BOSTON/NEW YORK (Reuters) - A failure by Washington leaders to raise the federal debt ceiling by next month could test whether new regulations have made money market mutual funds more robust.
With $2.7 trillion in assets, money funds play a key role in the financial system as purchasers of corporate and government debt used to fund short-term operations. Some funds’ managers were rattled when past debt showdowns cast doubt on the payment schedules of U.S. Treasury securities they held, though investors ultimately stayed with the funds.
Now Republicans in the U.S. Congress are once again resisting requests to raise the federal debt ceiling, leading to concerns the U.S. Treasury Department might not have enough cash to make interest payments due mid-November. The Treasury on Thursday decided to postpone a scheduled auction of two-year notes, citing the borrowing limit.
The threat of payment interruptions has already caused one-month T-bill rates to jump temporarily. This time, industry analysts say, money funds could face an extra squeeze because of reforms passed in 2014 that have sponsors converting funds into ones that hold more government-backed debt, which in the worst case could lose value if Washington seizes up.
More than $200 billion in funds are in the process of conversion, according to Peter Crane, who tracks the money-market industry, potentially shifting assets to the area that could be affected by a protracted debt-ceiling battle.
“If you have a debt showdown, the new rules are going to raise the risk,” said Crane, publisher of the cranedata.com website. On the other hand the government money funds did not face big withdrawals during prior debt debates, a record Crane said could reduce the stakes for the industry this time around.
Still the situation is a somewhat ironic outgrowth of new rules going into effect in 2016. These were passed with an eye to strengthening so-called “prime” funds for institutional investors that hold a wide range of debt, including corporate paper, and which caused the biggest problems during the financial crisis.
Starting next year these funds will allow their net asset values to vary, or float away from the traditional $1-per-share mark, as a way to get investors used to day-to-day fluctuations. Regulators allowed safer-seeming government funds to keep their traditional $1 per share value, however. They also exempted those funds from new rules that give fund boards new powers to limit withdrawals in times of stress, unless the government funds previously disclosed those abilities to investors.
Because investors prefer the fixed value and dislike withdrawal limits, funds including the $116 billion Fidelity Cash Reserves Fund have begun to convert from prime funds into government funds that are limited to the likes of treasuries and debt issued by agencies such as Fannie Mae and Freddie Mac. This potentially exposes more assets to Washington’s foibles.
As of Sept. 30, the Fidelity fund had 41 percent of its portfolio in U.S. government agency paper, up from 12 percent in June, though it has reduced its holdings of Treasuries to 4 percent from 6 percent in June.
Fund analysts say another issue is the leeway given to government fund sponsors on whether to assume new powers to limit withdrawals, which could leave their hands tied in a crisis.
Fidelity and Federated Investors Inc have said they will not adopt the new limits on certain funds, and pledges like those “remove some potential arrows from the quiver that you might want to use in a moment of overwhelming stress,” said Barry Weiss, director for Standard & Poor’s Ratings Services.
Deborah Cunningham, Federated’s chief investment officer for global money markets, said other SEC rules would still enable the funds to limit withdrawals in a crisis.
She also noted how institutional money fund holdings of Treasuries and other government securities have not changed much since 2013, suggesting the new rules have not had a big impact on the market. Lipper data shows institutional government money funds held $327 billion at Sept 30, down from $349 billion at the end of October 2013, for instance.
“The impact of the reforms has not been felt from a supply-demand perspective,” Cunningham said.
Fidelity spokeswoman Sophie Launay said its policies reflect the preferences of its investors who want access to funds with stable asset values and not subject to withdrawal limits. Of the debt ceiling debate, she said, “We closely follow market events and developments. We are comfortable with the positioning of our money market mutual funds.”
Fund analysts and executives say it is hard to predict exactly how disruptive events in Washington could become, and most still expect some type of deal. Jerome Schneider, head of the short-term and funding desk at Pacific Investment Management Co., said money managers learned from previous crises to avoid risky securities and said high demand for Treasuries should stabilize money markets.
A problem for any fund manager would be if the value of holdings like Treasury bills declined because of missed government interest payments, said Greg Fayvilevich, a Fitch Ratings director.
A manager holding those securities, he said, either would have to take a loss or hold them and hope for a quick resolution. “It will be a dilemma,” Fayvilevich said.
Fitch pointed to the $9.3 billion Vanguard Admiral Treasury money market fund as one exposed to a debt-ceiling fight, with 44 percent of its portfolio invested in Treasuries maturing in November, including $1.6 billion of notes maturing Nov. 15.
Vanguard spokesman David Hoffman said the company is monitoring the situation in Washington, saying: “We remain confident in the prudent and conservative approach to managing our money market funds.”
Reporting by Ross Kerber in Boston