September 11: National Scar, Market Blip
Sept. 11, 2001 was a one-of-a-kind moment for the nation's psyche. The terrorist attacks caused the death of almost 3,000 people, rained down fear and grief on countless others, and launched the nation into two wars.
But was that day similarly devastating for the financial world?
At first glance, it seems the answer is yes. On Sept. 17, 2001 — the emotional day the New York Stock Exchangereopened amid soldiers, police, and Wall Streeters wearing air masks on the smoky streets—the Dow Jones Industrial Averagelost 684 points, the largest single-day point loss on record.
Yet with a decade of hindsight, 9/11 can be seen as but one of a half-dozen financial dominoes to befall the U.S. economy in a long boom and bust cycle—from the 1998 collapse of the hedge fund Long Term Capital Management to the demise of Lehman Brothers amid the 2008 financial crisisto more recent events, such as as the downgrade of the U.S. credit rating and the European sovereign debt crisis.
"Nine-eleven was a shock, that we were in a new world, where America was no longer as safe as it was," says William Silber, a professor and historian at NYU’s Stern School of Business.
In that way, for a short time, the attacks and the fear and uncertainty they spawned were a classic case or perception versus reality. The situation looked worse than it was.
Events like 9/11 create ”sudden substantial revisions in expectations about future economic and financial variables,” Christopher J. Neely concludes in his 2004 study, “The Federal Reserve Responds to Crises: September 11th Was Not the First,” published in the Federal Reserve Bank of St Louis’ Review. ”A fall in stock price can also affect the real economy through its influence on the credit-worthiness of firms.”
And while 9/11, like other financial episodes of recent years, is symptomatic of the age of leverage on Wall Street, it differs in one key way: It is a classic example of the external shock, like Pearl Harbor or the 1973-74 oil embargo; not a self-inflicted wound, such as the subprime crisis, or a cyclical downturn, such as the 2001 and 2008 recessions , that also mark the timeline.
“The difference is whether the shock has a temporary liquidity impact versus an underlying credit impact. Nine-eleven didn’t necessarily go to the underlying credit-worthiness of the institutions,” says Silber, who chronicled the monetary crisis surrounding WWI in "The Day Washington Shut Down Wall Street." Adds Silber, “It goes to [show] how easily the central bank can counteract and can stabilize the system.”
The Domino Economy
Thanks largely to leverage, the last dozen years have been a timeline of boom and bust, of a financial services-dominated economy out of control and a central bank compounding the problem with cheap money and other instruments of interventionist monetary policy.
"It sounds a whole lot like the economy during and after the Civil War — one step forward and two steps back," says professor and author Charles Geisst of Manhattan College in New York City.
Silber compares the modern period to the stock market crash of 1929 and the 1930s. "There was not just one event, but a series of events," he says.
Think about the financial dominoes of the past decade: LTCM, the tech bubble, the 2001 recession, the subprime mess, the housing bubble, the Great Recession, the bailout packages of AIG, Citigroup and Bank of America, the bankruptcy of Lehman Brothers, the takeover of Fannie Mae and Freddie Mac. Ten years later, the 9-11 financial shock pales in comparison.
The 9/11 wound, though deep, was easily treatable. The Fed cut interest rates and added tens of billions of dollars in liquidity to the banking system.
"The Federal Reserve sought to restore confidence and avoid significant disruption to the payments and financial system," writes Neely.
Stocks plunged the day the markets reopened on Sept. 17, bottoming out with a 11-percent loss five trading days later. Yet by Oct. 11, the S&P 500— as well as NYSE trading volume — were essentially back to pre-attack levels.
"The Fed was brilliant,” says Silber. “The Fed could open the liquidity flood gates and solve the temporary problem."
With the payments system intact and functioning, the U.S. economy — which, unbeknownst to Wall Street and Washington, had been in recession since March 2001 — survived the stock market rout, much as it had during the Long Term Capital Management crisis of 1998.
LTCM went from near collapse to rescue following massive losses related to the Russian debt crisis; the S&P 500 fell 19.4 percent in a two-month period between Aug. 7 and Oct. 4, only to recover and rally on.
In their own ways, LTCM and 9/11 were singular events, and largely uncontagious.
Future dominoes would be very contagious and dangerous, with systemic ramifications.
Such was the case with the period bookended by the Bear Stearns and Lehman Brothers implosions, from February 2008 through March 2009 — as the mortgage meltdown caught up with the broader economy.
As Neely notes in his 9/11 study, "a fall in stock prices can also affect the real economy through its influence on the credit-worthiness of firms.”
From the time the Fed first acknowledged the problem by cutting interest rates in mid-August 2007 to the JP Morgan Chasebuyout of Bear in March 2008, the S&P lost 12 percent.
The second leg of the slide from the summer through the late fall of 2008—as creditworthiness and solvency concerns undermined Fannie Mae, Freddie Mac, AIG, Citigroup, Bank of America, Wachovia and Lehman—the S&P went from 1240 to 900.
A week after the Citi rescue, the National Bureau of Economic Research made the official declaration that the economy hadentered into recession almost a year before.
The Age of Leverage
Little of this — except for the Fed's intervention — sounds like the 9/11 period, but the undercurrent is the same: leverage and risk, which had been growing for years.
"The examples demonstrate that 'living on the edge' is the norm on Wall Street," says Ram Bhagavatula, a Wall Street veteran, who is now managing director at the hedge fund Combinatorics Capital. "Did the Fed’s 9/11 response influence people in the financial crisis 2008? Absolutely. Every time the government rescues an institution or its principal stakeholders, the markets learn and assume that the insurance will be there. People choose to take advantage of the one-sided risk reward equation."
In the case of 9/11, risk had already taken a backseat to capital preservation, with the puncture of the tech bubble and the arrival of the bear market in a one-two-punch fashion in March, 2001.
In retrospect, 9/11 was a big event in something even bigger—and more powerful. What's more, it was certainly not the best of times, as was the case with LTCM, when many were still celebrating Nasdaq 2000, and the economy was on the way to its longest peace-time expansion in history.
As external shocks go, 9/11 looks to have had a bigger market impact that Pearl Harbor, when the Dow fell 6.3 percent in two days.
Though the two events are generally analogous — acts of war, the high death toll, the tremendous physical destruction — 9/11 is a national scar but a market blip.
“It's hard to see it having much of a lasting impact on Wall Street directly,” says Dean Baker, co-director of the Center for Economic And Policy Analysis. “In many ways it probably had more impact on the rest of the country in terms of the [government's] response. It's hard to see how the sequence of events on Wall Street over the last 15 years would have been very different without the attacks."