WASHINGTON — The federal government on Friday stepped in to bolster the teetering $3 trillion money-market mutual fund industry and stem a wave of withdrawals that resembled a Depression-era run on the banks _ sparked largely by panicked institutional clients rather than individual investors in what are normally considered to be the safest of investments.
The Treasury Department said it will tap into a $50 billion fund created during the Depression and temporarily provide guarantees for the popular investment products, held in some 38 million accounts that enable investors to see modest returns while keeping cash readily available if needed. Providing additional support, the Federal Reserve took steps to back typically safe commercial short-term lending that underlies fund assets.
The moves, criticized as risky by the American Bankers Association, are expected to usher in an era in which money fund managers invest more conservatively, and customers increasingly seek the safest funds rather than those promising the highest yields.
The government's intervention came after the Reserve Primary Fund on Tuesday suffered a setback that had occurred just once before in the industry's nearly four-decades-long history: its underlying assets fell to 97 cents for each investor dollar put in, exposing customers to losses after a soured investment in debt of Lehman Brothers Holdings Inc. that led investors to pull out en masse.
While retail customers triggered that instance of a phenomenon the industry calls "breaking the buck," observers say it was subsequent pullouts by investors such as corporations and pension funds that threatened the whole system, leaving the government scrambling to prop up an industry holding about $3.4 trillion in assets.
The trigger to act appeared to be Putnam Investments' sudden move Thursday to shut down an institutional fund and return money to clients after investors rapidly pulled out _ even though the fund didn't hold any debt of the hardest-hit financial firms, such as Lehman.
Absent government action, the trouble at the $12 billion Putnam fund "would have started happening at other funds, and that would have built to a panic quickly," said Don Phillips, a managing director at fund research firm Morningstar Inc.
When a fund suffers a rush of orders to pull out money, fund managers must sell assets _ typically at a loss when it must be done quickly, and especially amid this week's market turmoil.
When the withdrawals are from institutional investors, "They're trading blocks of $1 million to $10 million and $100 million at a time, rather than $10,000 or $100,000" for the retail investor, said Peter Crane, president of Crane Data, publisher of the money-market fund newsletter, Money Fund Intelligence.
Industry watcher iMoneyNet said investors pulled $224 billion from money-market funds in the seven-day period ended Thursday. On Wednesday alone, about $89 billion was taken out, and another $56 billion was withdrawn on Thursday, said iMoneyNet Managing Editor Connie Bugbee.
The moves by Treasury and the Fed "will likely save the money-market fund business," Crane said. "It was getting quite dire, though funds could have withstood another couple of days of redemptions like they were seeing. But had it accelerated, you would have seen a dire threat of incidents of breaking the buck occur all over the place."
While money-market funds became popular in the 1970s among small investors, institutional investors are now bigger players, with nearly twice as much invested _ and more power to trigger a run on fund assets. In a volatile market, such clients have been fleeing investments with even the smallest risk and seeking the safety of Treasury Bonds, I.O.Us from the government that are now offering unusually low yields because of their sudden popularity.
Assets of institutional money-market funds dropped by $173 billion to nearly $2.2 trillion over the seven days ended Wednesday, while assets in retail money-market funds grew by nearly $4.3 billion in the same period to $1.2 trillion, according to the Investment Company Institute.
Money-market funds differ from funds investing in stocks and bonds, which make up some two-thirds of the nearly $12 trillion mutual fund industry. As a whole, until recently money-market fund assets had grown, because of their conservative reputation.
Out of the money fund total, the bulk is in taxable funds _ invested in such items as short-term loans between corporations and banks _ held by institutional customers. Retail funds hold most of the smaller component of funds' tax-exempt assets invested in safer and lower-yielding government debt.
To bolster the slightly riskier $2 trillion in taxable funds, President Bush authorized the Treasury Department to use its Exchange Stabilization Fund to provide guarantees of up to $50 billion for the next year. The exchange fund was created in 1934 to provide support for the dollar.
When the assets in a fund fall below the $1 per dollar invested, customers will be notified that their fund would be covered by the insurance program.
The Fed, meanwhile, will expand its emergency lending efforts to allow commercial banks to finance purchases of asset-backed paper _ a type of corporate I.O.U. _ from money funds.
Keith Hennessey, director of Bush's economic council, said the moves were prompted by broader concerns than just a run on funds.
"If you have a money-market mutual fund, you're used to that being a low-risk investment and you're also used to being able to call up your broker and say `Hey, I need to be able to withdraw money from that money today.'"
"We were seeing that there was a significant enough risk that either of those things might start to be jeopardized," Hennessey said.
Morningstar's Phillips said the government's moves "have essentially taken all the concerns an investor might have away, across the board."
Treasury's temporary guarantee of funds gives them as much government backing as FDIC-insured money-market accounts sold through retail banks, Phillips said.
Money-market accounts in banks typically offer lower yields than those offered through mutual fund firms, because they make safer investments and also must pay higher overhead costs for expenses such as operating bank branches.
The American Bankers Association issued a statement warning Treasury's move "runs the risk of undermining the nation's banking system."
ABA Chief Executive Edward Yingling said because money-market mutual funds lack the same regulatory restrictions that banks face governing the types of investments they can make, the fund companies' rival products could offer higher yields and "will be in a significantly superior market position to FDIC-insured bank deposits."
But Phillips said the fund firms' yield advantage may begin to shrink as this week's turmoil leaves investors more risk-averse, and fund managers shift to safer strategies.
He said investors also are more likely to select funds run by bigger firms with the financial might to pour money into a fund if it runs a risk of breaking the buck.
"Fund managers will prize avoiding losses over chasing the highest yield," he said.
Mark Jewell reported from Boston for this story. Associated Press economics writer Jeannine Aversa contributed to this report from Washington.