The Securities and Exchange Commission (SEC) has proposed reforms to money market funds. This is an issue that has a widespread effect on our financial system, and 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 our first article, we discuss the proposed reform itself and its effect on local governments nationwide, based on analysis of The National Association of Counties. In this article, we look at the money market and Maryland’s involvement in money market funds.
The Money Market
The money market is a part of the investment market made up of short-term debt securities, or debt that matures in less than one year. Money market funds are also sometimes called “cash investments” referring to the fact that they can normally be converted easily to cash. The money market includes markets for certificates of deposit, interbank loans, money market mutual funds, commercial paper, Treasury bills, and others. In the US, the money market accounts for about 1/3 of all credit according to the Federal Reserve Board’s Flow of Funds Study. According to Randall Dodd of the US Treasury Department,
For the most part, money markets provide those with funds—banks, money managers, and retail investors—a means for safe, liquid, short-term investments, and they offer borrowers—banks, broker-dealers, hedge funds, and nonfinancial corporations—access to low-cost funds.
Money Market Mutual Funds
Money market mutual funds are securities offered by companies that invest in other market instruments, such as certificates of deposit, commercial paper, and Treasury bills. Money market securities are considered very safe. A money market fund has relatively low risk compared with other mutual funds, though during the financial crisis and the collapse of Lehman Brothers, the US Treasury had to create a special lending facility for commercial paper to prevent these funds from falling below their standard $1 per share value.
As described by the SEC,
A money market fund is a type of mutual fund that is required by law to invest in low-risk securities. These funds have relatively low risks compared to other mutual funds and pay dividends that generally reflect short-term interest rates.
Maryland and the Money Market
Maryland counties and the State of Maryland interact in the money market as both investors and borrowers.
As investors, Maryland county governments and Baltimore City, and other units of government such as community colleges, boards of education, and pension funds invest in the money market. For example, more than 20% of Anne Arundel County’s primary government investments are in money-market pools.
Also in Anne Arundel County, as elsewhere, money markets are one type of fund in which the pension system is allowed to invest. This qualification is generally based on the traditional reliability of the money market, and also on the $1 per share standard. As described in the County’s Comprehensive Annual Financial Report,
The Retirement System is authorized to invest in U.S. Government securities, insurance company general accounts, commercial paper, money market mutual funds, corporate bonds, common and international stocks, limited partnerships, absolute return funds, private equity, mortgage participations, and real estate.
More information on county investments is available in each county Comprehensive Annual Finance Report, posted on MACo’s website.
As borrowers, Maryland counties issue municipal bonds, many of which are purchased by money-market investors. The Investment Company Institute (ICI) is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds and unit investment trusts. ICI tracks money-market mutual fund sales nationally based on the SEC Form N-MFP, a form submitted to The Securities and Exchange Commission monthly by money market funds that details their portfolio information. According to estimates of economists at ICI,
Based on an ICI calculation from the Securities and Exchange Commission’s N-MFP data, as of December 31, 2013, that money market funds held about $4 billion in Maryland municipal securities.
Some of this $4 billion estimate is held in county municipal bonds. According to the National Association of Counties’ Report, Municipal Bonds Build America, Baltimore City alone had $2.5 billion in outstanding tax-exempt municipal bonds in 2012, and state and local governments together issued $19.2 billion in municipal bonds in Maryland from 2003-2012. While some of these bonds are long-term, some are short-term debt that fall within the money market. According to the national Association of Counties, money market mutual funds are the largest investor in short-term municipal bonds, holding 72% of all outstanding short term bonds, totaling over $500 billion nationwide.
The Meaning of Money Market Reform
The involvement of Maryland’s county governments in the money market, both as investors and as borrowers, means that any reform of the money market has a potential effect on their budgets, especially in the area of capital spending. Municipal bonds are primarily used to build schools, hospitals, roads, water and sewer infrastructure, and power utilities throughout the country. The main concern over the proposed reforms discussed in the first article in this series, are that these reforms will make the municipal bond market less attractive to investors, thereby raising the price of debt and decreasing the amount of funding available for essential government infrastructure projects. In the final article in this series, we will in greater detail at the potential effect of the Securities and Exchange Commission’s proposed reform of money markets on Maryland Counties considering county infrastructure needs.