Comments continue accumulating on the SEC's web page for the "President's Working Group Report on Money Market Fund Reform (Request for Comment)". The most recent links to a 236-page work entitled, "Shooting the Messenger: The Fed and Money Market Funds," which was written by Melanie Fein of The Law Offices of Melanie Fein. (We previously mentioned this in a "Link of the Day," but the work has since been updated and submitted to the SEC.) Fein explains, "The Securities and Exchange Commission is considering regulatory proposals that may threaten the future viability of money market funds. Industry members believe the SEC is acting under pressure from the Federal Reserve Board to address Fed concerns that MMFs are "susceptible to runs," part of an unregulated "shadow banking system," and pose a "systemic threat" to the financial system. According to industry members, the Fed's narrative on MMFs distorts the facts and obscures the true sources of systemic risk in the financial system. Some in the industry believe the Fed's attack on MMFs is intended to deflect blame for the financial crisis from itself and the regulated banking industry. Many in the industry surmise that the Fed's ultimate goal is to eliminate MMFs as competitors of banks."

Her "Abstract" continues, "This paper examines the Fed's narrative on MMFs and finds it to be inaccurate and misleading in key respects. Among other things, this paper finds no basis for the view that MMFs are "susceptible to runs." It shows that the "run" that started the financial crisis was not a run on MMFs but a run on bank-sponsored commercial paper during which risk-averse investors fled to MMFs for safety. The "run" by MMF shareholders that did occur in 2008 was caused by the Fed's sudden reversal of its lender of last resort policy that ignited a massive run on the entire financial system."

Fein says, "This paper looks closely at the commercial paper market, which the Fed has said MMFs destabilized, and finds it to be largely an extension of the banking system operating under Fed supervision. The analysis herein strongly suggests that the Fed's overriding concern during the crisis was to prop up banks that had effectively guaranteed their asset-backed commercial paper, which risk-averse MMFs no longer would buy. The analysis suggests that the Fed's liquidity facilities and related regulatory actions that ostensibly benefited MMFs in reality were designed to support banks and the bank commercial paper market and that the bank commercial paper market was the source of systemic risk, not MMFs."

She adds, "Contrary to the Fed's narrative in which MMFs are part of an unregulated shadow banking system that threatens the financial system, this paper shows that banks are the shadow banking system and MMFs are merely the equivalent of its depositors. Moreover, the Fed subsidized the growth of the shadow banking system by lowering bank capital requirements for bank asset-backed commercial paper activities, thereby sowing the seeds of the financial crisis."

Fein writes, "This paper posits that the Fed's proposals for MMFs -- particularly the capital buffer concept -- would force MMFs to act as lenders of last resort to the bank commercial paper market -- a role for which they are not suited and could lead to their extinction. On the other hand, to the extent the bank commercial paper market provides a useful and cost-effective alternative to loans to finance business activity, MMFs offer efficiencies that can assist this important market while providing a much-needed service to investors that banks cannot provide."

Finally, she adds, "This paper concludes that imposing structural changes on MMFs to prevent a future "flight to safety" by MMF shareholders is equivalent to shooting the messenger who brings bad news and would punish investors for their prudent behavior much as if the government imposed a tax on depositors who withdraw their money from failing banks. Further, regulating MMFs and their shareholders to prevent them from acting in a risk-averse manner is a perverse way of preventing systemic risk. It would seem more appropriate for the Fed to encourage MMFs than to thwart them."

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