October 22, 2008 in Nation/World

Program infuses mutual funds with cash

By Neil Irwin Washington Post

WASHINGTON – The Federal Reserve on Tuesday created a program to provide cash to money-market mutual funds, the latest step in a vast expansion of the government’s safety net for the financial system.

The Fed will make up to $540 billion available to buy assets from money-market mutual funds – in which pension funds, university endowments and millions of Americans stash money – if they need it. The measure is intended to keep the funds from experiencing cash crunches.

Money-market mutual funds invest by lending money on a short-term basis to companies, banks and other financial institutions, as well as the government. They are normally considered safe places to park cash because they buy only debt that is highly likely to be paid back.

But from early September to mid-October, nervous investors pulled about $480 billon out of a particular class of money-market funds. If that run on the funds had continued, it could have forced them to sell assets into an already troubled market, potentially causing a cascading series of losses to investors, more fund redemptions, more forced selling and further losses.

Whereas a Treasury Department initiative announced last month protected investors in money-market funds against losses, Tuesday’s action was designed to ensure that a run on the funds would not prove devastating; government officials hope the action will also help ensure that lending remains available to banks and other financial institutions.

But the new program is a vivid example of how the government’s rescue of the financial system has raised new questions about long-term policy-making.

For example, though the new Fed lending is designed to be temporary – it is scheduled to begin winding down in April – the central bank has continued renewing other emergency lending programs that had been scheduled to expire. The Fed will have to decide by April whether the “unusual and exigent” circumstances that permitted the bank to set up the new facility have persisted. If they haven’t, it must close the program by law.

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