In the weeks following the spectacular collapse of US investment bank Lehman Brothers, Reserve Bank of Australia officials were often woken from their sleep and forced to make big calls about spending millions to oil the wheels of paralysed currency markets.
“My main memory of that time is that I didn’t sleep for two months”, recalls RBA deputy governor Guy Debelle, who in 2008 was responsible for running the central bank’s financial market operations.
At the time, most assumed the RBA’s intervention in foreign currency markets was aimed at putting the brakes on the Australian dollar’s precipitous decline. Ten years on, Debelle reveals this was not the case. Instead, the RBA wanted to narrow the yawning gap between the cost of buying and selling Australian dollars.
The tumbling Australian dollar “was good, we wanted the exchange rate to go down. It was just there was no liquidity in the market”, he says. “It wasn’t that people were shorting the currency and trying to drive it down. It was just that no one was wanting to make a market on any side, and do any risk intermediation, and so we did.”
But this meant that Debelle was on 24-hour call. Before he went to bed at night, he checked he had his Blackberry close by. A call could come at any time, either because the RBA was rolling up its sleeves to intervene in foreign currency markets, or because some new disturbance – a major hedge fund liquidating its position, for instance – had triggered wild market swings.
“Most of the time, the intervention was happening in London time, not our time. Plus I was on the phone to my counterparts around the world,” he recalls. “Most of the intervention was done here at 3 in the morning.”
Before he left of an evening, Debelle would agree when, and to what extent, the RBA would intervene in foreign currency markets. Once the RBA dealers decided to start buying Australian dollars, he says, “they rang me up and I’d be on the phone while it was happening … then we’d work out what to do next.”
If Debelle formed the view that the RBA needed more firepower, he would call RBA governor Glenn Stevens and deputy governor Ric Battellino, and rouse them from their slumbers.
“There was some point at which I had to ring Glenn and Ric and wake them up if I needed more, or thought I needed more,” Debelle recalls.
In the nocturnal discussions he held with senior central bank officials around the world, Debelle had a huge advantage.
The RBA has always sent its best and brightest to further their studies at leading international universities. Like RBA governor Philip Lowe, Debelle holds a PhD from the Massachusetts Institute of Technology (MIT) which has turned out a disproportionate number of the world’s top economists.
In the depths of the financial crisis, the benefits of the RBA’s policy became fully apparent. Not only did their staff receive an excellent theoretical training, they also forged deep – and extremely useful – personal relationships with their peers in other major global central banks.
“Knowing people helps,” Debelle agrees. “You’re not just some random Australian calling them up out of the blue. So the training helped in that respect. They knew who I was. I knew who they were too.”
During his time at MIT, Debelle was given the honour of being appointed to the position of teacher’s assistant by two of the world’s most venerated macro-economists, Stanley Fisher (who went on to become vice-chairman of the US Federal Reserve) and Rudi Dornbusch.
His academic pedigree gave Debelle automatic access to the intellectually arrogant elite of central banking. Indeed, in 2009, one of Debelle’s former MIT pupils, Brian Sack, took charge of the New York Fed’s extremely important market operations.
Debelle had also forged close personal ties with other top-ranking central bankers. “Paul Fisher, who was then head of markets at the Bank of England was, and still is, a close friend of mine,” he recalls. “I used to talk to Paul a lot. He would tell me what was going on in London markets, which was a reasonably important part of the deal.”
These connections were to prove critical when global markets went into a tailspin after the Lehman collapse. Adding to the sense of crisis, the giant US insurer AIG was teetering on the brink.
His standing in the close-knit central banking circle meant Debelle was able to grill his foreign counterparts on what was happening in offshore markets, how this would be likely to spill over into our market, and what steps – if any – governments were taking to restore rattled investor confidence.
It was a time of extraordinary disarray in global markets. “They were somewhat dysfunctional pre-Lehmans, but they were more dysfunctional post. AIG was in deep trouble … That week and through into the first part of October were the darkest times.”
The panic reached a crescendo on Friday, October 10, just days before the Rudd government decided to guarantee all wholesale borrowings of Australian banks as well as all retail bank deposits. At that point, Debelle says, “global markets ground to a halt. Including US Treasuries – the most liquid market in the world.”
But the RBA wasn’t simply relying on those running its market operations for information on what was happening in global markets.
Even before the financial crisis, senior RBA officials had regularly made a pilgrimage to Basel every two months, where the august Bank of International Settlements (known as the central bank’s central bank) had its headquarters.
Because of the esteem with which senior RBA officials are held, Australia’s central bank was included in the exclusive group cobbled together by the BIS – and which also included the US Federal Reserve, the Bank of England, the European Central Bank, the Bank of Canada and central banks from Germany, France, Sweden, Hong Kong and Singapore – to discuss the financial maelstrom.
As Debelle recalls, “we had conference calls organised through the BIS on a pretty regular basis. And plus we’d meet in Basel every two months, except at various stages through that period we got bonus trips to Basel.”
Glenn Stevens, who was then RBA governor, has a similar recollection.
“The BIS and Basel is where the central bank governors see each other regularly and get to know each other quite well. And that was very helpful because I think central bank co-operation, when needed, was very good and very quickly put in place.”
One example was the US central bank’s decision to supply the RBA with $US30 billion to meet the huge demand for the US currency in the region.
Stevens explains how this US dollar swap worked. “You would place in their account some of our currency, and they would put some of theirs in yours,” he says. “Then the local central bank would take local currency collateral to loan the US dollars out to their banks. So the central bank would have to manage the quality of that collateral and its exchange rate risk.
“And all the Fed was doing was taking US dollar exposure on another central bank, which is a very safe thing for them to do. Those mechanisms were quite effective.”
Stevens adds, “the fact that we knew our counterparts in the Fed very well meant we could talk to them about our problem. That was all sorted out quite quickly.”
Debelle recalls that the Fed’s swap line was important because of the disturbing pattern that had emerged.
“At the end of the US trading day, so 4pm New York time, there were more than enough US dollars going around. And then within an hour – so you’re now in the beginning of the Asian trading day – there was an absolute squeeze. You couldn’t find them anywhere.”
He adds that “some of the people who had been big providers of US dollars into this time zone before just pulled right back – global banks, very large asset managers – just didn’t lend as much as they had been previously.
“So there was just a lot less around in our time zone, and it got progressively worse over the Asian day. It got worse into London. And then New York would open and it would start to back off.”
He said the move by central banks to set up swap lines with the Fed “were as much about distribution. People weren’t willing to lend US dollars directly to these counterparties. Effectively, the central banks stepped in and intermediated. So we could distribute them to the people who needed them.”
Debelle points out that the Australian banks were able to earn a handy profit from their access to US dollars that the RBA provided. “Our banking system didn’t actually have any particular need for it [the US dollars].
“But they could borrow from us … [at a certain rate] and then they could on-lend to someone else at a higher rate.”
But while the RBA’s markets people were in constant contact with their counterparts in other major central banks, senior RBA officials were acutely aware that other global central banks were grappling with far graver problems.
According to Stevens, the RBA took the view that “our system – provided it could get some access to capital markets and provided we could manage the liquidity – there wasn’t really a question of solvency of any of our major institutions”.
This, he says, was in stark contrast to the problems of other central banks which were grappling with what to do with major institutions teetering on the brink of bankruptcy.
“In that sense, the nature of our problems were not as severe as the problems of some other jurisdictions where there was actually a question of capital adequacy and solvency, and not just in the banks.”
Those foreign bankers in the trenches battling to shore up their tottering financial institutions had little time to spare.
So while Stevens saw his counterparts, including Ben Bernanke, Mervyn King and Jean-Claude Trichet [who were then the heads of the US Federal Reserve, the Bank of England and the European Central Bank respectively] at the regular BIS meetings, where there were “very intense discussions”, there were not regular crisis calls.
“Our interest mainly was in them sorting their own problems out”, Stevens recalls. “For the most part, we were addressing spillover effects that arose as a result of the international things. Mostly we felt we could work out what to do in response.”
The issues confronting Australia’s banking system, he adds, “were not problems that we needed the Bank of England, the Fed or the ECB to help us solve”, Stevens says.
What’s more, he notes drily, “it’s not as though we’d hit on some genius solution for them, that we were anxious to ring them up and tell them”.
Instead, the RBA’s senior executives adopted the view that “they’ve got smart people. They know better than we could how to negotiate their way through their own complexities.”