The stock market may be humming along, but near-zero interest rates have produced feeble investment returns for some local governments, which are restricted in the types of securities they can purchase using public funds.
Local officials say it could be a long time before local governments see the kind of yields characteristic of the pre-recession years.
“We may not see the kinds of interest rates (for many years) that we saw 10 years ago,” said Judith Zimmerman, director of finance and investments with the Montgomery County Treasurers Office. “The money’s not there, and probably won’t be there.”
Montgomery County’s general fund this year is projected to receive $5.1 million from its investments, which is less than half of its investment earnings from five years ago.
Dayton projects relatively flat investment income this year, which fell off a cliff during the Great Recession.
The Federal Reserve has signaled it could raise the benchmark short-term interest rate sometime this year, which could in turn improve the yield on the U.S. government agency bonds that are bought by local jurisdictions. But any increase is expected to be small and may not even happen until 2016.
The last time the Fed hiked the short-term rate was in June 2006, when it was increased to 5.25 percent.
As the economy continued to deteriorate, the Federal Reserve lowered the federal funds interest rate from a target of 4.25 percent to a range of zero to 0.25 percent.
The short-term interest rate has hovered around zero ever since.
Low rates a help, hindrance
Slashing the interest rate was designed to stimulate investment and bolster economic growth.
Low interest rates encourage people and businesses to borrow money because the reduced rates decrease the cost of repayment. Low rates also encourage lenders to give out more loans.
The rates are often cited as a stock market booster.
“Low interest rates help households and businesses finance new spending and help support the prices of many other assets, such as stocks and houses,” according to the Board of Governors of the Federal Reserve System.
But just as low rates benefit borrowers, including local governments that borrow, they can slash government investment income. Unlike pension funds and individual investors, Ohio governments must comply with fairly strict rules about their investing activities, and are barred from dabbling in riskier funds.
“Interest returns are low because of the Federal Reserve keeping the interest rate at 0.25 percent,” said Susan Dunn, president of the executive committee of the County Treasurers Association of Ohio. “All counties have the same issue with the interest rates.”
By law, Montgomery County can only invest in ultra-safe securities that reach maturity within five years, officials said. The laws protect against losses, but also limit potential gains.
Permissible investments for Ohio counties include U.S. Treasury and U.S. agency bonds, bonds for the state of Ohio or its political subdivisions and federally-insured certificates of deposit from Ohio banks, according to the county treasurers association.
As much as 25 percent of a county’s portfolio can be commercial paper notes. Corporate notes can account for up to 15 percent of the portfolio.
The county’s $470 million investment portfolio is stashed in debt securities issued by the U.S. Treasury and U.S. government agencies, including enterprises such as Fannie Mae, Freddie Mac and Federal Home Loan Banks, Zimmerman said.
But the county also has about $30 million invested in AAA-rated money market funds, which is used to pay routine bills and short-term expenses.
The county’s general fund income from investments was $6.6 million in 2013, falling from $7.8 million in 2012 and $11.9 million in 2010. It dropped to about $5.7 million last year, and it is expected to fall again by about $600,000 this year.
Short-term investments are performing especially poorly.
In 2014, the county earned about $54,500 from money-market, bank-deposit and other “overnight” funds. That is down from $6.8 million in revenue in 2007.
City of Dayton
The city also must adhere to a conservative investing strategy by law and municipal policy designed to avoid losses, said Stanley Earley, deputy city manager.
Dayton’s investment portfolio produced about $548,457 in general fund income last year, which was up from 2013 but a fraction of its pre-recession earnings. In 2008, the city’s general fund received $4.3 million from interest.
The city’s investment yield was about 0.75 percent last year, compared to 1.61 percent in 2009 and 3.05 percent in 2008.
For every $1 million invested in 2007, the city would have received about $46,900 in earnings, compared to a return of $5,300 on the same principal in 2013, Earley said.
Low interest rates mean Ohio governments have nowhere to park their money where they can expect a solid return on investment, officials said.
And that’s unfortunate locally because the county this year has about $70 million in securities that will reach maturity and will need to be reinvested, officials said. The city of Dayton has about $100 million that can be reinvested.
The yield would improve if the Fed moves to increase interest rates, as some economists predict, but no one expects a big increase.
In a Jan. 2 interview with the Fox Business channel, Federal Reserve Bank of Cleveland President Loretta Mester said she expects interest rates to go up sometime in the first half of the year, depending on the economic data and outlook.
“As you know from the December meeting, the Fed is preparing the markets and the public for a time when interest rates are going to go up,” she told the network.
But Mester’s views do not necessarily reflect the views of the Federal Open Market Committee, the Fed’s monetary policy-making body. And Fed officials have indicated that when rates do go up, they will go up slowly.
Twelve of the 17 members of the Federal Open Market Committee predict the rate will be at or above 3.375 percent by the end of 2017.
Earley said he does not expect interest rates to climb significantly because of softness in the global economy.
He pointed out that the European Central Bank has embarked on a bond-buying program to stimulate growth, which could cause the Fed to delay a rate increase.
“I think we are looking at the end of this year or the beginning of 2016 before we see materially rising rates,” he said.
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