While the U.S. Treasury and Federal Reserve work on the biggest government intervention in the financial markets in almost 80 years, less attention has been given to the launch of the Exchange Stabilization Fund, a $50 billion temporary insurance fund announced early Friday morning that seeks to normalize money market mutual funds.

Money market funds - in which high-liquidity financial instruments are traded for short-term gains - are used primarily by individuals with moderate-sized accounts. Initiated in 1971, the mutual funds allow for borrowing and lending ranging from several days to just under a year, and are considered to be a safe haven for investors hoping to avoid the volatility of equity and fixed-income markets.

However, the funds do not carry a federal guarantee like bank savings do and, amidst the financial turmoil, regulators have become concerned about the stability of the funds, which currently hold over $3,500 billion. The Treasury's action is geared to provide the same confidence that the FDIC does in ensuring bank deposits.

The need for the ESF became clear this Tuesday when, after writing off debt issued by Lehman Brothers, shares in the Reserve Primary Fund fell to 97 cents, marking the first time in 15 years - and only the second time in history - that a money market share "broke the buck," or fell below its net asset value.

In a press release early Friday morning, The Treasury said concerns about money market funds had exacerbated financial markets and caused severe liquidity strains worldwide, initiating the creation of the Exchange Stabilization Fund. "For the next year, the U.S. Treasury will insure the holdings of any publicly offered eligible money market mutual fund-both retail and institutional-that pays a fee to participate in the program," the statement read.

Paul Ashworth, senior U.S. economist at Capital Economics, said the Treasury's action is "all about confidence." He said the $50 billion fund only represents about 1.5% of the total value of the money market funds, but if investors are confident their money is insured, then the Treasury will not have to pay out the money.

Eric Lascelles, senior rates and economics strategist at TD Securities, said the U.S. government has suffered criticism from helping out Wall Street rather than Main Street, and this action could alleviate some of those concerns as individual investors were at risk of losing money thought to be safe.

In the event that shares in a money market fund fall below $1, investors will be notified that the fund has triggered the insurance program, the Treasury said.

By Patrick McGee and edited by Sarah Sussman
©CEP News Ltd. 2008