One of the worst possibilities that people in the financial industry, like Mr. Lengsfield, have been discussing is that scores of insurance companies, pension funds and mutual funds might be forced to dump their Treasury holdings. Some investors have rules that they cannot hold assets that are rated below AAA. It was this sort of rule that drove the forced selling of mortgage bonds during the financial crisis.
But in some cases, Treasurys may be exempt from the AAA rules.
Deborah Cunningham, who oversees $271 billion in money market funds at Federated Investors in Pittsburgh, said the funds themselves—even the Treasury-only money funds—would not be pressured to dump their holdings if there were a downgrade. Securities and Exchange Commission regulations say only that the funds have to invest in Treasurys, not that those Treasurys must be triple-A rated, she said.
Several weeks ago, Ms. Cunningham put plans in place to deal with a default. The firm will convene a teleconference with the boards of affected funds, she said, and, she is considering arguing for holding onto the federal debt.
“We have to justify to the board why we would want to continue to hold them, which might be because they are a high-quality, minimum-risk security,” Ms. Cunningham said.
This shouldn't be surprising. Regulations just assume that U.S. government obligations are automatically the highest quality that exists. They don't make the U.S. government hostage to ratings agencies.