What a debt ceiling crisis could mean for money market funds (2023)

Are your money market funds about to be crushed if Congress gets the debt ceiling wrong and the US Treasury defaults on its debt?

In the bleakest of settings, somemoney market associationscould "break the money". It is when a fund's price per share, or its so-called net asset value (NAV), slips below $1. If that happened, panicked shareholders could pull out their money, forcing funds to dump depressed assets at a loss.

A similar scenario played out in the depths of the 2008 financial crisis during the bankruptcy of Lehman Brothers. One money market fund, the Reserve Primary Fund, was unable to meet redemption requests and was forced to cease operations and liquidate.

The hope is that congressional Republicans and the Biden administration can reach an agreement before something drastic happens. According to Robert Reich, former U.S. Secretary of Labor, the predictions of an imminent breach of the debt ceiling and a U.S. sovereign default "pure theater”, all part of the position between the political forces in Washington D.C.

Even if the Treasury defaults, MMF experts point to several reasons why a repeat of the primary reserve fund debacle is highly unlikely.

• A US debt default will affect only a small number of Treasuries, namely those maturing on the date the Treasury's cash is exhausted.
• The Treasury could change the impact of running out of money by paying off certain bills, such as its bonds, notes and bills, while deferring non-collateral payments.
• Many MMFs have had months to reduce their Treasury holdings and replace them with other high-quality, short-term debt from non-Treasury issuers.

Could bankrupt US MMFs default?

To help you understand how a US payment standard may affect yourmoney market fund, here are answers to some frequently asked questions.

When is the US Treasury expected to default?

In early May, Treasury Secretary Janet Yellen told House Speaker Kevin McCarthy that the United States could stop paying as early as June 1 if Congress does not do so.raise or suspend the loan limitbefore that date.

Are all MMFs equally at risk of potential default?

No. According to Peter Crane, chairman of Crane Data, which publishes data on money market funds, only funds that have debt that the Treasury actually defaults on will be directly affected.

"Probably only non-paying T-bills would see their prices fall, so even a technical default would probably not cause anyone to lose investments."

By "technical breach" Crane means a temporary and limited breach. Under this scenario, only a few US Treasuries would remain unpaid, and only for a short period of time.

Which money market funds are most exposed?

Money market funds whose portfolios consist entirely of US Treasuries would be most at risk in a debt ceiling crisis.

"The most exposed are 100% treasury funds, which cannot change their investments or generate liquidity through the use of repurchase agreements or 'repos,' or purchase securities from government agencies, commercial paper, certificates of deposit or other short-term debt options," says Crane.

By "100% Treasury funds," Crane means money market funds whose prospectus mandate allows them to invest only in government bonds.

Another category consists of funds that may contain government bonds in addition to other securities. Yet another category consists oftax-free municipal bonds, while a broad fourth category only invests in corporate bonds.

How many 100% own funds are there?

Crane tracks 881 funds. Of those, 220 are 100% government funds or funds that hold government bonds plus debt from government agencies.

Has the US Treasury ever defaulted?

The US has never really defaulted on its debt (there was a minor technical incident in 1979, discussed below). But this is not the first debt ceiling crisis, and unfortunately probably not the last. When considering the potential impact of a US sovereign default, it is helpful to understand the debt ceiling crises of the past.

How close did the US come to standard in 2011?

Very close to. As now, the impasse on the US debt ceiling in 2011 was caused by sharp partisan disagreements over spending and budgeting. The close call in 2011 triggered the first downgrade in the history ofUS sovereign credit rating. It also triggered a major stock market sell-off.

Has the Treasury ever defaulted before?

"The only time the U.S. 'technically' defaulted was in 1979, when a delay in word processing resulted in a late payment on maturing U.S. Treasury bills," wrote Robert Abad, former fund manager and current product specialist for Fixed Income Asset Manager Western Asset. .

To prevent default, Congress raised the debt ceiling 78 times since 1960, 49 of which were under a Republican president, 29 under a Democratic president.

What's different about the debt ceiling this time?

"Today's overcharged political partisanship, with Republicans controlling the House of Representatives and Democrats controlling the Senate and the White House, has only served to heighten market concerns that we may not see a political compromise on the debt ceiling," writes Abad. "This fear partly explains the recent increase in US credit default swap spreads."

How Much Government Debt Do MMFs Have?

According to Crane Data, US money market funds had April 30 $1.467 trillion in US Treasuries.

How are money market funds protected?

Money market fund managers and large institutional investors are already taking steps to prepare for a potential US default, however unlikely.

Is the demand for credit default swaps increasing?

Credit default swaps, commonly known as CDSs, are one typederivative contractwhich large institutional investors use to hedge their bond holdings. Think of CDS as a convenient form of insurance for your bond investments.

Right now, demand for CDS is increasing, showing that large investors are buying more insurance on their US Treasuries, most likely because they want to protect themselves against the possibility of a US default. To say that spreads have increased on CDS means that their rates have increased.

What does the increased demand for CDS tell us?

According to Ed Fitzpatrick, head of US fixed income strategy at J.P. Morgan Asset Management, investors say they believe political risks are higher now than they were during the 2011 debt ceiling crisis.

"Investors see the political context as more partisan than it was in 2011," says Fitzpatrick. "It costs relatively more to buy swaps now than in 2011. Since swaps are a kind of insurance against the risk of missing or late payments and defaults, it suggests that investors are more worried about missing or late payments than before. 2011."

How eager are investors to avoid the June 1 and slightly later period?

"Dividends in Junetax lettersthey are much higher than bills due before the debt deadline and later in the year, even after adjusting for expected Fed policy actions,” says Fitzpatrick.

Investors appear to be looking for a premium, an additional increase in their returns, of around 1%, he says. However, he adds that it is difficult to know how much of the difference is due to debt ceiling concerns and how much is due to seasonal tax considerations.

What steps are money market funds taking now?

The funds have reduced their treasury holdings. They have replaced other reliable short-term debt and also bought reverse repurchase agreements, so-called "repos."

Reverse repurchase agreements are contracts with another entity, such as the Federal Reserve, that need cash for a short period of time, such as overnight or up to 48 hours.

The borrower, the Federal Reserve says, pays interest and offers collateral, such as longer-dated Treasury bills. As a practical matter, neither will mature around the potential default dates.

Are MMF shareholders worried?

The experts we spoke to say that shareholders' concerns about the safety of their money market funds when they arise are allayed.

"Anecdotally, the most common reaction we've seen to this situation so far is, 'So what?'" said Andrew Schrage, co-founder and CEO of MoneyCrashers.com.

Aren't money market fund shareholders panicking for the exits?

No foundation we've spoken to reports that callers support lines who seem angry or scared. Shareholders in money market funds with Federated Hermes, a large fund complex, assume the fund group knows how to protect its money market assets.

"We have conversations with clients who are asking thoughtful questions about the debt ceiling and what's going on in Washington," says Susan Hill, head of the government liquidity group for the Federated Hermes fund family. "Because we are conservative money managers, they want to know that we have contingency plans and a thought process in place."

Financial advisor Ric Edelman says the vast majority of consumers are unaware of this situation. He also believes that most financial advisors don't know either.

"Yes, I get emails from my podcast listeners asking if they should get their money out of banks and into bitcoin," Edelman says. "I find it amazing that people would consider Bitcoin to be safer than an FDIC-insured bank account. But given what's happened in the last few months, this reaction is understandable, even if it's wrong."

The last word

Some people may worry that all this uncertainty could make government bonds permanently more expensive. Joe Lieber, director of research at CRFA Research, shared his view of what's really going on behind the scenes of the debt ceiling crisis.

"Remember, this doesn't happen because you have someone who can't pay their debt," Lieber says. "It's because the two 'guys' [Democrats and Republicans] who control the purse strings aren't willing to pay up. Once they work out their differences, things should go back to normal."

In other words, Lieber does not expect government bonds to incur additional costs to compensate investors for additional ongoing risk.