Debtpocalyse for Money Markets? Don't Bet on It

Let's say the ratings on short-term U.S. government securities get cut? Does that trigger a mandatory sell-off? Probably not.

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Money market funds are required by law and by their own charters to hold only high-quality securities. So if the ratings agencies downgrade the credit of the United States, will they have to sell their Treasury holdings?

This is a question that quite rightly has investors nervous. Money market funds are major holders of U.S. Treasuries. If they were all forced to suddenly dump their Treasury bonds because of a downgrade, the market would be flooded, prices would tumble and markets would become quite chaotic.

Fortunately, this fear is overblown. The SEC's regulations for money market funds do include a rating requirement for money market fund investments--but that requirement is so loose that it is unlikely to trigger a forced sell-off.

The first place to start is to notice that all that matters is the short-term credit rating. This is the rating that might be downgraded if the U.S. doesn't reach a deal to raise the debt ceiling, making a quick default likely. The latest noises out of Washington, D.C., indicate there's almost no chance of that happening.

A downgrade of the US government's long-term credit rating might come about if Moody's or S&P decide that the debt ceiling deal plugs a short term hole in our budget while not addressing the issue of sustainability. This might have other market effects, but it won't trigger any regulatory requirement for a money market fund sell-off.

All that matters is the short-term credit rating, as far as the regulations are concerned.

But let's say the ratings on short-term U.S. government securities get cut? Does that trigger a mandatory sell-off? Probably not.

The regulations say money market funds can purchase securities that agencies rate in their highest (or "First Tier") or second-highest (or "Second Tier) rating levels. Those tiers each include a number of ratings. The First Tier starts at AAA and goes all the way down to single A, in S&P's categorizations. The Second Tier goes all the way down to BBB.

Here's a helpful chart from the Investment Company Institute that shows the ratings levels eligible and ineligible for acquisition by money market funds.

The ICI adds:

Downgrading the U.S. government's short-term rating below Second Tier would be the equivalent of taking its long-term credit rating down by approximately eight steps, from AAA/Aaa to BBB+/Baa2. Indeed, even to reach Second Tier, a downgrade must be equivalent to taking the United States' long-term credit rating down by approximately six steps. None of the discussion by major credit rating agencies has contemplated a downgrade of U.S. government debt of that magnitude.

In short, there won't be a forced sell-off unless the short-term debt of the U.S. government gets downgraded much, much further than anyone imagines.

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John Carney is a senior editor at and the host of the blog NetNet.

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