Money market funds still vulnerable

The looming trial of the Reserve Primary Fund will not have the media-genic quality that the Rajat Gupta trial had, or any of the insider trading trials for that matter. But it will symbolize the plight of the money market fund industry, and perhaps foreshadow what's coming down the pike from a regulatory perspective.

A federal judge issued an order last month denying the requests of the fund's manager to dismiss an SEC suit, making a trial much more likely. The trial would come amid an acrimonious effort by the SEC to pass some new rules for money market funds to make it more unlikely that such a fund would ever break the buck again.

Recall that the Reserve Primary Fund became only the second fund to break the buck, though it eventually made customers basically whole, in the wake of the Lehman Brothers implosion. Reserve Primary was a huge holder of Lehman commercial paper. The SEC has stirred the pot recently by proposing that funds set aside capital to protect against an investor selling stampede and to change their valuation methods to better reflects the underlying assets.

The industry is staunchly opposed to many of the agency's ideas. They note that reforms already passed are sufficient. The Fed has weighed in with a report that notes that money market funds are still vulnerable to "runs" in times of financial stress, a topic that may be timely in light of the Euro-zone crisis. The last thing we need is another crisis in commercial paper market. So the issue remains relevant.

For more:
- here's a Reuters overview
-here's a Breakingviews look at the trial