Debt-Ceiling Standoffs from Years Past

We have watched this game played several times before. In the past, the hullabaloo has not really amounted to much—the debt ceiling got raised and we all went on with our lives. But let's not be naive about it. If the debt-ceiling impasse continues and the United States even approaches the line where the government cannot pay its bills, that will directly affect the value of many investments. Government money-market mutual funds (MMFs), inclusive of U.S. Treasuries only, face the most risk.

Closer to home, corporate treasurers may find their company's board responding to the headlines by asking what steps the treasury team is taking to fortify their cash buckets.

Consider what happened in the summer of 2011, when the specter of a default on U.S. Treasury debt contributed to turmoil in the financial markets. There were other factors in play as well, including S&P's historic downgrade of U.S. debt and the Eurozone crisis. But investors' reaction to the debt-ceiling standoff that summer was at least partially responsible for the significant market volatility—at least until resolution on the debt ceiling was reached.

Money-fund assets dipped more than 10 percent in the crisis, as investors tried to avoid exposure to U.S. debt. Today, as money funds are near historic highs—north of $5.6 trillion in 2023, according to Crane Data, and about double in size compared with 2011—this has the potential to become a "buyer beware" moment.

Over the past few years, government funds have seen a massive influx of investors seeking safety and yield. This increased demand could result in some unintended consequences if liquidity, and thereby pricing, issues emerge in the debt-ceiling standoff. A 10 percent dip in value for MMFs, similar in size to what happened in 2011, would wipe out all the record inflows that have come into money funds this calendar year.

Diversification 101

Meanwhile, what happened to Silicon Valley Bank is still fresh on everyone's minds. The sixteenth-largest bank in the country was driven out of business by customers' panicked liquidity run, reminding us that the behavior of some—it doesn't have to be many—can lock others into some precarious situations. The time-tested solution—or, at the very least, a mitigator of the pain—is always diversification.

Using diversification to protect a corporate treasury from the looming debt-ceiling crisis goes beyond just making sure the organization has no T-bills maturing around the time of a potential U.S. default. It also involves evaluating concentration risk in government money funds, with their inherent potential for panic withdrawals.

In addition to warnings from Yellen, Fitch, RBC Bank, and many others, the Federal Reserve Bank of Kansas City notes in a recent report that, although yields have historically shot up in the weeks prior to a potential government default, in the two weeks leading up to 2013's debt-ceiling resolution, investors in government funds triggered large outflows. And given the aforementioned run-up in government-MMF assets in 2023, "liquidity swings could be larger and more destabilizing today."

Treasury professionals' mettle is tested when they must balance safety and liquidity against yield and the increasing emphasis on volatility risk. Low risk can blend slowly into medium risk without much fanfare, so risks may go undetected. Right now, we are clearly in a situation of medium risk, with the potential to thrust into high risk in the blink of an eye. Whether real or merely perceived, a panic could create a destructive reality—and the weight would land squarely on those left holding the bag.

For the next few months, treasury teams should consider a rebalancing act that reels in any over-concentration creep. They should look at reaching deep into their diversification bag to incorporate solutions that may be less impacted, or even unaffected, should a government default occur. Structured bank products that introduce high levels of FDIC insurance on portions of the company's cash may make sense.

Between money funds, commercial paper (CP), direct Treasuries, repurchase agreements (repos), individual bank relationships, and structured bank products, there is no one solution that meets a treasury's needs. Instead, these investments offer a neat supply of options, tactics, and combinations that treasury groups can dial up or down as events unfold. Incorporating a broad diversification into your organization's cash holdings will enable you to make clear to the board that you are taking the actions necessary to mitigate headline risks.

As Bart Mancuso reminds us with poise from a tense Red October, playing chicken is not for the faint of heart. When politicians have the helm of the ship, it usually makes sense to keep open some alternatives to a head-on collision.

See also:

• Debt-Ceiling Deadline Tracker
• U.S. Credit Rating at Risk of Cut
• Treasury May Run out of Cash as Soon as June 1
• Regional Bank Fears Spur Haven Buying
• Powell Is Sounding the Alarm on the Debt Limit—Again

Frank V. Bonanno is the managing director and head of marketing for StoneCastle Cash Management LLC, a provider of FDIC-insured deposit solutions for treasury professionals in Fortune 500 and midtier companies, public funds, family offices, endowments, and foundations. You can learn more at stonecastle.com.