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By Christine Benz and Eric Jacobson | 08-30-2012 03:00 PM

Key Metrics for Money Market Funds

With the SEC dismissing a plan to reform the money fund industry, Morningstar's Eric Jacobson examines potential risks as well as focus points for investors going forward.

Christine Benz: Hi, I'm Christine Benz for Morningstar. The Securities and Exchange Commission recently scuttled a plan that would have changed the way that money markets funds work. Joining me to discuss the state of the money fund industry is Eric Jacobson. He is director of fixed-income fund research with Morningstar.

Eric, thank you so much for being here.

Eric Jacobson: Great to see you, Christine.

Benz: Eric, let’s discuss what was on the table before the SEC. Among other things, they were considering allowing or requiring money funds' net asset values to float to actually reflect the value of the underlying securities in the money funds portfolio. What other reforms was the SEC reportedly considering?

Jacobson: Well, that's obviously a very big one because part of the goal there was to make things more transparent so people would understand that their net asset values could fluctuate and to protect investors from being left behind if people were to begin redeeming early before 'buck breaking' actually takes place.

The other proposals had to do with requiring money markets to maintain a capital buffer of some kind, which would have been very much like making them into banks, if you will, but that's a tough one certainly. And also they were talking about implementing rules that would require a holdback in the event of redemptions so that the small amount of money that they would be holding back would be a first loss position, if you will, if in fact the fund were to break a buck.

Benz: So, all of this was under consideration to prevent a recurrence of what happened back in the fall of 2008 where one big money market fund, the Reserve Primary Fund broke the buck, meaning that its net asset value did slip below that $1 mark. The idea was that the SEC didn't want any government entities to have to step in and provide a backstop to money market funds as was the case four years ago.

Jacobson: That's right. And I think part of the issue of course, though, was that it wasn't just that they're worried about a single fund breaking the buck, but the potential for what we would call a run on the bank, a run on money market funds, which we sort of had back during the crisis and which was only stopped when the government promised to guarantee against losses which was very much like the guarantee that people already had with their bank accounts.

Benz: So, it sounds like the Treasury Department might be considering what it can do to prevent future situations like the 2008-type environment for money market funds. But in the meantime, Eric, can you address what the risk is, albeit small, for money fund investors? What should they do now?

Jacobson: I would say that in some ways the risks are still the same. It's crucial to remind people that money market funds despite the fact that they are allowed to maintain that $1 mark in their accounting are not guaranteed, and they can lose money. As you said, we've only seen it really happen a couple of times before, but it's especially important now because it's a question of political will. Nobody knows for sure. In fact, we may never see another case again where the government is willing to come in and backstop funds.

That said, I will say that things are a little bit safer than they were prior to the crisis because the SEC has implemented a few changes that have to do with the quality of issues that money market funds can buy. They are restricted to a small amount of lower-quality issues than they used to be, and they've reduced the average maturity requirement from a longer position that it used to be--out at 90 days--now down to 60 days. They made a couple other adjustments that do make money funds a little bit less likely to run into trouble than they used to be, but fundamentally you still have that $1 share issue.

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