Additional regulation of money-market mutual funds could increase short-term borrowing costs for state and local governments, leading municipalities to raise taxes or cut spending on infrastructure and other critical projects, according to a paper released Monday by a Georgetown University professor.
In a 15-page report called “Money Market Mutual Fund 'Reform:’ The Dangers of Acting Now,” James J. Angel, associate finance professor at Georgetown University’s McDonough School of Business, said money market regulations being considered by the Securities and Exchange Commission and other agencies could transform the industry in ways that would “severely damage municipal finance” and potentially hinder the country’s economic recovery.
“Imposing major structural experiments on such a vital part of our economy is particularly dangerous at this time, given the current state of anemic economic growth and continued failure to resolve the European sovereign debt crisis,” the paper said. “Now is not the time to raise borrowing costs for businesses or governments.”
Angel, who received financial support for the paper from the U.S. Chamber of Commerce, warned that the impact of new rules could be widespread, and urged regulators to fully study potential fallout.
“When drafting regulations, the SEC must engage in a comprehensive analysis that goes beyond simple compliance costs,” the report said. “The total costs to the economy include follow-on effects from the economic activity that is inhibited by the regulations.”
Angel’s paper follows recent calls by regulators for more oversight of the $2.6 trillion money market industry. Rules being considered include those that would increase reserve requirements, restrict investor withdrawals and require funds convert from a stable $1 net-asset-value to a “floating” NAV.
In May, SEC chairman Mary Schapiro told hundreds of money-market industry executives that she has “very legitimate concerns” about risks posed by a stable NAV. “We know what happened in 2008,” she said, referring to the instance in September of that year when the NAV of the $62.5 billion Reserve Primary Fund fell below $1 per share, known as “breaking the buck.”
The drop was due to losses the fund suffered from the bankruptcy of Lehman Brothers. Financial fears spread, and within weeks investors withdrew $310 billion from money market funds. Short-term credit markets froze.
Angel’s paper warns that new regulations being considered could shrink or eliminate the money market industry and lead to higher short-term borrowing costs for governments and businesses.
The paper noted that money markets hold 60% of state and local government short-term debt, which municipalities use to finance infrastructure projects and to maintain cash flow between revenue “spikes,” which occur when governments receive property tax payments.
If short-term borrowing costs rise, municipalities could be forced to issue new, longer-term debt at higher interest rates, Angel said during a press call Monday.
“The munis will have to pay more. ... That means they are going to have to raise taxes, find some other way of raising revenue, or ... forgo very useful projects,” he said. “At a time when our infrastructure is crying for renewal, now is not the time to be raising the costs.”
SEC spokesman John Nester said that Schapiro “continues to welcome constructive input to help further guard against the threat of a run on a money market fund that could destabilize the financial system or put taxpayers at risk.”
“Having seen what happened during the financial crisis, the chairman believes there’s a danger in not acting,” he said.
Angel said regulations could “paradoxically” increase risks by leading municipalities and companies to borrow from “highly leveraged too-big-to-fail banks.”
Angel and another speaker on Monday’s call, David Hirschmann, president and chief executive of the Chamber’s Center for Capital Markets Competitiveness, said SEC rules passed in 2010 already address the risks of a run on capital.
Those regulations tightened money market holding requirements and liquidity standards and require that funds conduct periodic stress tests.
Funds must also disclose holdings and their “shadow” NAV — the fund’s actual net “mark to market” NAV — every month.
“After the 2010 reforms, I don’t think there is a problem,” said Angel, who specializes in the structure and regulation of financial markets, has testified before Congress and has chaired NASDAQ’s economic advisory board.
Hirschmann called for more conversation between the industry and the SEC about risks and possible solutions. “But instead of having that kind of conversation, this has all been about a proposal that fundamentally would destroy the product,” he said.
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