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 our second article, we looked at the money market and Maryland’s involvement in money market funds. In this final article, we will suggest some potential effects of the proposed reform on Maryland county government finances.
The Dual Effect of the Proposed SEC Money Market Reform
Maryland counties interact with the money market in primarily two ways, as investors and as issuers of bonds that are purchased by other money market investors. The proposed SEC reforms will have an effect on both of those interactions.
Effect #1: A Downturn in Investment Income
County governments have limited options for investing. In recent years, these options have become both more limited and less rewarding. Rates on repurchase agreements following the implementation of the international Basel III reforms are abysmal, while sometimes treasury bills have negative yields. Options for institutional investments such as Fannie Mae and Freddie Mac are narrowing following their federal takeover during the foreclosure crisis of 2008. Now, the proposed money market reforms could limit investing options further.
If the reforms go through and there is a floating net asset value for money-market funds, it may be difficult for county governments to invest in the money-market. The appeal of the money-market funds, and the reason why they are considered safe investments, is based on the premise that each share will not drop below $1. Breaking the facade of that stability could eliminate the money market as an option for county and municipal investors.
Even though yields in the money market have not been high in recent years, some other short-term, liquid alternatives would yield even less. Some alternatives include savings accounts, repurchase agreements, and US treasury bills. As Janet Morgan, Anne Arundel County Investment Manager said,
“The available investment vehicles that county governments can buy are shrinking, and as the whole money market shrinks the yields are lower and lower.”
Lower yields translates to fewer dollars for county governments. For example, in Montgomery County, money market investments yielded from between 4.00% and 4.10% in 2001. By 2010, the Montgomery County CAFR describes how money market investment returns dropped to historic lows, giving a range of 0.04% to 0.09%. In 2013, they rebounded slightly, ranging from 0.07% to 0.35%.
This means that, for example, in 2001, the county’s investment income on $100 million invested in the money market would have been approximately $4 million. In 2010, income on the same investment would have been around $40,000. In 2013, the income would have been near $70,000. The concern is that if the SEC’s proposed reforms are implemented, even this modest upward trend will not continue.
In addition to purchasing individual investments, and participating in money market mutual funds, Maryland counties participate in the Maryland Local Government Investment Pool (MLGIP). This pool is especially helpful for smaller counties and municipalities with fewer staff to research and manage investments. There are 301 registered participants in the pool, including municipalities, counties, schools, register of wills, and others. According to its 2013 Annual Report, the Maryland Local Government Investment Pool has about $2.8 billion of local government investments.
The proposed SEC reform may also influence on the administration of local government investment pools such as the MLGIP. While the SEC does not have the authority to regulate these local pools directly, they are typically run like money market mutual funds. Treasurer Hewitt who also serves on the Advisory Committee to the Maryland Local Government Investment Pool, recently joined Maryland State Treasurer Nancy Kopp, and treasurers from other states in a meeting with the SEC Chairman to discuss this issue. It is uncertain how the MLGIP will respond to the proposed SEC reform, if it is implemented.
Effect #2: An Increase in Project Costs
Municipal bonds are the primary vehicle for funding local infrastructure projects, and short-term municipal bonds are used by county governments to raise money associated with these projects and as a part of larger cash management practices. As described by Securities Industry and Financial Markets Association (SIFMA), county governments issue these notes in anticipation of future revenues such as taxes, state or federal aid payments and future bond issuances; to cover irregular cash flows; meet unanticipated deficits; and raise immediate capital for projects until long-term financing can be arranged.
The primary uses for municipal bonds by county governments nationwide are for building schools, hospitals, water, sewer facilities, public power utilities, roads and mass transit. Short-term debt issued to fund planning or break ground on these new projects, is one key way that county governments use short-term municipal bonds. As described by Kathryn Hewitt, Harford County Treasurer and President of the Maryland Government Finance Officers’ Association,
“Shorter term paper is issued before going out for permanent financing, while a project is being started and built. Short term funding is then often paid off by issuing longer term debt. It is a lot easier to issue the short term commercial paper than the effort of the full bond sale. This is helpful when at the beginning or planning stages of a capital project, or, for example, when an administration is not yet prepared to go to bond sale.”
According to the National Association of Counties, money market mutual funds (MMMFs) are the largest investor in short-term municipal bonds, holding 72% of all outstanding short term bonds, totaling over $500 billion nationwide. One proposed reform to money market mutual funds would change the net asset value of the funds from fixed to floating, also called floating the NAV. This could affect the municipal bond market, upsetting the current supply-demand dynamic thereby increasing the amount of interest that county governments pay on municipal bonds. Again, as described by Treasurer Hewitt,
“If fewer people invest in MMMF because they do not like a floating NAV, then there is less money in the MMMFs to buy the securities. If there are not people out there grabbing our paper, then interest rates will go up. We have more supply, they have less demand.”
The National Association of Counties describes the impact of this change on infrastructure projects in their comments submitted to the SEC,
Changing the NAV from fixed to floating, would make MMMFs far less attractive to investors, thereby limiting the availability for MMMFs to purchase municipal securities. Losing this vital investing power would lead to higher debt issuance costs for many state and local governments across the country, which could force the delay or cancellation of much-needed infrastructure projects that would have otherwise helped drive and support national economic output.
It is difficult to determine the exact amount of short-term municipal bond issuances by Maryland’s county governments that are held by money market mutual funds. While the ICI estimated that money market funds hold about $4 billion in Maryland municipal bonds, that number includes short-term debt issued by a variety of Maryland institutions, not just county governments. For example, the top ten holdings of T. Rowe Price’s $126 million Maryland Money Market Mutual Fund include three Montgomery County bonds and seven state government-issued bonds. Again, as described by Treasurer Hewitt,
“Maryland’s counties do not have $4 billion in short term debt outstanding. The money market mutual funds are not buying only the plain vanilla county bonds, they are buying a lot of other things, including state debt, and health and higher education bonds.”
In fact, at the end of 2013, the only two counties with short term debt outstanding were Howard County, with approximately $100 million, and Queen Anne’s County with about $30,000 outstanding. While the amounts might not be overwhelming, the change is disruptive in other ways, too. For example, some county computer systems are not set-up to handle a floating NAV.
For more information and background on the effect of the SEC’s proposed reform to money markets, see the SEC’s Fact Sheet: Reforming Money Market Funds, The GFOA’s presentation, Money Market Fund Regulation: The Impact on Municipal Finance, and one page summary, SEC Money Market Proposal Will Harm State and Local Governments.