Fed Sets Up New Program to Buy Money-Fund Assets (Update2)

Oct. 21 (Bloomberg) — The Federal Reserve will help finance purchases of up to $600 billion in assets from money- market mutual funds roiled by redemptions from investors seeking the safety of government debt.

“The short-term debt markets have been under considerable strain in recent weeks as money market mutual funds and other investors have had difficulty selling assets to satisfy redemption requests,” the Fed said in a statement released in Washington today. About $500 billion has flowed out of prime money-market funds since August, a central bank official said.

JPMorgan Chase & Co. will run the five special units that will buy certificates of deposit, bank notes and commercial paper with a remaining maturity of 90 days or less. The Fed will lend up to $540 billion to the five funds, an official told reporters on a conference call on condition of anonymity.

The new effort is called the Money Market Investor Funding Facility, the Fed said. Each unit will by paper from up to 10 separate issuers.

“In terms of the redemptions money-market funds are seeing, and hedge funds as well, any of these moves by the Fed are going to help,” Mike Holland, chairman and founder of Holland & Co. LLC in New York, said in a television interview. “We are going to see those redemptions eased.”

Commercial Paper

Money-market funds have been hurt by being unable to sell back at par the commercial paper they bought from banks and other issuers, Fed officials said.

The new program “should improve the liquidity position of money market investors.”

The private special-purpose vehicles set up under the program being announced today will finance 10 percent of their purchases by selling asset-backed commercial paper. The New York Fed will lend the remaining 90 percent to the facilities on an overnight basis at the discount rate, which stands at 1.75 percent.

Each special-purpose vehicle will only purchase debt with ratings of at least A1/P1/F1. The Fed said the facility will be in place until April 30 unless extended by the Board of Governors. Fed officials said they will announce a start-date by the end of the week.

Third Program

The central bank already has two other facilities designed to provide liquidity to the commercial paper market and backstop money fund sales of asset-backed securities.

Turmoil worsened among money-market funds after the bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 and the breakdown of the oldest money-market fund the following day.

The $62.5 billion Reserve Primary Fund announced Sept. 16 that losses on debt issued by Lehman had reduced its net assets to 97 cents a share, making it the first money fund in 14 years to break the buck, the term for falling below the $1 a share that investors pay. Over the next two days, investors pulled $133 billion from U.S. money-market funds, according to IMoneyNet.

The record run abated only when the Treasury said it would use an existing $50 billion emergency pool to guarantee money funds against losses. The Treasury on Sept. 29 began using an existing $50 billion emergency pool to guarantee money-market funds against losses.

The Fed on Oct. 7 invoked emergency powers and said it would create a special fund to buy commercial paper. It plans to lend $152.1 billion to money funds in exchange for asset-backed commercial paper.

The government this month also announced plans to offer guarantees on new bank debts and start purchasing commercial paper. Treasury Secretary Henry Paulson also plans to put $250 billion of taxpayer funds into bank balance sheets.

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