Federal Reserve Bank of New York.

Note: The shaded bands indicate +/- two standard deviations of the benchmark averages.

The timing of Fedwire payments followed an unusual and disorderly course after the September11 attack.

Value-Weighted Average of the Timing of Payments on Fedwire
Benchmark Period and September 4-21, 2001

Source: Federal Reserve Bank of New York.

Estimates of banks’ payment reactions show the reluctance of banks to send out payments until liquidity injections by the Fed increased their balances and decreased their dependency on transfers from other banks.

Reaction Functions Illustrating Payments Coordination after the Attacks

Source: Authors’ calculations.


The views expressed in this article are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System.

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