The Securities and Exchange Commission (SEC) has proposed reforms to money market funds. This is an issue that has a widespread effect on the overall financial system, but also a direct effect on county governments. In a series of three articles, Conduit Street takes a look at the meaning of the SEC’s proposed reform and its potential effect on local governments across the country, and on Maryland counties specifically. In this first article, we discuss the proposed reform itself and its effect on local governments nationwide, based on analysis of The National Association of Counties.
Breaking the Buck
Money market funds are considered to be a safe investment. Recent history, however, has shown that even a money market fund’s value can fall below expectations. “Breaking the buck” is the term used for the rare financial occurrence when a money market fund’s net asset value (NAV) per share falls below one dollar. As described by this tutorial from CNBC, when a money market funds starts up, it creates the same number of shares for dollars, so the net asset value per share is $1. Then,
The goal of money market funds is to never lose money and maintain a net asset value (NAV), or per-share value, at $1. When their NAV goes below $1, this is called breaking the buck.
According the CNBC, when there is a threat of breaking the buck, the parent company of the money market fund will typically make the share or fund whole, to preserve the reputation of the fund and the confidence of investors. However, in 2008, this did not happen, when, as described by Reuters,
In 2008, exposures to Lehman Brothers caused a large prime institutional fund known as the Reserve Primary Fund to have its net asset value dip below $1, an event known as “breaking the buck.”
At the time, news and editorials noted the jolting signal this occurrence sent to investors. As described by the Wall Street Journal in 2008,
Lehman Brothers Holdings Inc. filed for Chapter 11 bankruptcy protection on Monday. . . The withdrawals meant the Primary Fund had to “break the buck.” That is, its net asset value sunk below the time-honored standard of $1 a share.
The Lehman debt, whose face value was $785 million, had to be written down to zero for the flagship fund of New York’s Reserve Management Corp. That pushed the fund’s per-share price down to $0.97, a bracing signal to investors and a jolt to money-market investors world-wide.
Ultimately, the concern over such an event is that news of a drop in share value below $1 will trigger a run on money market funds, a tightening of the short-term credit markets, and a possible financial collapse.
Floating the NAV
In direct response to the financial crisis of 2008, the SEC proposed reforms to the money market funds in 2010. Then, in June 2013, the SEC proposed additional reforms, including a new way to measure the net asset value of money market funds, called “floating the net asset value (NAV).” Floating the NAV allows the value of equity to change with the market value, rather than using a net asset value (NAV) of $1 per share.
As described by NACo,
The SEC has proposed floating the NAV as a means to provide investors with a more frequent and accurate assessment of the value of a fund’s assets. Under current law (SEC rule 2a-7), MMFs are allowed to round their share price to $1, so long as the actual value of a share does not fall below $0.9950 (“break the buck”). Floating the NAV will require funds to more consistently provide investors with the actual value of the fund’s assets and the value of a fund’s share compared to the $1 pricing model. The SEC’s proposal is predicated on the belief that investor awareness of the actual value of the fund’s assets will make investors less likely to redeem shares in times of economic distress.
Effect of Proposed Reforms on County Governments
The reforms are intended to improve the transparency of the value of money market funds and protect against breaking the buck, however floating the NAV could cause operational and accounting issues for all investors, and have significant negative cost implications for state and local governments. County governments across the US interact with money market fund in two important ways. First, money market mutual funds are the largest investor in short-term municipal bonds, according to The National Association of Counties (NACo), they hold 72% of all outstanding short term bonds, totaling over $500 billion.
Second, many county governments invest in money market mutual funds as part of their cash management practice. The Federal Reserve reports that as of the end of the first quarter of 2013 state and local governments hold over $120 billion of their short- and mid-term investments in money market funds. NACo expects that moving to a floating NAV would carry significant costs for state and local governments as investors.
NACo has joined other national associations in a comments submitted to the SEC regarding the proposed reform. In comments submitted on September 17, 2013, NACo states,
We believe that such a move would be harmful to state and local governments and the entire MMMF [money market mutual fund] market. The fixed NAV is the trademark of MMMFs and changing its structure likely would eliminate the market for these products, leading to fewer investors of municipal bonds, and forcing state and local governments to divest their MMMF holdings.
State and local governments and other issuers rely on the sale of these bonds to build and maintain schools to support an educated workforce, and to build our roads, public transportation systems and airports, all of which are essential for supporting commerce. They also help to address the country’s water infrastructure, public utilities, health care and affordable housing needs, as well as provide public safety infrastructure that ensures local and national security.
Update & Action
According to Reuters, the SEC is reconsidering the breadth of their reform based on the comments they have received:
The SEC is still actively eyeing a plan that would force prime institutional money market funds to abandon their stable $1 per-share net asset value and float their share price.
In response to some complaints from the industry, the SEC is also exploring whether to make some changes from its initial proposal that could effectively expand the number of money market funds that would be exempt from a floating net asset value. . .
In the meantime, NACo encourages all county governments to voice their concern over the proposed change. From NACo:
The Government Finance Officers Association (GFOA) is working with a coalition of stakeholders to voice its concerns with SEC’s proposal, however it is critical that individual jurisdictions weigh in with SEC to discuss their own specific money market fund needs and uses, and the proposal’s projected impacts on their communities.
For more information, see this factsheet and additional information from the National Association of Counties.