A new report entitled, "Money Market Funds: What a U.S. Default Would Mean, says, "While Fitch Ratings continues to believe that an agreement will ultimately be reached to raise the U.S. debt ceiling, it has been asked by market participants to explore the potential ramifications for U.S. dollar-denominated money market funds (MMFs) should the U.S. government fail to make timely payments on its debt obligations." Fitch says, "MMFs hold $1.3 trillion in direct and indirect exposures via holdings of U.S. Treasury and government agency securities as well repurchase agreements (repos) collateralized by such securities." (Note that this includes "offshore" money funds; Crane Data shows the U.S. total amount at $1.014 trillion as of June 30, 2011 -- $346 billion in Treasury debt, $348 billion in Government agency debt, $210 billion in agency-backed repo, and $111 billion in Treasury-backed repo.)
Fitch's report continues, "The risk of one or more MMFs 'breaking the buck' due to mark-to-market declines on U.S. government exposures appears manageable, absent significant redemption activity. This view reflects MMFs' low weighted average maturities.... MMFs would not be required to sell U.S. Treasury securities in the event of a downgrade. Thus, any liquidity pressures would more likely arise from increased redemption activity. Thus far, the reaction of MMF investors has been fairly muted, with U.S. government MMFs experiencing net inflows of late. That said, the lesson of 2008 is that MMFs can be vulnerable to confidence-driven runs."
They explain, "MMFs rely on repos and to a lesser extent direct U.S. Treasury securities as a primary source of liquidity. If MMFs were facing net outflows, a failure by the U.S. government to rollover maturing U.S. Treasury securities could have an immediate liquidity impact for MMFs. Potentially more problematic would be a material disruption of the repo markets given their interconnectedness and importance to MMFs' liquidity."
Finally, Fitch says, "Liquidity risk is a concern for MMFs in a scenario where the U.S. debt ceiling is not raised and the U.S. defaults. MMFs with financially stronger sponsors may be better positioned to weather any liquidity pressures.... A failure to meet timely redemptions and maintain preservation of capital, consistent with Fitch distinct rating scale and criteria for MMFs, would have negative rating implications. A lower rating on the U.S. (for example, in the 'AA' category) also could negatively impact MMFs rated 'AAAmmf' from the standpoint of daily and weekly liquidity and repo collateral. As events unfold over the next few weeks, Fitch will dialogue with advisors to rated MMFs seeking to understand their liquidity positions and risk management plans as well as the reaction of broader markets in the event of a U.S. government default or downgrade."
On another note, we were reminded recently by a regulator that the text of Rule 2a-7 of the Investment Company Act defines "Eligible Security" as, "A Rated Security with a remaining maturity of 397 calendar days or less that has received a rating from the Requisite NRSROs in one of the two highest short-term rating categories.... or, An Unrated Security that is of comparable quality to a security meeting the requirements for a Rated Security ... as determined by the money market fund's board of directors." "First Tier Security is defined as "[A]ny Eligible Security that: Is a Rated Security that has received a short-term rating from the Requisite NRSROs in the highest short-term rating category for debt obligations ... or Is an Unrated Security that is of comparable quality ...; or Is a Government Security." Thus, Eligible Government Securities are automatically considered "First Tier" by 2a-7. Note too that funds classified as "Treasury" by Crane Data, which primarily buy U.S. Treasury securities and repo, hold $351.6 billion, or 13.9% of all money fund assets.
