USA Today featured an article recently called, "You Don't Want Surprises from Your Money Fund." It's a basic overview of money funds with commentary on potential SEC reforms by columnist John Waggoner. Writes Waggoner, "Why are they so popular? In large part, because they're convenient. Many money funds let you write checks on them, just as you would a bank checking account. If you decide to sell shares of stock, you can park your proceeds in a money fund until you decide what to do with them. And if you're a big institution, buying shares of a money fund can be more convenient than, say, purchasing money market securities on the open market." It goes on, "What, then, is so ominous about a money fund? The funds invest in short-term, high-quality IOUs, such as Treasury bills, which are short-term loans to the government, and jumbo bank CDs, which are short-term loans to the nation's largest banks. No one is particularly worried about those investments. But some funds -- known as "prime" funds -- invest in an array of other short-term loans that are normally safe. The key word here is "normally." The day after Lehman Bros. declared bankruptcy, the Reserve Fund, a large, prominent money fund, announced that it couldn't keep its share price at $1 -- it had, in Wall Street parlance, "broken the buck." The reason it had broken the buck was because it held a fair amount of short-term Lehman Bros. IOUs, called commercial paper. Those IOUs were problematic, at best. And once word had gotten out, institutional investors sold shares like they were annoyed scorpions." The piece continues, "The SEC has proposed a floating share price for institutional funds, if only to disabuse investors of the notion that money funds are risk-free. The rules wouldn't apply to retail funds, or those that simply invest in U.S. government securities. An alternative would be restrictions on withdrawing money from money funds in times of crisis -- probably a more onerous requirement, since the time you need money most is during a financial crisis. The SEC is expected to vote on the proposal on July 23, and it's by no means a lock, given the powerful mutual fund industry's vehement opposition to it. If the SEC does adapt any of the proposals, here's what you need to keep in mind: Money funds aren't insured, and they never have been. The potential loss from a money fund is small -- the Reserve Fund's share price fell to 97 cents, a 3% loss -- but it does exist. If you can't stand the possibility of a loss, invest in a federally insured bank account, and mind the limits on Federal Deposit Insurance Corp. coverage. Banks fail, too. Some day, short-term interest rates will rise again, and money market funds will look more appealing than they currently do." See also, Bloomberg's "Money Funds Get New Restrictions Aimed at Preventing Runs".
