Rescuing U.S. Money-Market Fund
Treasury provides temporary guarantee to money fund, while Fed pumps money
September 19, 2008
The Treasury Department and the Federal Reserve announced separate actions Friday, September 19, designed to bolster the nation's $2 trillion of assets in money market fund assets and to pump money into the financial system and convince banks to begin lending again and stop hoarding cash, which was choking financial markets and threatening the already fragile economy following Lehman Brothers bankruptcy Monday, September 15, and AIG bailout on the next day, Tuesday, September 16.
The Treasury Department said it would use its $50 billion Exchange Stabilization Fund, a Depression-era fund created in 1934, to provide guarantees for the money market mutual funds, which had come under threat from one of the worst financial crises in decades.
For the next year, the U.S. Treasury will insure holdings of any publicly offered money market mutual fund, retail and institutional, that pays a fee to participate.
Money market fund is an open-end mutual fund which invests only in money markets. These funds invest in short term (one day to one year) debt obligations such as Treasury bills, certificates of deposit, and commercial paper. The main goal is the preservation of principal, accompanied by modest dividends.
Money market funds saw nearly $90 billion of net investor cash pulled out on Wednesday, among the largest single-day drops in history. Reverse Primary Fund, one of the original and largest money market funds, put a seven-day freeze on investor redemptions Wednesday after the net asset value of its shares fell below $1 caused by investor withdrawals. Primary Fund is managed by New York-based money market fund inventor The Reserve.
The freeze, also called "breaking the buck, is a rare instance in the fund industry. This is only the second time that a money market fund's net asset value has dipped below $1. In 1994, Denver-based Community Bankers U.S. Government Money Market Fund returned 96 cents on the dollar to investors when bad derivatives investments forced it to liquidate.
Separately, the Federal Reserve said it will expand its emergency lending efforts to allow commercial banks to finance purchases of asset-backed paper from money market funds. The Fed will also buy from primary dealers short term debt issued by Fannie Mae, Freddie Mac, and the Federal Home Loan banks. The central bank's move should help the funds to meet demands for redemptions.