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Boston Fed leads loan plan to ease money market fund woes

By Steven Syre
Globe Staff / September 26, 2008
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The Federal Reserve Bank of Boston loaned $72.7 billion to commercial banks across the country during the first three days of this week in an effort to ease intense pressure on the nation's money market mutual funds and rejuvenate markets where short-term debt is traded.

State Street Corp., which does extensive business with investment firms operating money market funds, confirmed it participated in the program by borrowing an undisclosed amount from the Boston Fed to acquire money fund assets. It was unclear how many banks in total participated this week.

The loan plan was one of several recent efforts implemented by the Federal Reserve and US Treasury to alleviate pressure on money market funds that were facing demands from customers who wanted their money back. The requests put the funds at risk of losing money by having to sell holdings in a frozen market.

By being able to sell holdings to State Street and other banks at full value, the money market mutual funds were able to raise cash to repay shareholders without suffering losses. The Treasury Department also offered temporary insurance for existing money market mutual funds, over the protests of bankers who compete against them with savings and other accounts that have long been insured.

A money market mutual fund is an investment and can lose money. It was, until last week, not insured by the federal government. A money market account is a bank account that, like savings and checking deposits, is insured up to $100,000 by the FDIC.

The revival of markets where short-term debts trade is important because companies and financial institutions depend on them as reliable and relatively inexpensive sources of money needed to run their businesses.

Besides easing pressure on money markets, the Fed hopes the loan plan will help markets that trade high-grade, short-term securities begin to function more normally. Money funds could have driven down prices and created widespread losses if they became desperation sellers in an illiquid market.

The money market crisis peaked last week, when Reserve Management Co. became the first manager in more than a decade to reduce the value of money market shares below the constant $1, meaning investors stood to receive less than $1 for every $1 they had deposited. Customers pulled $90 billion out of money funds just last Wednesday, putting pressure on the funds to sell assets under extremely difficult market conditions. Four other money funds would also "break the buck" later in the week.

Putnam Investments abruptly closed its $12.3 billion Putnam Prime Money Market fund, citing high demand from institutional customers that wanted their money back. Federated Investors Inc. acquired the assets of the Putnam fund this week.

The Fed disclosed the temporary money market asset program last week and began offering the loans through its Boston bank on Monday. The amount of money borrowed during the first days of the offer was disclosed in a routine weekly Fed report yesterday.

The Boston Fed was selected to run the program because there are many money market funds in the region and the Fed's bank in New York was already involved in many other plans to combat the financial crisis, according to a senior Fed staff official.

The plan offers loans to banks that purchase asset-backed commercial paper - short-term securities backed by home equity lines, car loans, and other types of credit - from money market funds that held them.

The Fed offer covers only the highest grade asset-backed commercial paper, but its loans are issued on a "nonrecourse" basis so the buying banks will not be on the hook if any of the investments default.

Participating banks will make money because the securities they buy pay higher yields than the interest rates they are paying on the Fed loans.

Evergreen Investments in Boston confirmed its money market funds sold some asset-backed commercial paper under the program this week. Evergreen's funds didn't face liquidity problems but wanted to see how the program worked, said spokeswoman Laura Fay.

"We did it as a test and found it worked well," she said. "Of all the [government] programs, we think this one will have the most immediate and direct impact in restoring liquidity to the marketplace. It can address the root of the problem."

Other Boston investment firms that manage large money market funds, including Putnam Investments and Fidelity Investments, said late yesterday they were unsure if they sold assets under the program or declined to comment.

Steven Syre can be reached at syre@globe.com.

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