Masters of financial universe manage to avert crash

When the American Airlines and United Airlines planes exploded into the towers of the World Trade Centre on Tuesday last week, the most important manager of the global economy was on a Washington-bound flight from Switzerland. As the plane was ordered back to Zurich, the chairman of the US Federal Reserve, Mr Alan Greenspan found the in-flight telephone had gone dead. It was not until he was in the terminal that he learned of the catastrophe which was to bring the world to the brink of financial chaos.

Mr Greenspan was immediately flown back to the United States on a US military air tanker and was at his desk by Wednesday afternoon.

US Treasury Secretary Mr Paul O'Neill was watching CNN in a Tokyo hotel room when the first news flash came. He was put on a military cargo plane with canvas jump seats that refuelled in mid-air so he too could be at his desk by Wednesday evening.

By then the implications of the attack were beginning to dawn on the Bush Administration. Not only the financial district of New York, but the world money markets had been crippled. This was a crisis of war-time proportions which threatened the global economy.

Contingency planning modelled on the Y2K crisis and the market meltdown in 1987 was put into effect. An emergency response team was set up involving the Fed, the Treasury and the securities and commodities commissions and it began meeting two or three times each day.

In Mr Greenspan's absence, Federal Reserve vice-chairman Mr Roger Ferguson had conferred with regional Fed presidents, and made a critical announcement. "The Federal Reserve system is open and operating," he stated. "The discount window is available to meet discount needs." The discount window is a seldom used source of cash for banks, as the markets offer more attractive rates, and borrowing from the Fed is seen as a sign of weakness. Bank borrowing from the discount window was running at about $200 million (€217 million). It zoomed upwards to $45.6 billion.

At the same time, with many major finance houses and their systems buried in rubble, bankers and investment brokers began calling urgently on the Fed's routine overnight loan operation to raise essential funds. This is normal procedure, amounting to a few billion dollars a day.

These were not normal times. On Wednesday the Fed, anxious to keep credit flowing to brokerage houses that were unable to raise cash because of the catastrophe, lent $38.25 billion, twice the previous record. By Friday this had exploded to $81.25 billion.

Meanwhile a potential crisis was looming in international finance. European banks were encountering problems trading in the New York money markets. They needed dollars. On Thursday, the Fed arranged an emergency deal with the European Central Bank to exchange $50 billion for euros, and came to a similar arrangement with the Bank of England to swop $30 billion for sterling.

The next thing the policy makers had to worry about was the performance of the markets when the New York Stock Exchange and the Nasdaq reopened on Monday. At 7.30 a.m. on Monday, two hours before the opening bell, the Fed met in emergency session in Washington, joined on the telephone by regional presidents. After two minutes' silence and 20 minutes' discussion they agreed to slash short-term interest rates by half a percentage point down to 3 per cent, the lowest in seven years.

It was an easy call. With the weakness in business spending, unemployment and production before the attack, central bank presidents in Richmond, Chicago, Minneapolis, Dallas and San Francisco, had already been appealing for another cut.

Mr Greenspan then broke with practice and informed the European Central Bank before the cut. The Europeans, British and Canadians quickly cut rates in unison. So far so good. The markets didn't crash. As the Wall Street Journal pointed out, the 6.84 per cent fall on Monday didn't even make the top 10 worst days in percentage terms.

Now comes the really hard part, preventing the global economy slipping into recession. The collateral damage of the attack is being felt in the air and shipping lanes of the world. Americans don't want to fly any more, not just because of the risk but the frustrating security delays. And people overseas will think twice before coming to America in the present climate. A collapse in air travel could have a severe impact on the US economy. The airlines and related businesses, from plane-making to catering, account for 10 per cent of the US gross domestic product.

As it is, the airline sector was already struggling. It lost a billion dollars from January to June, as business travel declined steeply. The shutdown last week cost up to $3 billion more. The action has switched therefore to the White House where some hard-headed decisions have to be made by conservative Republicans, who came to office intent on cutting federal spending. They are now faced with the prospect of having to bail out the US flagship airlines or let them go under. President Bush is under pressure to sign off this week on a federal subvention of more than $20 billion.

The disruption in US air travel and air freight threatens a slowdown in world trade and in production in countries as far away as the Pacific Rim. The flow of goods to the US has been reduced to a crawl in the last week and is slow in picking up. Hundreds of tons of air cargo are backed up in airports from Europe to the Pacific Rim.

Increased security at border crossings has also clogged road traffic from Mexico and Canada.

Meanwhile, some sectors have gained from the crisis. An increase in defence industry stocks was to be expected when markets re-opened, given the prospect of increased military spending. Helicopter and small-plane manufacturers are probably a good buy as people turn away from big airliners.

In the early days of the crisis, some businesses did very well. According to Wal-Mart stores, Americans rushed to buy guns, ammunition, petrol containers, bottled water - and American flags, the biggest seller of all.