Why is the debate over of the U.S. debt ceiling and deficit relevant to money market funds?

Failure to increase the U.S. debt ceiling or address the long-term U.S. spending and fiscal imbalance could adversely affect investors, markets, and economies across the globe—with severe consequences for interest rates, stock prices, investor confidence, and the day-to-day activities of businesses and consumers.

Money market funds are required to invest only in short-term, highly liquid securities that present minimal credit risk. As of August 31, 2013, money market funds owned $831 billion in U.S. Treasury and agency securities—and held another $452 billion in repurchase agreements collateralized by Treasuries and agencies. Because these amounts are large, it is important to understand how a Treasury default or downgrade could affect financial markets.

For more information on money market funds, please visit our Money Market Fund Resource Center .

Would a downgrade of U.S. Treasury debt affect U.S. money market funds?

That depends on many factors. One of the most important is whether any downgrade affects only the government’s long-term credit rating, or applies to both long-term and short-term debt. A money market fund’s ability to purchase or hold a rated security depends on the issuer’s short-term credit rating.  If the U.S. government’s long-term credit rating were to be downgraded, but not its short-term credit rating, there would be no implication for money market funds.  If the U.S. government short-term credit rating were downgraded, money market funds might be affected, but likely only if the short-term credit rating dropped below “investment grade.”

In 2011, rating agency Standard Poor’s lowered its long-term sovereign credit rating on the United States from “AAA” to “AA+” with a negative outlook. Importantly, it maintained its “A-1+”—the the highest possible short-term rating—on the United States. The two other major ratings agencies—Moody’s Investor Services and Fitch Ratings Ltd.—have, for now, kept their rating on the United States at “AAA,” the highest possible rating.

Would a downgrade in the short-term credit rating of the U.S. government force money market funds to dispose of their holdings of Treasury debt?

That’s unlikely. Credit rating agencies would have to cut their ratings on short-term Treasury debt steeply—reducing them by at least seven steps on the long-term rating scale—to force such an action. 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 at least eight steps, from AAA/Aaa to BBB+/Baa2 (see table below) for Fitch and Moody’s and at least seven steps for SP.

A security rated by multiple credit-rating agencies designated as Nationally Recognized Statistical Rating Organizations (NRSROs) is eligible for purchase by money market funds if two or more of those NRSROs rate the security in either their highest (“first tier”) or second-highest (“second tier”) short-term rating levels. The U.S. government’s short-term debt is currently rated as first tier by all of the NRSROs that have issued short-term ratings.

A downgrade of U.S. government short-term debt from first to second tier would not preclude money market funds from purchasing or holding U.S. government securities. Nor would it require money market funds to sell their current holdings of Treasury or agency securities.

What credit ratings correspond to first tier and second tier for money market funds?

Moody’s Investor Services uses “P-1” and “P-2” as its symbols for the two highest short-term ratings categories. Standard Poor’s Rating Services uses “A-1+” and “A-1” for first tier and “A-2” for second tier. Fitch Ratings Ltd. uses “F-1+” and “F-1” for first tier and “F-2” for second tier.

The following table shows how these major credit rating agencies align their long-term and short-term ratings, and which short-term ratings constitute first tier and second tier: