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The Impact of The Debt Ceiling on the Money Market

Of the many possible negative consequences that will result if the U.S. Government fails to raise the debt ceiling, the effect it could have on any individual with a money market account is significant. As the deadline continues to approach, there is growing concern that there may be a “run” on these accounts, as investors attempt to convert their funds to cash while they still can. The other significant impact that is possible is that a failure to raise the debt ceiling could trigger a downgrade in the quality of U.S. debt. This move will in turn cause interest rates to rise sharply, driving down the value of the assets that might typically be held in a money market account or fund.

Run on the Bank

Without needing to understand the specific mechanics of the fallout, there is mounting concern that many Americans will prefer to hold cash going into the deadline. A prime source of this cash for a typical individual may be his or her money market account. These accounts are typically used to hold short-term funds, as they offer more competitive rates than most savings or checking account, but still provide limited check writing privileges; they are a natural source of demand assets. As the deadline grows near, individuals, fearing a lack of future availability, may try to raise cash by liquidating (or reducing the size of) these accounts. If this happens in large enough scale, there will be an impact.

Declining Asset Values

The immediate impact of the debt ceiling issue, should it not be resolved, is that the rating agencies are likely to lower their rating on U.S. Government guaranteed debt – given the decreased ease of the government honoring its debt and paying. If the rating is lowered, interest rates rise and asset values decline (it is important to remember there is an inverse relationship in the fixed income world between prices and rates). With a lower rating, an investor will demand a better return in order to be willing to hold the asset. What this means for instruments, like those held in money market funds, with a fixed interest rate is that to create an “effective rate” that is in keeping with the rates prevailing in the market, the price must be reduced. The money market is estimated to hold an estimated $1.3 billion in debt that would be affected by a ratings decline. The impact that this could have on the industry, and the economy in general, is significant.