In just the third entry of 2014 on the SEC's "Comments on Proposed Rule: Money Market Fund Reform; Amendments to Form PF" website, counsel Melanie L. Fein of the Fein Law Offices posted a comment paper entitled, "Missing the Mark on Money Market Funds. Fein writes, "Shortly after the financial crisis five years ago, senior Federal Reserve officials began a concerted campaign to blame money market funds ("MMFs") for the crisis and otherwise discredit the MMF industry. These officials argued, among other things, that MMFs were unregulated, part of a leveraged "shadow banking system," engaged in risky investment activities, prone to runs, a threat to the ability of banks to provide credit, and a source of instability in the financial system as a whole. These arguments went through various iterations, each of which, when examined closely, proved wrong. None of the arguments were supported by empirical data or credible economic arguments, and Federal Reserve officials lately have toned down their rhetoric on MMFs."
She explains, "Nevertheless, the Federal Reserve Bank of New York, in an apparent attempt to remedy the analytical deficiencies in the central bank's unseemly attack on MMFs, recently publicized the results of a study on MMFs by its economists. The study examines what the theoretical impact on the banking system might be if MMFs were the only depositors of banks. This implausible scenario is referred to by the economists as a "MMF-intermediated" banking system as opposed to the present "direct finance" banking system whereby banks receive deposits directly from individual, corporate and other depositors. The results of the Reserve Bank Study were highlighted on the Reserve Bank's economics blog. The Study, entitled "The Fragility of an MMF-Intermediated Financial System," (by Cipriani, Martin, and Parigi) concludes that a MMF-intermediated banking system can be "particularly fragile" and "more unstable" than a direct finance system."
Fein says, "The Reserve Bank Study appears intended to prove the following hypothesis: MMFs hold significant amounts of uninsured bank deposits that, if suddenly withdrawn by MMFs en masse, would be more destabilizing to the banking system than if individual and corporate depositors suddenly withdrew their deposits. The reason for this, the Study posits, is that MMF shareholders who become aware of adverse information about a troubled bank signal such information to MMFs by redeeming their MMF shares. The MMFs in turn react by withdrawing additional deposits from the bank, thus triggering larger withdrawals from the bank than would otherwise occur, exacerbating instability at the bank and the larger banking system."
She explains, "Apart from the improbability of the underlying scenario in which MMFs are the only holders of bank deposits, the Reserve Bank Study is based on assumptions that are demonstrably wrong. Among other things, MMFs at present do not hold any systemically significant amount of U.S. bank deposits. Thus, the central premise of the hypothesis is critically flawed."
Fein tells us, "A troubling implication of the Study is the suggestion that MMFs or other investors should not respond promptly to information indicating problems at a bank. Rather, according to the Study, it would be less destabilizing to a troubled bank and the rest of the banking system if depositors exercise "patience" and withdraw deposits "gradually." The Study does not envision ways of enforcing depositor patience or gradual withdrawal of deposits from a faltering bank -- an exercise fraught with difficulties."
She continues, "The Study reflects an exceedingly narrow range of financial regulatory considerations. Among other things, the Study fails to give any credence to market discipline as a check on undue risk-taking and unsafe and unsound practices by banks. The Study ignores the dangers of "moral hazard" by taxpayer-subsidized banking organizations operating free of market restraints. It fails to consider the potential for increased systemic risk in the financial system if uninsured deposits at "too-big-to-fail" banks grow in the absence of MMFs. Nevertheless, the implied suggestion is that depositors should bear more risk of loss in a failing bank situation than they do now. However, any action to impose more risk on depositors would require a radical change in national banking policy and affect depositor behavior in unpredictable ways, with potentially severe implications for banking stability that are not addressed by the Study."
Fein also writes, "Most importantly, the Study assigns no value to the regulatory framework under which MMFs operate that makes them safer investments than bank deposits for many investors. The Study aligns with other Federal Reserve studies that view the transparency of MMFs as a threat to banking stability, contrary to the disclosure-based regime of securities regulation. The Study reflects the bank-centric view -- inherent in comments of senior Federal Reserve officials -- that MMFs and their investors are second-class citizens in the financial world, whose interests are subordinate to those of banks and bank shareholders. Under this view, MMFs are mere props to support the regulated banking industry, not efficient investment vehicles that exist independently to meet important investment and liquidity needs in the financial system."
Finally, she adds, "This paper discusses these and other flaws in the Reserve Bank Study and shows why the Study fails to provide credible support for regulatory changes that would diminish the role of MMFs in the financial system."
