This volume of the Economic Policy Review, "Special issue on the economic effects of September 11," explores some of the key economic consequences of the attacks of September 11. The six articles that make up the volume address several important questions: how great were the losses in New York City on September 11 and in the difficult months thereafter? 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 minimize further damage? Will these events hurt New York's future vitality and cause businesses and workers to retreat from the city? ; The six articles fall into three broad groups: 1) detailed accountings of economic costs--those incurred as a direct consequence of the September 11 attacks and those arising from efforts to prevent future attacks, 2) studies of the attacks' disruptive effects on the payments and securities settlement systems, and 3) analyses of New York City's prospects after September 11.Disaster relief ; Terrorism ; War - Economic aspects ; Economic conditions - New York (N.Y.) ; Federal Reserve District, 2nd

Carol L. Osler

Donald P. Morgan

Erica L. Groshen

Hamid Mehran

James A. Kahn

Linda S. Goldberg

English

Research Papers in Economics

FRBNY Economic Policy Review / November 2002 1
Introduction
his special volume of the Economic Policy Review, issued 
soon after the one-year anniversary of the attacks of 
September 11, 2001, explores some of the key economic 
consequences of the attacks. The six articles that make up the 
volume address several important questions: How great were 
the losses in New York City on September 11 and in the difficult 
months thereafter? How much will the nation spend to prevent 
future attacks? Did the destruction of information and infra-
structure 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?
The authors consider these questions from their vantage 
point in the Research and Market Analysis Group of the 
Federal Reserve Bank of New York. Economists in the Group 
conduct research and policy analysis in support of the New 
York Fed’s responsibilities, which include carrying out the 
Federal Reserve System’s open market and foreign exchange 
operations, managing payments-clearing activities between 
banks, contributing to the formulation of monetary policy, and 
tracking economic conditions in New York City and the 
Second Federal Reserve District. The economists’ knowledge 
and experience in these areas inform their analysis of the 
September 11 events, as does their strong commitment to 
understand and illuminate events that took place in the Bank’s 
own Lower Manhattan neighborhood.
The articles in the volume range in subject matter—from 
the concrete effects of the attacks on the financial system 
infrastructure to more abstract issues such as the viability of 
cities in the face of terrorism. But while the articles touch on a 
wide variety of topics, all employ the language and the 
viewpoint of economics. Thus, the authors follow the 
conventions of their discipline when they use forgone earnings 
to measure the “cost” of lives lost in the attack on the World 
Trade Center. Certainly, these losses should not be omitted 
from accountings, and forgone earnings is the best measure 
available for this purpose. However, the authors and editors 
recognize very clearly that the true cost of September 11—the 
grief, terror, and general loss of well-being—is beyond any 
calculus.
Overview
The six articles in the volume fall into three broad groups: 
1) detailed accountings of economic costs—those incurred as 
a direct consequence of the September 11 attacks and those 
arising from efforts to prevent future attacks, 2) studies of the 
attacks’ disruptive effects on the payments and securities 
settlement systems, and 3) analyses of New York City’s 
prospects after September 11.
Cost Accountings
Jason Bram, James Orr, and Carol Rapaport begin the volume 
by analyzing the costs of the attack on New York City. Their 
account is indeed sobering. New York lost an estimated 
$7.8 billion in prospective earnings from those who died in 
the attack and $3.6 billion to $6.4 billion in job earnings from 
workers displaced afterward. These losses are distinct from the 
concurrent income losses attributable to the national recession 
and are spread across both high- and low-wage industries. 
Property losses—including the destruction of real estate, 
subway lines, and communications equipment—and the 
costs of cleanup and site restoration are expected to reach 
T2I n t r o d u c t i o n
$21.6 billion. Adding up the earnings losses, destruction of 
property, and cleanup costs, the authors calculate the direct 
damage from the attack on the World Trade Center to be 
between $33 billion and $36 billion. The additional 
productivity losses from psychological stress are harder to 
estimate, but quite real—as reflected in several surveys of city 
residents’ experiences. Although insurance payments and 
federal aid have helped markedly to mitigate the attack’s 
financial impact on New York City residents and businesses, 
these financial transfers do not lessen the more personal and 
psychological effects of the destruction.
The authors are careful to note that their cost estimates 
reflect the information available as of June 2002, the end of the 
recovery process at the World Trade Center site; the actual 
magnitude of the costs will become much clearer over time. 
There are, however, some signs that the brunt of these costs has 
already been borne: the Trade Center site has been cleaned up 
ahead of schedule, employment levels appear to have bottomed 
out, and housing market indicators remain surprisingly 
buoyant.
Focusing on the national effects of the attack, Bart Hobijn 
assesses how much the country might spend to prevent more 
such incidents. The federal government plans to spend 
$38 billion in 2003 on border security, protection against 
biological threats, emergency preparedness, and various other 
homeland security measures. State and local governments are 
expected to spend about $1.3 billion on security next year. 
Although a public expenditure of $39 billion is large in absolute 
terms, it is small relative to the $10 trillion expected output of 
the U.S. economy next year. Private-sector spending on 
counterterrorism is harder to gauge. Adopting the assumption 
that firms will double the amount they have spent in recent 
years on “protective services” (security guards, surveillance 
equipment, and so forth), Hobijn estimates that private 
security spending next year will reach about $33 billion. Thus, 
the author’s total figure for the direct costs of homeland security 
spending for fiscal year 2003—private and public—is about 
$72 billion.
The effort to protect the nation from further attacks also 
entails indirect costs—including the inconvenience and delays 
experienced by the public as heightened security measures are 
put into place. Hobijn focuses on the costs associated with 
increased waiting times at airports. Drawing on a variety of 
sources, he estimates that about $12 billion will be lost this year 
in production and leisure time because passengers are waiting 
longer to pass through security checkpoints at airports.
Signficantly, Hobijn does not try to evaluate the efficacy of 
the $72 billion expenditure in securing the country against 
further attacks. A complete accounting of the economic costs 
of the attacks—one combining the $33 billion to $36 billion 
estimate advanced by Bram, Orr, and Rapaport for New York 
City and the costs associated with the Pentagon attack and the 
Pennsylvania crash—can only suggest the size of the loss that 
the country is seeking to prevent. A proper evaluation of the 
$72 billion expenditure would require an assessment of its 
impact on the likelihood of future attacks and on intangibles 
such as peace of mind—a very different, and difficult, question.
The Impact on the Payments and Securities 
Settlement Systems
The World Trade Center was not only an important symbol of 
business and finance, it was also a key location for those 
activities. The attack claimed lives, destroyed physical capital, 
and disrupted the information flows that facilitate transactions 
in financial markets. How well did the U.S. financial system 
withstand the blow? In particular, how did the various 
payments mechanisms—that is, the facilities used to transfer 
large amounts of money and financial instruments among 
institutions—perform on September 11 and the days that 
followed? And how did important market participants and 
policy institutions, including the Federal Reserve and the 
Treasury Department, respond?
Two articles in the volume examine the problems that arose 
in the payments and securities settlement systems in the wake 
of the September 11 attacks. The first studies the prolonged 
failure of brokers, dealers, and investors to deliver on Treasury 
security trades, and the second examines the disruption to 
Fedwire, the electronic network that processes large payments 
among financial institutions. The articles describe the technical 
exigencies and market conditions that led the Federal Reserve 
to inject vast amounts of liquidity into the banking system and 
to relax normal limits on securities lending. 
Michael Fleming and Kenneth Garbade set the stage for their 
study of Treasury market functioning with a review of the 
market’s normal settlement procedures. They then describe 
how the events of September 11 led to a huge and prolonged 
increase in settlement “fails” as sellers of Treasury securities did 
not meet their commitments to deliver securities on the dates 
scheduled. During the week ending September 19, daily 
average fails increased to $190 billion, a sharp rise from the 
$7.3 billion daily average observed during the first eight 
months of 2001. The increased fails can be traced to the 
technical problems created by the massive physical destruction 
in Lower Manhattan: several brokers and dealers could not 
operate, a clearing bank for dealers had to close its downtown 
offices, telephone lines were severed, and trading records were FRBNY Economic Policy Review / November 2002 3
lost. The Federal Reserve responded by relaxing its limits on 
securities lending, thereby making Treasury collateral more 
readily available. This action, together with restored 
communications, made the situation less acute, but fails 
persisted at higher than usual rates into October.
How did severe, but relatively short-lived, technical 
problems cause an extended disruption? Fleming and Garbade 
explain that “specials” rates—the rates that investors earn 
when they lend cash to borrow the particular securities they 
need to settle earlier trades—were near zero for several actively 
traded securities. The low specials rates gave investors little 
incentive to borrow securities to avert or remedy fails. The 
authors attribute the low specials rates in the weeks after the 
attack to a low federal funds rate and to concern among owners 
of securities that lent securities might not be promptly 
returned. Ultimately, worries that chronic fails were 
undermining market functioning led the Treasury to reopen its 
ten-year note. The additional supply raised the note’s specials 
rate and increased investors’ incentives to settle their trades. 
Fleming and Garbade 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.
James McAndrews and Simon Potter investigate the problems 
affecting Fedwire, a backbone of the U.S. payments systems. 
Payments fell off sharply after the attacks: 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. The immediate problem was logistical: 
some banks were unable to send payments because of the 
destruction caused by the attacks. Because banks routinely use 
anticipated receipts to fund their own payments, many banks 
expecting payments found themselves unexpectedly short of 
liquidity. As a consequence, these banks were less likely to send 
payments to other banks in the normal pattern.
As the coordination of payments broke down, upsetting the 
distribution of balances across the banking system, banks 
sharply increased their precautionary demand for liquidity. 
McAndrews and Potter track this phenomenon by estimating 
banks’ payments responses to the receipt of payments from 
other banks. The authors’ analysis shows 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 Federal Reserve responded to the payments disruption 
by supplying extraordinary amounts of liquidity to the banking 
system: it loaned billions of dollars through the discount 
window (more than two hundred times the daily average 
amount of lending in the prior month), temporarily suspended 
penalties for bank overdrafts, and bought securities on the 
open market. In addition, Federal Reserve staff contacted the 
banks to assure officials of the availability of discount loans and 
to encourage them to make payments as usual. These actions by 
the central bank, McAndrews and Potter argue, helped 
reestablish payments coordination.
The authors identify the discount window as a particularly 
valuable tool in restoring coordination after September 11. The 
effectiveness of discount window loans calls into question the 
view espoused by some that open market operations alone can 
meet the liquidity needs of banks in extreme circumstances. 
The authors also discuss longer run payments system 
reforms—including infrastructure changes and changes in the 
protocols for submitting and settling payments—that might 
preserve coordination in the event of future disruptions.
Prospects for New York City: 
Can the Center Hold?
The September 11 attack was a severe blow to New York City. 
Could this event jeopardize the standing of the city as a leading 
financial capital? Will the trends toward higher income and 
improved quality of life in the city be halted or reversed by the 
attacks? Interestingly, the two articles that assess the city’s 
longer term prospects reach similarly optimistic conclusions, 
despite very different approaches. One examines the economic 
trends that have helped New York City to prosper in recent 
decades and considers whether the attack will force the city off 
its course. The authors’ findings indicate that New York’s mix 
of industries should continue to serve the city well over the near 
horizon. The second article looks at current theories about why 
cities come into being, in order to assess the likelihood that 
terrorism could threaten the existence of New York. Here, the 
analysis suggests that forces strong enough to create cities are 
very difficult to overcome by terrorist actions.
Jason Bram, Andrew Haughwout, and James Orr use data on 
rents, wages, and labor shares to argue that the economic 
prospects for New York City at the time of the attack, even with 
the incipient recession, were favorable. Over a period of 
twenty-five years, New York City has enjoyed stable 
employment, rising real earnings, and appreciating land prices. 
Earnings in the city have advanced at a rate well above rates in 
the rest of the country, owing to accelerating productivity in 
the city’s existing jobs and expanding employment in the high-
paying services sectors—most notably finance. The high rents 
in New York, though lamented by residents, offer a clear 
indication that people are willing to pay a premium to live in 4I n t r o d u c t i o n
the city. Together, these patterns are consistent with a model of 
New York as an attractive, mature city in an open, competitive 
environment.
Looking forward, the authors tie the city’s future to the 
supply of amenities such as safety, the arts, and municipal 
services, and to the demand for the goods and services 
produced in New York City. The authors find that trends in 
these areas have been encouraging in recent decades. With 
respect to amenities, crime rates have fallen rapidly, and the 
city government has strengthened New York’s fiscal position, 
lowered property taxes, and improved public transit. Whether 
the fiscal strains from the attack will reverse these gains, the 
authors argue, will depend on how the city manages its finances 
and how it rebuilds the destroyed infrastructure.
As to the demand for its goods and services, New York City 
has a high concentration of some of the nation’s fastest-
growing industries, suggesting that the city’s specialties tend 
to be in high demand. Moreover, national employment 
projections indicate that over the next decade, most of the city’s 
key industries should fare better than average in generating jobs.
Seen in this context, the terrorist attack would be most 
damaging if it upset either the amenities available to city 
residents and businesses, or the demand for New York’s 
products and services. Preventing such outcomes, the authors 
suggest, is the challenge now facing the city. New York’s policy-
makers will need to close a substantial city budget gap without 
letting crime rise or municipal services deteriorate significantly, 
and without pricing New York’s products and services out of 
the market. Judicious policy choices, along with the support of 
federal aid, will be key to New York’s economic growth.
James Harrigan and Philippe Martin provide a more abstract 
analysis of New York City’s prospects. They assess the viability 
of cities, and New York in particular, in the face of catastrophes 
such as terrorist attacks by considering why cities exist in the 
first place. The authors draw on two models, or theoretical 
explanations, for the existence of cities. The first centers on the 
idea that cities “pool” labor (that is, offer workers and firms an 
easy way to find each other); the second is based on the notion 
that cities lower transport costs (for goods shipped between 
producers and consumers). These rationales for the existence 
of cities are called agglomeration forces. In both models, the 
stable outcome—a city in equilibrium—is very stable indeed, 
because the agglomeration forces that create the city also tend 
to preserve it.
Using these models, Harrigan and Martin ask whether 
terrorism could overcome a city’s agglomeration forces, 
causing firms and workers to scatter and the city to decline. 
They describe terrorism and the threat of terrorism as a special 
type of “tax” on a city’s firms or residents, reflecting the costs 
of such hardships as higher insurance rates and security-related 
delays. This new tax detracts from firms’ profits or workers’ 
income without funding improvements in infrastructure or 
services, as a normal tax might.
The authors’ simulations of the two models, conducted with 
data that approximate the characteristics of a large U.S. city, 
suggest that the vitality of cities could withstand terrorism 
“tax” rates well in excess of those that are likely to occur. Given 
the magnitude of the economic benefits that major cities 
generate, New York and its counterparts elsewhere should be 
remarkably robust in the event of subsequent terrorist attacks.
Concluding Remarks
The authors and editors hope that this volume will contribute 
to a fuller understanding of the September 11 events and their 
aftermath. In calculating the costs of the New York attack and 
those of protecting the nation from further assaults, the volume 
provides a measure of the injury sustained by the United States. 
But while these cost estimates may in some sense speak to the 
country’s vulnerability, many of the volume’s findings 
underscore the strong performance of our markets and 
institutions—both national and local—in a time of crisis. 
Economic data presented here show that New York City’s 
prospects for growth remain favorable, while the economic 
theory outlined in the collection’s final article upholds the 
resilience of all cities in the face of great shocks. The articles 
detailing events in the Treasury market and the nation’s 
payments system tell a similar story of recovery, affirming the 
flexibility of U.S. financial and regulatory institutions and the 
resourcefulness of the individuals within them.
Erica L. Groshen, Linda S. Goldberg, James A. Kahn, 
Hamid Mehran, Donald P. Morgan, and Carol L. Osler

Introduction

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