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Capital Markets

Debt Ceiling MMF Impact?

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August 25, 2017

Though past debt ceiling dust ups have been resolved, an unpredictable president adds new concerns for investors.

Tragedy and comedyOver the past 18 months government institutional money market funds saw their popularity soar after new regulations shackled prime institutional funds with a host of unpalatable rules. But as a debt-ceiling deadline looms, it could be government funds that start to lose favor.

The debate over the debt ceiling has become almost a fall ritual, but this time an unpredictable president has investors worried. Will this time be more than the usual Kabuki dance? Will Congress raise the US Treasury’s borrowing authority in time? If not, will the US default on its debt, bringing on downgrades and surging interest rates?

JPMorgan for one thinks ultimately a default is unlikely. “[P]rior debt ceiling debates have never resulted in a technical default, and we do not think it is likely to occur,” the bank said in a Q&A on its website.
And if there were a technical default it might not mean much at first. “Ultimately,” JPMorgan said, “we believe these funds would not be forced to liquidate Treasury securities in a technical default.” However, “the concentration of short-term Treasury exposure in Treasury MMFs suggests these funds are the most susceptible to default-driven shareholder liquidation.” And since Treasury MMF investors “tend to be ultraconservative, liquidation pressure could increase as a potential default grows closer.”

Not that they would be required to liquidate in a default, says JPMorgan: “Neither Rule 2a-7, nor any of the criteria governing rated funds’ investments explicitly requires immediate liquidation upon default. The decision to sell-or-hold would most likely be left to the discretion of the boards of directors of individual funds. In the case of a solvent, high-quality government issuer facing a temporary payment delay, we believe few fund boards would choose to liquidate defaulted securities at distressed levels. Likewise, fund ratings criteria include provisions giving managers reasonable cure periods for dealing with defaulted securities.”

Nonetheless, money market fund investors should be at least wary of what may happen should a default occur. Frank Bonanno, managing director at StoneCastle Partners, agrees that funds wouldn’t be forced to liquidate in the event of a technical default, but any lengthy standoff between congress and the president could spook investors, inducing them to sell. And while many treasurers are staying put for now, he said there has been a shift out of government funds and into other products like bank deposits and structure bank deposits. Products like StoneCastle’s structured deposit, the Federally Insured Cash Account program or FICA, have seen a surge in usage in 2017.

The reason for the popularity of these products at this time is that they’re not pooled, Mr. Bonnano observes. “They’re not like money market funds where big outflows could spook everyone else,” he says.

But if investors are worried, they’re not showing it yet. The Investment Company Institute reported this week that total money market fund assets rose nearly $30 billion to $2.7 trillion for the week ended Wednesday, August 23. This is the fifth week in a row that total MMF assets have risen and the 10th week in a row for prime MMFs.

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