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By Christine Benz and John Rekenthaler | 06-06-2013 03:00 PM

Rekenthaler: Money Funds Still Good Investments

Regardless of which SEC money-fund reform gains approval, retail investors will still find safety in this asset class, says Morningstar's John Rekenthaler.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The Securities and Exchange Commission recently issued a few proposals related to money market funds. Joining me to discuss them is John Rekenthaler. He is vice president of research for Morningstar. John, thank you so much for being here.

John Rekenthaler: Thank you, Christine.

Benz: John, let's start with a little bit is stage-setting. Let's talk about why the Securities and Exchange Commission is looking at the money market fund industry, and why it thinks that perhaps some tighter regulations are in order?

Rekenthaler: Sure. It takes us back to 2008, as so many things do. That was a momentous year for money market funds where the Reserve Primary Fund broke the buck, as the saying goes, in owning Lehman paper back in the September 2008. At the time it started a bit of a run on money funds and exacerbated the financial panic. So the SEC, obviously, in many ways across the board does not want to see 2008 repeat, and the run on money funds that was a part of that panic would be one of the issues that the SEC and Washington regulators have been looking at ever since.

Benz: Just to back up, "break the buck" means that the net asset value would actually drop below $1.

Rekenthaler: That's right. Money market funds historically have a fixed asset price of $1 per share. They do not float, that's why they feel like money in part, or cash. The Reserve Primary Fund, because it owned Lehman Brothers commercial paper and Lehman went bankrupt overnight, was forced to mark down its assets to I believe it was $0.98. So, it wasn't substantially less than $1. But it was less. It surprised people. They didn't expect it, and they bailed out of that fund in a hurry and started looking at other funds. As you know in a financial crisis, panic begets panic, and the Reserve Primary Fund and the money market system was a part of that panic.

Benz: So, the SEC has been looking at the industry. There have been a few tightened regulations over the years. The recent set of proposals take a look at a couple of different areas. The one area in the proposal relates to institutional prime money market funds. Let's talk about what they are and how they might be different from the funds that retail investors might hold.

Rekenthaler: I want to take a step back here, too, and set the context. There were proposals that were floated last year for all kinds of mutual funds for every flavor, not just institutional prime. And they did not pass within the SEC. The SEC staff had come up with them and recommended them, but the SEC Commission has voted 3 to 2 against it. So there has been dissension within the SEC. There's also been an enormous amount of political pressure on it. The banking industry has a strong view on this subject. The mutual fund industry has a strong view on this subject. And Congress has a various people with views. So there has been a lot of pressure, and what one might term a bigger solution that was proposed last year was shot down.

The [recent activity] is a retreat and more of a compromised solution where the proposal is to take a segment of the money funds and say, "We'll let those net asset values float, but other money funds we will treat as in the past." So, I look at this as something of a retreat from the strong reforms that were proposed. Now it's a partial reform. And it's a sign the Investment Company Institute, the mutual fund trade organization, is now happy with the proposal, as opposed to previous ones that they were unhappy with.

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