U.S. Default Poses Minimal Risk to Money Funds, Fitch Says

Rating agency says funds have cut their holdings of the Treasuries that would be most immediately affected.

Money-market mutual funds can cope with a short-term default in U.S. Treasuries as long as it doesn’t trigger the kind of investor run that followed the collapse of Lehman Brothers Holdings Inc. in 2008, according to Fitch Ratings.

The funds have reduced their holdings of Treasuries that would be most immediately affected by the failure of the U.S. to extend its borrowing capacity, and have high levels of short-term liquidity, the ratings company said today in a report and in an interview. Fund managers wouldn’t be forced to sell Treasuries in the event of a default and would be free to continue buying non-defaulted Treasuries, said Roger Merritt, managing director of fund and asset management at Fitch.

“Mark-to-market declines on U.S. government exposures are probably manageable assuming any default is short-lived and absent significant redemption activity,” according to the report, which Merritt wrote with two colleagues.

Money-market funds give millions of households, companies and other institutions a safe parking spot for cash and channel $2.5 trillion to issuers of short-term debt including the U.S. government, financial institutions and companies. A run on funds that hold corporate debt after the collapse of Lehman Brothers in September 2008 helped freeze global credit markets.

U.S. money funds held about $475 billion in Treasury securities as of Aug. 31, and an additional $156 billion in repurchase agreements collateralized by Treasuries, according to research firm Crane Data LLC in Westborough, Massachusetts. Crane Data estimates that about $74 billion in Treasuries held by money funds matures from Oct. 24 to Nov. 15.

Assets in U.S. money funds declined by $9.4 billion, or about 0.4 percent, in the seven days through yesterday as clients pulled money, according to data compiled by research firm iMoneyNet, also based in Westborough. Institutional funds that focus almost exclusively on debt backed by the U.S. government dropped $14.4 billion, or 2 percent of assets.

Money-fund assets can be influenced not only by market conditions but also by corporate deadlines, such as those for making payroll or paying taxes.


‘Simple’ Lesson

Republican lawmakers in Washington have refused to approve new funding for the U.S. government, triggering a partial shutdown of operations since Oct. 1. They have also vowed not to approve an increase in the government’s debt limit unless President Barack Obama and his Democratic Party agree to change the Patient Protection and Affordable Care Act of 2010, known as Obamacare. Treasury Secretary Jacob J. Lew has said “extraordinary measures” to avoid breaching the debt limit will be exhausted no later than Oct. 17.

Paul Schott Stevens, president of the Investment Company Institute, a Washington-based trade group representing mutual fund companies, urged Congress to resolve the standoff before a default in the text of testimony he plans to deliver tomorrow to the Senate Banking Committee.

“Once Treasury has exercised the option to delay payments, investors will learn a lesson that cannot and will not be unlearned -- even after all missed or delayed payments have been made good,” Stevens said. “That lesson is simple: Treasury securities are no longer as good as cash.”

Stevens said funds regulated by the Investment Company Act of 1940 hold $1.7 trillion in securities issued by the Treasury and U.S. government agencies.

Most fund managers, Fitch’s Merritt said, have been working to boost the level of assets that can be quickly turned into cash and handed back to clients who wish to withdraw. Fitch-rated funds that are eligible to purchase corporate debt held an average 26 percent in assets maturing in one week or sooner, excluding Treasuries, the firm said.

Managers are also moving out of Treasuries most susceptible to a default, Merritt said.

“We have avoided maturities in the time period toward the end of October,” Nancy Prior, head of money funds at Boston-based Fidelity Investments, said in an interview. Fidelity is the largest manager of U.S. money funds with $427 billion in assets as of Aug. 31, according to Crane Data.

Bill Gross, who runs the world’s biggest bond fund at Newport Beach, California-based Pacific Investment Management Co., said he is doing the opposite of Fidelity.

“Fidelity sells, Pimco buys,” Gross said today in a television interview on CNBC.

Pimco doesn’t believe the Treasury will default, he said.

Money-fund managers would be the most compelled among owners of Treasuries to sell in the event of a default, according to two-thirds of respondents to a survey conducted Oct. 7 to Oct. 9 by Citigroup Inc. About 40 percent said they expect central banks, money managers and insurance companies to face pressure to sell.

In yesterday’s trading, Treasuries fell and rates surged on bills maturing on the Oct. 17 deadline projected for when the U.S. reaches its borrowing capacity as investors avoided the securities with the risk of default rising.


Bloomberg News


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