First, it was the banks. Now the Federal Reserve has come to the aid of money market funds as the government seeks to break the credit logjam that threatens the global economy.
A week after the government announced it would spend $250 billion to buy stakes in U.S. banks, the Fed stepped up yesterday to help money market funds that have been squeezed by worried investors demanding to cash out their holdings.
Under a new program, the Fed will help buy up to $540 billion in short-term debt, including certificates of deposit and commercial paper that expires in three months or less.
This type of debt has historically been used by money market funds seeking safe, conservative returns for their clients. But the recent turmoil has caused one prominent fund to fall below $1 a share, an extremely rare occurrence.
Since that fund "broke the buck," many money market funds have had trouble selling assets to meet redemption requests by customers.
The new program "should improve the liquidity position of money market investors, thus increasing their ability to meet any further redemption requests and their willingness to invest in money market instruments," the Fed said in the statement.
"Improved money market conditions will enhance the ability of banks and other financial intermediaries to accommodate the credit needs of businesses and households."
It was a move supported by Legg Mason Inc. Chief Executive Officer Mark R. Fetting, who said yesterday that the Baltimore company is interested in participating in the program. Separately, Legg has been shoring up some of its money market funds hurt by investments in soured mortgage-backed securities.
"We and other industry players have been working on things like this and this particular development, I think, will have a real impact on bringing a real catalyst to bringing more confidence in the market," Fetting said in a brief interview.
Fed officials said that about $500 billion has flowed out of prime money market funds since August as investors worried about their ability to redeem shares.
Of the total $3.45 trillion held in money market funds as of Friday, about $858 billion was in so-called "prime" money market funds - the type that typically invest in commercial paper - according to fund-tracking firm iMoneyNet.
Mutual fund managers, including Legg, also have seen skittish investors move money to Treasury funds that have lower yields. Fetting said yesterday that the federal government's latest move also could help restore investor confidence in prime money funds.
"Eventually, people who are in Treasury and government funds will start to be dissatisfied with the yield differential and ... be willing to go back to prime funds and pick up some yields," Fetting said. "This helps those prime funds have the liquidity to move their portfolios in ways that make sense."
T. Rowe Price Group spokesman Brian Lewbart said the Baltimore money manager is looking into the details of the program.
"Anything that helps liquidity in the market is welcomed," he said.
Last month, the Reserve Primary Fund managed by New York-based Reserve Management Co., dipped below $1 per share because of losses on debt of the collapsed investment bank Lehman Brothers. It was only the second incident of investor losses in the 37-year history of money funds.
Several financial services companies decided to cover the losses for their clients invested in the fund, including the parent of Baltimore brokerage firm Ferris, Baker Watts. The Royal Bank of Canada, which acquired Ferris, promised as much as $35 million to cover customer losses.
The Reserve Primary Fund's decline prompted many money market investors to move their investments for greater safety. In response to a run on those funds, the Treasury Department announced last month that it was tapping a $50 billion Treasury fund to insure money market mutual funds. Legg and T. Rowe Price were among asset managers that signed up for the insurance program.
And the Fed agreed to give emergency loans to banks so they could buy commercial paper from the funds.
JPMorgan Chase & Co. was chosen yesterday to run five special funds that will buy from money market mutual funds certificates of deposit, bank notes and commercial paper. Each of the five special units will buy assets from up to 10 bank and financial company issuers. The program may be expanded to include purchases from other money market investors.
Sun reporter Hanah Cho and The New York Times, Bloomberg News and the Associated Press contributed to this article.