The Investment Company Institute published a revised (from 2011) "Money Market Funds and Credit Ratings on U.S. Treasury Securities: Frequently Asked Questions" yesterday, which asks, "Why is the debate over of the U.S. debt ceiling and deficit relevant to money market funds? It answers, "Failure to increase the U.S. debt ceiling or address the long-term U.S. spending and fiscal imbalance could adversely affect investors, markets, and economies across the globe -- with severe consequences for interest rates, stock prices, investor confidence, and the day-to-day activities of businesses and consumers. Money market funds are required to invest only in short-term, highly liquid securities that present minimal credit risk. As of August 31, 2013, money market funds owned $831 billion in U.S. Treasury and agency securities -- and held another $452 billion in repurchase agreements collateralized by Treasuries and agencies. Because these amounts are large, it is important to understand how a Treasury default or downgrade could affect financial markets." (Note: Crane Data's Sept. 30 Money Fund Portfolio Holdings, which will be released this morning, show money funds held $483 billion in Treasury debt, with $28 billion maturing Oct. 24, $28 billion maturing 10/31 and just $10 billion maturing 11/7.)
ICI's Q&A also asks, "What would be the consequences of failure by the U.S. Congress and Administration to raise the debt ceiling before the government runs out of cash to pay all of its bills (currently estimated to be October 17, 2013)? They respond, "The U.S. Treasury "estimates that extraordinary measures will be exhausted no later than October 17" unless the statutory debt ceiling is raised from its current level of $16.7 trillion. In that event, Treasury says, "the government would have to stop, limit, or delay payments on a broad range of legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and many other commitments."
Finally, they add, "For a money market fund, what would constitute "default" in a U.S. government security? If the U.S. government fails to pay interest or principal when due on a security in a money market fund's portfolio, the security would be in default. The fund must then dispose of the security in an orderly way, unless the fund's board determines that disposing of the security would not be in the best interests of the fund and its shareholders. In deciding, the board may consider market conditions and other factors. If the security accounts for 0.5 percent or more of the fund's portfolio, the fund also must report the default to the SEC. In addition, the U.S. government's failure to pay its obligations could trigger a severe downgrade of its short-term credit rating by NRSROs. In that case, U.S. government securities may no longer be eligible securities (i.e., may no longer be rated first or second tier by at least two NRSROs), or a money market fund's board or its delegate may determine that the credit risk of those securities is no longer minimal."
Thursday at 10am, a Senate Committee will hold a hearing on the "Impact of a Default on Financial Stability and Economic Growth". ICI President Paul Stevens says in his released testimony, "We already can see early signs of these effects developing in the market, as the October 17 debt-ceiling deadline approaches. Unsure about its future ability to borrow, the Treasury Department is scaling back its auctions of bills-squeezing the supply of securities that are in high demand and undermining the predictability of Treasury issuance. Rates on the Treasury securities most at risk have risen sharply. Yields on Treasury securities maturing between October 17 and October 31 rose from around 2 basis points on September 24 to between 20 and 25 basis points on October 8."
He continues, "We saw similar rate spikes in 2011, when a previous stalemate over the debt ceiling brought the U.S. to the edge of default. In the weeks before the 2011 debt ceiling impasse was resolved, yields on maturing Treasury securities rose sharply. The rate on the Treasury bill set to mature on August 4, 2011, climbed from slightly above zero in early July to almost 30 basis points by the end of that month. Even as Congress and the White House averted a default, the confrontation reflected so badly on the nation that Standard & Poor' s felt compelled to issue its historic downgrade of the United States' AAA sovereign debt rating."
Finally, Stevens adds, "The effects of a default would quickly spill beyond the Treasury markets and into the broader economy. As noted, failure to meet interest payments or to redeem maturing Treasury securities could directly hit the finances of those who depend on Treasuries in their cash management -- individuals, businesses, nonprofit institutions, and state and local governments. These entities in turn may struggle to meet their obligations to suppliers and creditors, undermining economic activity and damaging confidence. When the asset valued by millions of investors for its "risk-free" nature suddenly assumes unanticipated risk of illiquidity or default, these investors and others will rapidly adjust their expectations -- and grow increasingly cautious. Rising rates on Treasury securities could be expected to drive up interest rates for other borrowers and increase the cost of capital for corporate issuers and state and local governments. Homebuyers hoping to price mortgages during the default period could face unpredictable swings in rates, and other variable-rate household borrowing could be affected."
Fitch Ratings says in their update, "Fitch: What a U.S. Technical Default Could Mean for Money Market Funds," "Fitch-rated U.S. money market funds (MMFs) hold an estimated $234.9 billion, or about 37% of total assets in exposures to the U.S. government via holdings of U.S. Treasury (UST) and government agency securities as well as reverse repurchase agreements (repos) that are collateralized by such securities. In addition, U.S. dollar-denominated offshore MMFs hold a further $46 billion of exposures, of which $26 billion is via repos. The U.S. Treasury has said that available funds could run out as early as October 17th, absent a debt ceiling increase. Fitch Ratings continues to believe that an agreement will ultimately be reached to end the current political impasse in order to raise the U.S. debt ceiling and avoid a 'technical' default. Nonetheless, it's worth exploring the potential ramifications for U.S. dollar-denominated MMFs should the U.S. government fail to make timely payments on some portion of its debt obligations."
They continue, "Fitch believes the overall risk to MMFs due to a U.S. default to be low. Mark-to-market declines on U.S. government exposures are probably manageable assuming any default is short lived and absent significant redemption activity. In part, this view reflects MMFs' low weighted average maturities and high amounts of short-term liquidity available to meet redemptions. Importantly, MMFs would not be required to sell U.S. Treasury securities in the event of a technical short-term default under Rule 2a-7 of the 1940 Investment Act and under Fitch's MMF rating criteria. Thus, any liquidity pressures would more likely arise from increased redemption activity. So far there is no evidence that investors are taking money out of U.S. MMFs, although this might change as the deadline to raise the debt ceiling nears. U.S. MMFs experienced net outflows of $8.5 billion last week, or roughly 0.3% of the industry's $2.694 trillion in assets under management, after mostly rising for several months".
Fitch explains, "Some of the liquidity MMFs hold, however, is in the form of maturing UST securities and/or short-term repos secured by USTs that help MMFs meet overnight and one-week liquidity requirements. Fitch-rated U.S. MMFs hold $98.4 billion of repos secured by U.S. government securities. Many MMFs rely in part on short-term repos and to a lesser extent direct U.S. Treasury securities as a source of liquidity. A material disruption of the UST-backed repo market would be a credit negative given its size, interconnectedness and importance to MMFs."
Finally, they add, "MMFs with heavy exposure to UST securities maturing in October and early November could be pressured in the face of heavy redemption activity. Fitch understands that many MMF managers have shifted out of US Treasury securities maturing in October that could be most at risk to a debt ceiling impasse. Fitch's rating criteria for MMFs would not require funds to sell UST securities that are in a short-term 'technical' default, provided that payment is expected to be received imminently, and that the MMF has sufficient liquidity to meet redemptions even when excluding the defaulted UST securities. However, a longer-term impasse could put pressure on of the ability of some MMFs to meet timely redemptions and maintain preservation of capital, consistent with Fitch's rating criteria for MMFs, which could have negative rating implications."
