A chronicle of repurchase agreements (RP) and other paradoxical property ownership contracts - www.omo.co.nz


Letter #1 sent 2/7/02      

Office of Hon Dr Michael Cullen
Minister of Finance
Parliament Buildings


Dear Minister,

Ref : http://www.rbnz.govt.nz/statistics/govfin/D3/download.html

I am assured by those charged with the responsibility of acting on the Crown's behalf that the repo lending statistics detailed in the attached RBNZ OMO spreadsheet URL reflects the lending of surplus cash to finance broker/dealer positions in the New Zealand Government Bond Market.

The sum lent over the three years since the Contact Energy sale represents a daily average of near $1.5 billion. This compares to a current figure close to $2.0bn. Since we are in a positive yield curve environment this daily sum represents a substantial subsidy to the professional purchasers of Government debt at the expense of the taxpayer.   

One can only assume, since the requirements to become a repo counterparty with the RBNZ are beyond most New Zealand owned financial institutions, this astronomical (by international per capita standards*), ongoing subsidy is benefiting an offshore entity and adding to our Current Account Deficit.

Can you justify why I as an ordinary taxpaying citizen should be bound to redeem current issue Government Stock yields in the range of 6.0 - 6.5% when others (presumably non New Zealanders) can finance that same position to the tune of $2.0bn with Crown cash at the current repo rate near 5.50%.

* The Federal Reserve Bank of New York has outstanding term repo's of 25bn on average at the moment (US Pop. 280 mn)

Yours faithfully


Stephen L Hulme


Letter #2 sent 7/7/02

Office of Hon Dr Michael Cullen
Minister of Finance
Parliament Buildings


Dear Minister

You have failed to reply (see attached letter above) to justify why we as taxpaying citizens should subsidise the banks that create credit to finance the Government's social objectives, supposedly on our behalf, in an extremely inflationary manner i.e. "Printing Money" (see same named article below outlining the exact procedure in the US - courtesy of The Monetary Letter. By saying this I mean that inflation is a monetary phenomenon. On 05 September 1997, in a speech at Stanford University Alan Greenspan made the following points:

"Increasingly since 1982 we have been setting the funds rate directly in response to a wide variety of factors and forecasts. We recognize that, in fixing the short-term rate, we lose much of the information on the balance of money supply and demand that changing market rates afford, but for the moment we see no alternative. In the current state of our knowledge, money demand has become too difficult to predict."

"Nonetheless, we recognize that inflation is fundamentally a monetary phenomenon, and ultimately determined by the growth of the stock of money, not by nominal or real interest rates. In current circumstances, however, determining which financial data should be aggregated to provide an appropriate empirical proxy for the money stock that tracks income and spending represents a severe challenge for monetary analysts."

All the recent twaddle in the press concerning the RBNZ using too tight a definition of CPI to regulate interest rates is totally insignificant, when the government of the day employs the RBNZ through a contractual arrangement with the Debt Management Office to enter the market via its daily OMO to monetise authorised private financial credit created when the same banking institutions purchase New Zealand Government Stock.

These banking entities only have to retain a maximum of 4% capital adjusted by the 10% credit weighting for tier 1 capital and as much 8% adjusted by 10% for tier 2 capital to raise an international short term forward sale money market liabilty on their balance sheet to purchase Government Stock at tender from the Debt Management Office via the RBNZ on behalf of the Government (taxpayer). In return the RBNZ will supply the same institutions the full amount in cash for a marked to market amount of bonds using reverse term repos conducted on a daily basis for a total current rolling amount near $2.5bn.

So for as little as $8mn or as much as $16mn initial capital requirements the banks can relend the 2.5bn subject to the risk and limitations of repo rollover failure and the capital requirements adjusted for the credit risk factor for the new asset created as determined by the BIS. In the case of private property mortgages there is a 50% weighting compared the 10% risk weighting for government stock - see this URL for NZ rules applied by the NZRB.

No matter how you look at it this process it is what is known as 'Printing Money' and we (the taxpayer) have to pay a margin to affect the transaction .ie. usually the positive carry difference between the repo rate and the accrued bond coupon rate, and then the marked up mortgage rate.

And of course someone's mortgage becomes the seller's deposit and so the process proceeds. Credit creation chases asset inflation not deflation via the multiplication of bank deposits usually at the expense of productive commercial assets that attract a 100% risk weighting on the bank's balance sheets.

Is it necessary to distort the relative level of general prices in our society using such financial engineering techniques for short term gain?    


PRINTING MONEY: Speculating on the Possibilities for Funding and Financing High Priority Interests

I'm certain many traders and investors have heard someone either say or write of a circumstance that normally involves either the Federal Reserve or the Treasury, "They're printing money again."

The statutory definition of printing money is the sale of U.S. debt obligations by the Treasury to the Federal Reserve, an act disallowed by U.S. law. I'm aware it's not what is normally intended by printing money, though it is the correct definition.

U.S. Code: Title 12, Section 355 -- Every Federal Reserve bank shall ... (1) ... Notwithstanding any other provision of this chapter, any bonds, notes, or other obligations which are direct obligations of the United States or which are fully guaranteed by the United States as to principal and interest may be bought and sold without regard to maturities but only in the open market.

The Federal Reserve does indeed purchase U.S. debt paper directly from the Treasury, not in the primary auction, but in a concurrent refunding where the Federal Reserve only replaces the maturing issues in its account; which is, therefor, not an act of printing money.

The law effectively prevents an incident of complicity or collusion between the Federal Reserve and the U.S. Treasury. Were it not so, the central bank might make opportunity for the one(s) that appointed its policymaking executives. The Treasury would simply offer an official certificate of government indebtedness in return for money created by the Federal Reserve. It does not, however, require much in the way of a wit to construct a plan for circumventing the open market restriction detailed in what's otherwise known as The Federal Reserve Act. Afterall, who would the open market operatives or intermediaries be but either Fed member institutions or merchant banks listed among the Federal Reserve's primary government securities dealers?

A proxy arrangement might be formed, whereby, a bank purchases U.S. Treasury or Federal agency debt, then contracts for money on either a temporary or permanent basis from the Federal Reserve during one of its daily open market activities. The debt initially purchased is employed as either collateral for temporary funds or the item sold in exchange for the permanent funds during a coupon pass. Regardless; Treasury debt has been exchanged for money which is now at the loan disposal of the contracting commercial or merchant bank, both of which number among the top financiers of U.S. policy-making organisations and political campaigns. In this instance there may be no real complicity on the part of the Federal Reserve, only a bank procurator which serves to circumvent current law.

You might question why a bank would not make provision of its own stock or in the secondary market of its own float. Quite simply, after procuring Federal funds the bank is now by the constructs of the system in possession of the ability to lend in multiples of the original amount through a variety of its branches or subsidiaries to an organisation for purposes that undoubtedly and ultimately number among its own best interests. Keep in mind, however, in this scenario it was not the bank but the Treasury that initiated the funding. The bank is merely facilitating the funding process, albeit happily.

Reconsider the preceding statement for a moment and see why private enterprise should be prevented from any involvement that might influence official government conduct; but also know that we are too far along that path to avoid proprietary U.S. policy initiatives and the eventual harm that might be inflicted upon the collective concerns and welfare that government is supposedly employed to protect.

Certainly there are other than financial institutions and funds that purchase U.S. Treasury debt, though not many. For example, Treasury reports on refunding activity clearly depict public individuals participating in only four to eight percent of 30-yr bond purchases from 1998 through 1999. Public individuals have also had no participation in the recent debt buybacks conducted twice monthly by the Treasury.

You might ask who is assigned, if anyone, to guard against illicit attempts at printing money. And that would be the Congress.

But, Congress also has an interest in the high-powered money created by the Federal Reserve. With a total tax burden that's grown heavy for many in the U.S. electorate, the Congress is very wary of adding any additional weight; as is the U.S. President. They, therefor, are more prone to float bonds than raise taxes to finance many of their spending projects. Some of those projects very dear to individual legislators.

It appears almost too easy. Does it not? And it is easy. It is also a chief reason for the size of the current U.S. national debt.

I'm aware there are many who are unconcerned over the size of our nation's debt. They will also, undoubtedly, be among the first to influence a transfer of social security revenues to privately managed funds, effectively obviating the need to tap funds already vanquished; or at least lessening the need for large Treasury refundings in the future to restock an empty coffer. You might also see where real conflict may develop between interested parties, battling over who will receive what funds and when. It often comes to that when such a reliable creditor's debt-carrying capacity may be called into question.

A review of Treasury records for earlier in this decade indicates that by the year 2000 receipts from U.S. individual income tax would no longer be sufficient to fund the payment of the interest on our outstanding public debt.

Though not the entire cache, receipts from individuals comprise the lion's share of federal funding. With a sovereign debt so large, and receiving so much public attention by international and foreign official fiduciaries, constraints could be issued against what more might be gotten through debt issuance. The U.S. Government could begin to pay-down or buyback the debt, if circumstances permitted; which can also be a lucrative source of funds for private interests. The mere act of buying-back debt -- $7 billion recently, and in only private or institutional hands -- recapitalizes the system or accounts therein. That's the way money is created ladies and gentlemen, by issuing debt to the Federal Reserve System in return for funds it, the Federal Reserve, controls.

The Treasury, should they so desire, can also avoid sourcing tax receipts from custodial Treasury Tax and Loan ( TT&L ) Note accounts at *depository institutions, a halting action that increases system reserves ( money supply ) which can then be put to use in a variety of other purposes. A news service, such as INO , will report this activity and did so this Spring on several occasions. Several hundreds of millions of dollars can be involved. Had they the desire, the U.S. Treasury is quite able to divert revenues during the tax payment process to fund whatever they fancy. However, there is a legal collateral-based limit on the amount of tax receipts each bank depository may hold.

The note option banks have use of the Treasury's funds for loans and investments, yet are required to provide collateral and pay interest ( Fed Fund Weekly Average minus 0.25% ) to the Treasury. The Treasury early this year expanded the types of collateral deemed acceptable for this purpose; as has the Federal Reserve expanded collateral rules in it's lending programs.

You might ask of one of the above scenarios, why a bank wouldn't advance special interest money from its cash reserves. Simply, banks are not in the habit of holding more than a minimum of cash in reserve. Too, many banks today apply vault cash for meeting their statutory reserve requirements and operating balances. And cash pays no interest; debt does. Banks, however, do maintain sizeable debt portfolios. Debt that, as explained above, is tradable for money. Cash-on-hand could be used, of course. But, you do see where that needn't be the case.

Government-Sponsored Enterprises

Many of you may know the Federal Reserve has extended until January the term of the expanded collateral agreement originally intended as a pre-Y2K precaution that would ensure market participants had ample and ready access to funds or liquidity. That the Federal Reserve continues beyond the Y2K event to accept, among others, mortgage backed securities ( MBS ) and federal agency debt is indicative of a collateral basis for the creation of even more money. Recall, as I stated above, that the Federal Reserve creates money by purchasing debt. The aforementioned agreement, then, introduces a new element of complicity. Though there are others.

Note: The Fed was able to accept agency debt prior to the original expansion agreement, though they rarely did. The collateral agreement has expanded that ability into a practice.

It's here, also, at the agency level, where one of the schemes above may be extended. The mortgage GSE's simply purchase securitized loan packages from the banks, freeing-up balance sheets for more credit expansion.

Some may question why international market entities do not call for an accounting of activities exploding the U.S. money supply, crippling the dollar's purchasing power, and what some suppose should be weakening the forex value of the U.S. currency. Quite simply, the same institutions operating within our credit complex are providing loans to foreign organisations and individuals as well as domestic, and efforts that increase their capitalisation aids them in doing so.

The End Game

The fundings and financial assistance I've speculated upon are certainly attractive opportunities for large, cash poor but urgent agendas, yet ones that last only as long as the public remains satisfied in their own finances. The rapid escalation in money and credit may eventually lead to inflationary consequences which the public can not and will not tolerate. It is then that all the intrigue suggested above might be put to an end. But how much in private and public liabilities and assets have been created and supported by the games while they were afoot? That's what many may be woe to discover -- players as well as spectators. For, if they slow the creation of money and credit in order to reduce the inflationary stimulus, the ramparts of what's been constructed and maintained by chronic system abuse may come apart.

It's not difficult to also understand why the benefactors of the aforementioned fleecing would endeavour to dilute the indicators of their game's demise, e.g. cpi, ppi, et al. And, why our Fed Chairman, aware of the inflationary harbingers, has reportedly availed himself of more secure sources of economic indicators.

*The financial collective termed depository institutions is not comprised entirely of commercial banks. Never-the-less, the largest revenue producing entities in the subgroup are banks.

Yours faithfully


Stephen L Hulme


Reply #1 f rom Hon Dr Michael Cullen , Minister of Finance  

Emailed 1/08/02
Mr S Hulme
Response to letter 

Dear Stephen

Thank you for your email.

Your main point appears to be simply incorrect. The Reserve Bank conducts open market operations simply to smooth out day-to-day flows in banking system liquidity. In effect, these operations largely offset the accumulated balance on the Crown's account at the Reserve Bank. That balance has been unusually large in the last year or two, but we expect it to return to more normal levels by the end of the current financial year. In an ideal world, the times in which the Reserve Bank is a net lender to the financial system would be approximately offset by the times when the Bank is withdrawing cash from the system. There is no subsidy involved, and no bias towards boosting credit creation.

The   Reserve   Bank does stand willing to provide unlimited funds, against the collateral of   government securities, at 25 basis points above the Official Cash Rate. All indications are that banks are reluctant to use this costly financing source, and do so reluctantly only at the end of the day when the system itself is short of cash and there is no other way of squaring up other than the Reserve Bank.

Yours sincerely

Signed by Hon Dr Michael Cullen


  Hon Dr Michael Cullen

  Minister of Finance


Letter #3 sent 1/8/02

Office of Hon Dr Michael Cullen
Minister of Finance
Parliament Buildings


Dear Minister

Please accept this letter as a response to the email ( above) you sent to me in reply to my email (subject:Government Surplus Funding Broker Dealer Positions) sent to you on 7th July 2002.

Your assertion that my main point (and by that I presume you mean my contention that you are committing the act of printing money) appears to be simply incorrect is not adequately refuted by a loose detailing of the Reserve Bank of New Zealand's (RBNZ) supposed liquidity management functions as conducted daily during open market operations. Neither is your denial that no subsidy and credit creation action exists when these activities are carried out beyond what you rightly point out is a mechanism of the RBNZ to offset the daily net flows to or from government.

A daily outstanding collateralised repo loan of $2.0bn plus to the authorised banking system hardly constitutes a liquidity smoothing operation for an economy the size of New Zealand. The contradiction is more so when you continue to issue government debt rather than retire the taxpayer's liability when a supposed surplus is recorded.

The existing issuance of Government liabilities on our behalf which require us to redeem and service them and their subsequent ongoing purchase by the RBNZ for cash which facilitates a further private liability required to be serviced and redeemed by those same taxpayers is printing money.    

The Debt Management Office previously recognised the conflict of interest in itsinstitutional arrangements brief located here; http://www.nzdmo.govt.nz/publications/historical/inst-arr-dm-nz.pdf

This excerpt clearly states their perception;

"Monetary Policy

During the 1980s, increasing attention was being given to the question of the reform of the RBNZ's role and operations. There were two motivations for this. One was to improve the conduct of monetary and exchange-rate policy, and the second was to improve the RBNZ's efficiency as a government-owned enterprise.

Prior to the formation of NZDMO, debt issuance in the domestic market was an adjunct to monetary policy. There were no separate objectives regarding debt management, although maturities were avoided from 1986, because of high nominal and real yields. The result was a debt portfolio containing many tranches, each with relatively small outstandings.

To improve the conduct of monetary policy, it was concluded that the RBNZ's objective should focus more specifically on the control of inflation, rather than on a multiplicity of objectives. Its inflation objective should be transparent and clearly defined. This was implemented with the enactment of the Reserve Bank of New Zealand Act 1989.

To make monetary policy as transparent as possible, and hence to minimise the uncertainty in the financial markets as to its short-term impact, the RBNZ's targets and instruments had to be clearly understood and delineated. Moreover, the RBNZ's activities in the domestic market had to be capable of clear interpretation. This had a major implication. Namely, that the Treasury's debt management instruments should not simultaneously be monetary policy instruments. This was achieved in two steps. First, the requirements for financial institutions to hold certain quantities of government debt for monetary policy reasons were removed in 1984. Second, a 'Reserve Bank bill', a discountable short-dated money market instrument, was introduced in 1988 to take the place of government debt as a liquidity management tool.

The Reserve Bank bill is a claim on the RBNZ and, more importantly, it is discountable at the RBNZ, whereas Treasury bills are not. The reason for having Reserve Bank bills rather than Treasury bills to be used for the same purpose is to allow the supply of discountable instruments to be kept constant, therefore giving better control over monetary conditions.

These changes have ensured the separation of monetary policy from debt management and thereby allowed NZDMO the freedom to issue different instruments in the domestic market for debt management purposes."

Unfortunately for NZer's this situation did not persist - see italic highlight below in this excerpt from the RBNZ Annual report June 2001 Notes to accounts- 1 part (e)

(e) Local Currency Activities

Local currency activities arise as follows:

(i) Liquidity management operations. Liquidity management largely involves the Reserve Bank offsetting the daily net flows to or from government by advancing funds to or withdrawing funds from the banking system. Most of this business is undertaken through daily open market operations and any residual banking system liquidity is advanced or withdrawn using the Official Cash Rate scheme (OCR). Under the OCR scheme, the Bank advances or withdraws cash at a margin to the OCR. The financial instruments used in these operations include local currency reverse-repurchase transactions and forward foreign exchange swap contracts. In September 2000, the Bank began to use securities from its investment portfolio of NZ government securities in repurchase transactions (to withdraw funds from the banking system) for liquidity management purposes.

(ii) Holding an investment portfolio comprising New Zealand government bonds to support the liability for currency in circulation and representing the investment of the Reserve Bank's net equity. The Bank's policy is to hold these investments until maturity. From time to time, the Bank may also hold small trading positions in Crown or registered bank securities as part of market test activities.

I can only think, for the reasons, outlined above that this change of policy was made more for self serving political purposes than not. It must now be clear that monetary policy is being exercised in ways other than the mandated independent RBNZ control of the OCR.  

Yours faithfully


Stephen L Hulme


Letter #4 sent 8/8/02

Office of Hon Dr Michael Cullen
Minister of Finance
Parliament Buildings


Dear Minister

Further to my email correspondence of 1st August 2002 (sent via Katy Greco, above) addressing my contention and related concerns that the Crown is influencing monetary policy with quantity term reverse repo money injections through the RBNZ's open market operation (OMO), I have set out below further evidence from the United States to reinforce my views and refute your apparent denial of such actions and their consequences.   

Moreover, I request that you submit the record of the actual daily net flows to or from government which would require the RBNZ's OMO to advance funds to or withdraw funds from the banking system over the last two years, unrelated to placing longer term Crown surpluses.   Please consider this request as falling under the Official Information Act 1982.



The market for repurchase agreements on U.S. government securities is of vital importance to the New York Fed, and the whole Federal Reserve System, because it is where virtually all of our monetary policy operations are conducted.

- Peter Fisher, Manager, System Open Market Account   January 15, 1997

July 2002 - The Monetary Letter

Peter R. Fisher, Treasury Undersecretary for Domestic Finance and former New York Fed Executive VP, is in the process of beginning his own open market operation at the US Treasury Department. Proposed is the US Treasury investing its excess cash balances by participating in the market for repurchase agreements. The stated considerations are an investment return for the Treasury on idle moneys and commercial banks that have apparently reached the collateral limit ($55 billion) of what Treasury moneys they are able to hold (and use) in loan note accounts. Longtime readers of this writing will know the Treasury Tax and Loan (TT&L) accounts have been a topic here from time to time.

The essence of the proposed Treasury involvement in the repo market is a cash injection, just as the Fed does, and just as we track in the Fed RP outstanding in the top plot on the graphics page. All readers will, of course, also know that balances in the Treasury's accounts do have a seasonal surge.

Briefly, the Treasury maintains its working balances at the Fed for making and receiving payments on behalf of the government. Too, since they involve the transfer of funds from the banking system to the Fed, increases in these balances absorb reserves. The Treasury keeps its operating balance at the New York Fed near to $5 billion by transferring funds, as required, from its Treasury Tax & Loan accounts at commercial banks which serve as collection points for tax receipts. The note option banks have use of the Treasury's funds for loans and investments. The $5 billion balance is a figure easily verified by reviewing weekly statistical releases.

Although I suspect that Mr. Fisher has already made his debut in the marketplace as a Treasury official, he may eventually have a more regular opportunity to do so.

Mr. Fisher may not find a conflict in this type of operation; nevertheless, he is no longer an official employee of a politically independent organization. To lead operations that involve injecting cash liquidity into the financial markets may involve proprietary political considerations, or moral hazard, the knowledge of which no other public entity than you and I are ever likely to have. First among the probable political considerations are this year's Autumn elections and a US presidential campaign that begins next year.

It has also been recommended that the Treasury, in its repo operations, purchase a wide variety of securities, including agency and mortgage-backed issues.

  Without the means to buy or maintain lower mortgage rates with reverse Treasury auctions (buybacks), term repo is the next best alternative.

With widespread and lower predictions for stock market performance in the years ahead, and American consumers fairly stretched in their ability to sustain the current rate of retail consumption, a means to ensure the continued vitality of the housing market must be explored in order to ensure economic performance going forward. See, also, political considerations mentioned immediately above.

Let's not forget, too, the switch over the past several years of enormous amounts of private and official offshore moneys out of US Treasury debt and into that of the federal home loan agencies.


Minutes of the Meeting of the Treasury Borrowing Advisory Committee [Tue April 30, 2002 9:00A]

Final Treasury Term Repo Letter  [Fri June 28, 2002 3:39P]

Yours faithfully


Stephen L Hulme


Reply #2 from Hon Dr Michael Cullen , Minister of Finance

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Reply #3 f rom Hon Dr Michael Cullen , Minister of Finance

Emailed 28 August 2002

Dear Stephen

  I write in response to your Official Information Act inquiry of 08 August
  2002 seeking the daily net flows to or from the government which require
  the RBNZ's OMOs to advance or withdraw funds from the banking system over
  two years. The information that you require is in the attached file.

  Yours sincerely


  Hon Dr Michael Cullen
  Minister of Finance

  (See attached file: Hulme Stephen re Settlement Cash Jul00 to Jun02.xls)



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OMO Matters

US Federal Reserve Reference Publications

"The market for repurchase agreements on US government securities is of vital importance to the New York Fed, and the whole Federal Reserve System, because it is where virtually all of our monetary policy operations are conducted."- Peter Fisher, Manager, System Open Market Account - 15 January 1997.

"Open market operations are not another weapon in the Fed's arsenal, but the only weapon in its arsenal." - Monetary Trends, St Louis Federal Reserve, August 2003.

Repurchase Agreements with Negative Interest Rates - FRBNY - A primer detailing how short sales of Treasury securities can lead to protracted RP fails and consequently negative rates to address capital requirement issues.

OMO-Repo Misuse - Letters to Hon. Dr. Michael Cullen, N.Z. Minister of Finance.

Repo Transaction Accounting. Letter to Mr A Orr, RBNZ.

IMF Repo Accounting Examples, Full Article

NZ Debt Management Office Uridashi issue and associated EuroKiwi letters to Hon. Dr. Michael Cullen, N.Z. Minister of Finance.