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1998-05-01 22:43:23


FED's Kelley Warns of Major Consequences of Y2K Repair Failure



Edward Kelley, Jr., is the Federal Reserve Board's spokesman for the Year 2000 Problem.

His April 28 testimony to the Committee on Commerce, Science, and Transportation is a mixture of doom and optimism: doom if the problem is not fixed; optimism that it can be fixed.

Notice that he says, "It is impossible today to forecast the impact of this event, and the range of possibilities runs from minimal to extremely serious." Then he says things won't be too bad unless we don't get this fixed. In short, things won't get bad unless they do.

Whenever you read such stuff, keep in mind the word "we." Who, exactly, are "we"? The word is the equivalent of "they," as in, "they'll get it fixed."

He tells us that corporations are spending a lot of money to fix this. I ask: Which corporations? Where? Most corporations in the U.S. are not spending vast amounts. The big ones are spending money, but where is the evidence that such expenditures have led to compliant companies? There is none. These companies got started late -- 1995 or later. A recent report by the insurance firm, Marsh & McLennan, says that only 10% of U.S. businesses are as far along as half of their remediation work. Completion of remediation gets you to the halfway point or less: testing is 40% to 70% of a y2k repair. Chase Manhattan Bank, the largest bank in the U.S., has only recently begun code remediation. And if Chase actually completes its remediation and tests the systems, and if they do not crash while testing, then the bank has 2,900 computerized links to other institutions. Any of those other computers could send noncompliant data into Chase's computers, thereby wiping out the original remediation. This is the problem of shared data, which is the heart of the Year 2000 Problem. It is a systemic problem.

What good is spending money if the problem is inherently unsolvable if the rest of the world doesn't get its y2k problems fixed? This is a systemic problem. Outside the English-speaking world, almost nothing is being done. (Think "Japanese banks.") We have no examples of successful conversions of systems with more than 10 million lines of code, except possibly Visa/MasterCard.

He openly states that the Federal Reserve's own systems are not compliant, and that if they don't get compliant, there will be a disaster. Of course, he assures us that the FED will get compliant. Real Soon Now.

He says that international bankers are aware of the problem. There is even a Joint Council. (The phrase "joint council" means "large committee without any authority.") What is missing is evidence of a single compliant bank on earth. The rest of the world is far behind the U.S., and the U.S. has yet to see a single compliant bank.

The FED is dependent on softeware vendors, he says. The FED is monitoring progress in these areas, he says. But what if whatever they monitor reveals that the vendors aren't going to make the deadline? We know the threat, as an Australian banker has admitted: a collapse of the financial services industry.

Monitoring is not the same as fixing. Awareness is not the same as compliance. A challenge is not the same as a victory. Hopes are not the same as successes. But you would not know this from the papers read to government committees by representatives of noncompliant government agencies and organizations.

Note: On May 1, the following message was posted on Peter de Jager's forum. It was from ESTERBKID (

"I attended these hearings yesterday and thought the most critical moment occured during the question and answer period following the presentation of prepared, written testimony. Unfortunately, this extemporaneous information never shows up in the press handouts nor does it ever get posted on the websites.

"At one point Senator McCain asked FRB Governor Kelly what serious issues the banking industry was facing in dealing with Y2K. The response (paraphrased, as I was not recording) was:

"We can't get any information from the telecommunications industry. They won't tell us the status of their Y2K efforts. We need this information in order to test our systems. We simply don't know what they are doing and we very much need the information."

The FED, the banks, and your pension fund are dead in the water, even if compliant (fat chance), if the phone system goes down. Will it go down? Don't ask Mr. Kelley. Senator McCain already did.

* * * * * * *

I am pleased to appear before the Committee today to discuss the Year 2000 computer systems issue and the Federal Reserve's efforts to address it. The stakes are enormous, nothing less than the preservation of a safe and sound financial system that can continue to operate in an orderly manner when the clock rolls over at midnight on New Year's Eve and the millennium arrives. . . .

The Macroeconomic Effects of the Millennium Bug.

The Year 2000 ("Y2K") problem will touch much more than just our financial system and could temporarily have adverse effects on the performance of the overall U.S. economy as well as the economies of many, or all, other nations if it is not corrected. The spectrum of possible outcomes is broad, for the truth of the matter is that this episode is unique. We have no previous experiences to give us adequate guideposts. A few economists already are suggesting that Y2K-related disruptions will induce a deep recession in the year 2000. That is probably a stretch, but I do not think that we shall escape unaffected. Some of the more frightening scenarios are not without a certain plausibility, if this challenge were being ignored. But it is not being ignored. While it is probable that preparations may in some instances prove to be inadequate or ineffective, an enormous amount of work is being done in anticipation of the rollover of the millennium. It is impossible today to forecast the impact of this event, and the range of possibilities runs from minimal to extremely serious. . . .

Corporate business is spending vast amounts of money to tackle the Y2K problem. To try to get a handle on the magnitude of these Y2K expenditures, we have reviewed the most recent 10-K reports filed with the SEC by approximately 95 percent of the firms in the Fortune 500. These are the largest businesses in our economy, with revenues of around $5-1/2 trillion annually, and are likely to be on the cutting edge of efforts to deal with the millennium bug. Before the end of the decade, these firms report that they expect to spend about $11 billion in dealing with the Y2K problem. (Of this total, financial corporations are planning expenditures of $3-1/2 billion, while companies in the nonfinancial sector have budgeted funds of around $7-1/2 billion.) . . .

The United States is not alone in working to deal with the millennium bug. Efforts by our major trading partners also are under way, although in many cases they probably are not yet at so advanced a stage as in this country. In Europe, the need to reprogram computer systems to handle the conversion to the Euro seems to have taken precedence over Y2K efforts, although there may be efficiencies in dealing with the two problems at once. The financial difficulties of Japan and other Asian economies certainly have diverted attention and resources in those countries from the Y2K problem, increasing the risk of a Y2K shock from one or more of these countries. . . .

What can monetary policy do to offset any macroeconomic effects? The truthful answer is "not much." . . . We will, of course, be ready if people want to hold more cash on New Year's Eve 1999, and we will be prepared to lend to financial institutions through the discount window under appropriate circumstances or to provide needed reserves to the banking system. But there is nothing monetary policy can do to offset the direct effects of a severe Y2K disruption. . . .

Background on Federal Reserve Year 2000 Preparations

The Federal Reserve operates several payments applications that process and settle payments and securities transactions between depository institutions in the United States. These systems are critical national utility services, moving funds much as the national power grid moves electricity. . . .

The Reserve Banks also operate check processing systems that provide check services to depository institutions and the U.S. government. . . .

Year 2000 Readiness of Internal Systems

The Federal Reserve is giving the Year 2000 its highest priority, consistent with our goal of maintaining the stability of the nation's financial markets and payments systems, preserving public confidence, and supporting reliable government operations. The Federal Reserve completed assessment of its applications in 1997; our most significant applications have been renovated; and internal testing is underway using dedicated Y2K computer systems and date-simulation tools. Changes to mission critical computer programs, as well as system and user-acceptance testing, are on schedule to be completed by year-end 1998. Further, systems supporting the delivery of critical financial services that interface with the depository institutions will be Year 2000 ready by this July and a depository institution test program will be in place at that time. This schedule will permit approximately 18 months for customer testing, to which we are dedicating considerable support resources. . . .

A significant challenge in meeting our Y2K readiness objectives is our reliance on commercial hardware and software products and services. Much of our information processing and communications infrastructure, as well as our administrative functions and other operations, is composed of hardware and software products from third-party vendors. As a result, we must coordinate with numerous vendors and manufacturers to ensure that all of our hardware, software, and services are Year 2000 ready. . . .

We are also coordinating with the international community of financial regulators to help mobilize global preparations more generally. These efforts are discussed more fully in the Addendum. In particular, through the auspices of the Bank for International Settlements, international regulators for banking, securities, and insurance along with global payments specialists recently jointly hosted a Year 2000 Round Table, which was attended by over 50 countries. A Joint Council was formed that will promote readiness and serve as a global clearing house on Year 2000 issues. In the final analysis, however, the regulatory community recognizes that it cannot solve the problem for the financial industry. Every financial institution must complete its own program and thoroughly test its applications with counterparties and customers if problems are to be avoided.

Contingency Planning. . . .

The Federal Reserve has formed a task force to address the contingency readiness of our payments applications. Although we have no grounds for anticipating that specific failures could occur and we cannot act as an operational backstop for the nation's financial industry, we view it as our responsibility to take action to ensure that we are as well positioned as possible to address major failures should they occur. We are currently focusing on contingency planning for external Y2K-related disruptions, such as those affecting utility companies, telecommunications providers, large banks, and difficulties abroad that affect U.S. markets or institutions. The Federal Reserve has established higher standards for testing institutions that serve as the backbone for the transactions that support domestic and international financial markets and whose failure could pose a systemic risk to the payments system. . . .

Our preparations for possible liquidity difficulties extend as well to the foreign bank branches and agencies in the U.S. that may be adversely affected directly by their own computer systems or through difficulties caused by the linkage and dependence on their parent bank. Such circumstances would necessitate coordination with the home country supervisor. Moreover, consistent with current policy, foreign central banks will be expected to provide liquidity support to any of their banking organizations that experience a funding shortfall. . . .

While we can't predict with any certainty, there clearly is the potential for problems to develop, but these need not be traumatic if we all do our part in preparation.


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