The Treasury Department announced yesterday that the government for the first time will insure money market mutual funds to discourage investors from pulling trillions of dollars from a bedrock investment that isn't supposed to lose money.
Investors have grown increasingly skittish this week after the oldest money market fund, Reserve Primary Fund, announced that investors will lose some principal 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.
A couple of days later, Putnam Investments closed one of its money funds because of a run of withdrawals that occurred even though the fund hadn't lost any of its investors' money.
In the past week, investors pulled more than $220 billion from money market funds, leaving $3.29 trillion parked in the funds, according to iMoneyNet, a provider of money market fund information.
Financial experts say the Treasury Department's move was necessary to restore investor confidence.
"The financial markets were really in the worst turmoil that they have ever been in. The impact was felt around the globe," said Connie Bugbee, managing editor of iMoneyNet. "We were in danger of a real shutdown."
Money market funds are considered among the safest investments available. While they do not have federal deposit insurance like money market bank accounts, they invest in debts including highly-rated corporate commercial paper and very short-term U.S. Treasury securities. Investors could count on getting the return of their principal and earn some interest on top.
But in more recent years, some fund managers attempted to juice up their yields to attract more investors by investing in more aggressive securities. Now some of those investments have soured.
Reserve Primary Fund announced Tuesday that its net asset value dropped below $1 per share, something called "breaking the buck." Its investors cannot get access to their money until next week.
Treasury will tap the $50 billion Exchange Stabilization Fund, established during the Depression, to temporarily guarantee the principal in money market funds that have the insurance. Details of the voluntary insurance program will be worked out over the weekend, including how much fund sponsors will pay for the insurance.
The program will run for one year. If a money market fund's net asset value drops below $1 a share, insurance will kick in to make up the difference.
