November 12, 2002

NOTE TO EDITORS

This special volume of the Economic Policy Review, The Economic Effects of September 11, issued soon after the one-year anniversary of September 11, 2001, explores some of the key economic consequences of the attacks.

The volume's six articles, all by economists at the Federal Reserve Bank of New York, address several important questions: How extensive were the losses in New York City on September 11 and in its aftermath? How much will the nation spend to prevent future attacks? Did the destruction of information and infrastructure impair the functioning of the payments and securities settlement systems, and what steps minimized further damage? Will these events hurt New York’s future vitality and cause businesses and workers to retreat from the city?

Cost Accounting

The first two articles detail the economic costs incurred as a direct consequence of the attack on New York City and from efforts to prevent future attacks.

"Measuring the Effects of the September 11 Attack on New York City," by Jason Bram, James Orr, and Carol Rapaport. Adding up the earnings losses, property damage, and cleanup costs, the authors estimate the direct damage of the attack on the World Trade Center to be between $33 billion and $36 billion. This estimate includes $7.8 billion in lost lifetime earnings of those who died in the attacks; $3.6 billion to $6.4 billion in forgone earnings from economic disruptions; and property losses, cleanup expenses, and site restoration costs that are expected to reach $21.6 billion.

"What Will Homeland Security Cost?" by Bart Hobijn. The author estimates that the direct cost of security spending, in both the public and private sectors, for fiscal year 2003 will reach approximately $72 billion, or a modest 0.66 percent of U.S. GDP. Of that total, the federal government plans to spend $38 billion, state and local governments are expected to account for about $1.3 billion, and private-sector spending for next year is estimated at $33 billion. The increase in private-sector security expenditures implies a reduction in the level of private-sector productivity of 1.12 percent.

The Impact on the Payments and Securities Settlement Systems

The following two articles address how well the U.S. financial system and its various payments mechanisms withstood the blow, and how market participants and policy institutions responded.

"When the Back Office Moved to the Front Burner: Settlement Fails in the Treasury Market after 9/11," by Michael Fleming and Kenneth Garbade. This article examines the prolonged failure of brokers, dealers, and investors to deliver on Treasury security trades, known as settlement fails. Average daily fails for the week ending September 19 increased to $190 billion, a sharp rise from the daily average of $7.3 billion for the first eight months of 2001, and remained unusually high after that.

How did the severe, but relatively short-lived, technical problems resulting from the physical disruption in Lower Manhattan cause extended settlement disruptions? The authors determine that there was little incentive for investors to borrow securities to avert or remedy fails because alternative strategies proved as costly as failing to deliver securities. The U.S. Treasury resolved the fails problem by increasing the supply of bonds through an unprecedented "snap" reopening, an auction that was both announced and conducted on the same day. The authors conclude with a discussion of longer run reforms to prevent chronic fails, including the creation of a Treasury facility that could lend specific securities on a temporary basis and the imposition of a penalty fee for fails.

"Liquidity Effects of the Events of September 11, 2001," by James McAndrews and Simon Potter. The authors investigate disruptions to the normal ways banks provide and distribute liquidity. On September 11, the coordination of payments between banks broke down as some banks were unable to send payments because of the physical destruction in Lower Manhattan, and other banks, expecting payment, found themselves unexpectedly short of liquidity.

The Federal Reserve responded to the payments disruption by supplying extraordinary amounts of liquidity to the banking system. The authors identify the discount window as a particularly valuable tool in restoring coordination after September 11. They also discuss longer run payments system reforms that might preserve coordination in the event of any future disruptions--including infrastructure changes and changes in the protocols for submitting and settling payments.

Prospects for New York City: Can the Center Hold?

The articles below ask if the events of September 11 could jeopardize the standing of New York City as one of the world’s leading financial capitals.

"Has September 11 Affected New York City’s Growth Potential?" by Jason Bram, Andrew Haughwout, and James Orr. The authors examine the economic trends that have helped New York City to prosper in recent decades and consider whether the attack will force the city off its course. They suggest that New York’s mix of industries should continue to serve the city well over the near horizon.

Over the past twenty-five years, New York City has enjoyed net stable employment, rising real earnings, and appreciating land prices--trends that are consistent with a model of New York as an attractive, mature city in an open, competitive environment and that augur well for its future. The authors tie the city’s continued success to the supply of amenities such as safety, the arts, and municipal services, and to the growing demand for many of the goods and services produced in New York City. Whether the fiscal strains from the attack will reverse these gains, the authors argue, will depend on how well the city manages its finances and rebuilds the destroyed infrastructure.

"Terrorism and the Resilience of Cities," by James Harrigan and Philippe Martin. This article provides a more abstract analysis of New York City’s prospects, looking at current theories about why cities come into being in order to assess the likelihood that terrorism could threaten the existence of a major city such as New York.

The authors suggest that forces strong enough to create cities are very difficult to overcome by terrorist actions. They draw on two accepted models to explain why cities exist: that cities "pool" labor by offering workers and firms an easy way to find each other, and that cities lower transport costs for goods shipped between producers and consumers. The authors describe the costs of terrorism as a "tax," reflecting the higher costs of insurance rates, security-related delays, and similar hardships. They conclude that the vitality of cities could withstand terrorism "tax" rates well in excess of those that are likely to occur.

Contact: Linda Ricci
(212) 720-6143