Volcker Blasts Money Market Funds

NEW YORK (TheStreet) -- Forget Goldman Sachs (GS Quote), AIG (AIG Quote) or Moody's (MCO Quote): The real villains of the financial crisis are money market funds, according to Obama adviser and former Fed Chairman Paul Volcker.

Volcker, in an interview with Bloomberg, said money market funds are "free-riders" that compete with banks for assets but aren't subject to the same kind of strict rules and regulations.

Volcker's comments appear shocking because the strain on money market funds didn't attract the same kind of publicity as the woes of big banks like Citigroup (C Quote) and Bank of America (BAC Quote).

Still, money market funds have had their share of woes lately. The $62.5 billion Reserve Primary Fund "broke the buck" last September when its net asset value fell below $1 due to its investment in Lehman Brothers' commercial paper. That caused a run on money funds, which according to The Wall Street Journal is a $3.7 trillion dollar industry.

The Bloomberg article includes comments from industry consultants and executives of money market fund giants such as Federated Investors (FII Quote), who paint Volcker as a radical who has some kind of long-standing vendetta against the industry and wants to run it into the ground.

While those groups are obviously not objective, Volcker does appear to be somewhat on the fringe on this issue. The system did not break down. Regulators called on whatever emergency powers they had at their disposal to stop the panic.

Still, something was clearly wrong if a fund that was thought to be ultra-safe was allowed to invest heavily in the short-term debt of Lehman Brothers, which clearly was not a foolproof investment. If money market funds want to invest in stuff like that, they should at least have to disclose the risks associated with doing so.

-- Written by Dan Freed in New York.