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


Sent 26/01/03 by email

Office of Hon Dr Michael Cullen
Minister of Finance
Parliament Buildings, Wellington

Dear Minister

I wrote the following letter in response to Brian Gaynor's article in the Weekend Herald Business Section, edition 25/26 January 2003.

Upon reflection I felt the concepts discussed and their impact upon the New Zealand economy deserved the attention of your policy advisors, if not yourself. It is such a short time ago, 1997/98 in fact, since Dr Brash and the National led Government had to grapple with the debacle of huge inward flows of foreign investment abruptly and upwardly revaluing the NZD because of structured finance deals.

Brian Gaynor is not a personal friend and does not necessarily share my views, but we were associates in the late 70's and early 80's employed at our respective stock broking firms as research managers.

Yours faithfully

Stephen L Hulme



Dear Brian

Your excellent article in the Business Herald of 25 January 2003,  highlighted some important factors facing the New Zealand economy. In particular you dichotomised the over investment in domestic capital consumption factors compared to the productive and export sectors as a pending dilemma for the RBNZ's OCR deliberations given the strengthening NZD.  

Ironically, the demand for NZD has risen dramatically as the increase of foreign claims accelerates in the form of renewed 'Eurokiwi' bond issuance. Read -. RBNZ research - ' Developments in the Eurokiwi Bond Market' by Kelly Eckhold - Mr Eckhold clearly explains the procedures and mechanisms of these structures that led to NZD volatility then and again now.   

Furthermore, then compare the graph (detailing outstanding issuance) contained in the attached EUROKIWI.XLS, also prepared by the RBNZ and the NZD chart below and you will see the correlation that leads me to think that the financial (ie structured finance) economy is the real problem inhibiting the physical economy. 

New Zealand Dollar (CME)
Monthly Price Chart

The NZD billion plus issuance of these securities since midway through 2002 is dwarfed by a similar instrument offered by the Australian market called Uridashi -  meaning retail targeted in Japan. Same principle though. In January 2003, alone, over AUD 4.0 billion  has been issued by IBRD (World Bank) 1.0bn, EBRD (Sovereign Backed) 1.5bn and Westpac 1.575bn and sold to individual Japanese investors. 

Once again, another irony - why should supranationals charged with lending to poorer nations be actively involved in arbitraging their AAA credit rating to raise cheap short term floating capital ie USD or Yen through the FX swap at the expense of the Australasian export sector? Even more inexplicable is that Dr Cullen is a Govenor of the IBRD and Dr Bollard the alternate appointee. You will note in the xls that these institutions issued extensively in NZD in the 1997/98 round of heavy placement.

A much unannounced sympton of this significant AUD and NZD dollar purchasing frenzy is the entrance of the speculative trader element. Large mutli-national investment firms arranging these deals and even the ones just observing cannot resist the opportunity to 'coattail' these trades. Inevitably this means buying the currency in anticipation of deal completion and parking in both NZ and  Aust Government stock. New Zealand being the smaller country necessarily sees greater volatility and hence price extension. 

The subsequent rally in the prices of these government bonds serves to invert the benchmark yield curve out to at least five years. See Table below.

New Zealand Bonds
Sun, 26 Jan 2003, 01:50pm EDT

  Coupon Date Price Yield
3 Months 0.00000 04/29/03 5.575 5.575
6 Months 0.00000 07/29/03 5.515 5.515
1 Years 8.00000 04/15/04 102.844 5.524
2 Years 6.50000 02/15/05 101.851 5.529
3 Years 6.50000 02/15/06 102.359 5.645
5 Years 8.00000 11/15/06 107.789 5.684
7 Years 7.00000 07/15/09 105.825 5.902
8 Years 6.00000 11/15/11 99.982 6.001
10 Years 6.50000 04/15/13 103.494 6.035

This only encourages further deals as the margin for the New Zealand banks to lend 3 to 5 year fixed rate mortgages above the OCR narrows. Even if the RBNZ hiked rates to slow the housing investment boom and consequent consumer demand it would only  encourage further NZD purchases and the curve would invert further until we are borrowed out or international circumstances change.  

As you you can guess the RBNZ is impotent to affect a change of policy that will impact while this process proceeds unless the blunt instrument of regulation is brought to bear. The situation is further exacerbated by the NZ Crown funnelling its $4.0bn plus surplus through the RBNZ's Open Market Operation window via reverse repos, thus helping to fund these very same Government bond positions held by speculating offshore broker/dealers.  

Finally, I suppose these supranational and large domestic bank issuers of these NZD & AUD Eurobonds take their cheap swapped floating currency loans to on-lend and facilitate the very types of productive urban infrastructure, you mention is necessary for New Zealand, in  other more deserving places than here.

As you will start to note we are fueling the fires of consumption with our current monetary and fiscal policy prescriptions, but in doing so we tend to have to destroy the furniture and eventually the house of our economy to do so. 




Stephen L Hulme



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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.