Treasury Pads Coffers in Bailout

By SHEFALI ANAND At least one government bailout seems to be working -- and even boosting the coffers of the Treasury Department. In mid-September, money-market mutual-fund investors were jolted after the $63 billion Reserve Primary Fund fell below a $1 net-asset-value level because it held commercial paper issued by Lehman Brothers Holdings Inc., which filed for bankruptcy. Investors began pulling money from other prime funds, which are a key source of funding for U.S. companies. It became harder for companies to raise money for their daily working needs, threatening to cripple the entire financial system. Within days, the Treasury took the unprecedented step of insuring assets in money-market funds to thwart massive withdrawals. Simultaneously, the Federal Reserve announced a liquidity facility to finance purchases of asset-backed commercial paper held by money funds. This allowed funds to hold this paper without worrying that withdrawals by investors would force them to sell into an illiquid market. View Full Image Bloomberg News Paul Volcker looks toward President Barack Obama while speaking Feb. 6 about his role as an economic adviser. The Treasury has collected $813 million in fees in its bailout of the money-fund market. It worked. Money-fund assets began climbing and are now close to hitting a record $4 trillion, $450 billion more than in mid-September. These funds also are more comfortable in buying commercial paper and asset-backed securities. These measures "provided huge amounts of confidence in a market that was sorely lacking in that," says Deborah Cunningham, money-fund manager at Federated Investors Inc. In the case of the money-fund bailout, the government could even make money. To insure money funds, the Treasury charged them 0.01% to 0.022% of their assets. It has collected $813 million in such fees, and the agency hasn't paid any claims yet. One reason for the success of the money-fund bailout is that the problems were relatively simple and contained. Money funds held high-quality and short-term assets, so the risk of guaranteeing them wasn't high for the government. It also helps that no other financial giants have followed Lehman into bankruptcy. In contrast, the situation with troubled mortgage assets held by banks is much more complex, posing a greater risk of loss to the government. Despite launching the Troubled Asset Relief Program to bail out banks, the government is still trying to figure out exactly how to value and acquire distressed assets. Still, the money-fund bailout highlights the need for swift and decisive action when the government intervenes in a failing market. In contrast, the changing emphasis of TARP has confused investors and undermined confidence in the rescue plan. Treasury Secretary Timothy Geithner recently proposed a plan to buy toxic bank assets, which was the original idea when TARP was announced. "We could have done this in October, when we first got the chance," says Milton Ezrati, senior economist at money-management firm Lord Abbett & Co. More recently, the Federal Reserve has been trying to figure out how to make a program work that would help finance longer-term asset-backed paper. The Term Asset-Backed Securities Loan Facility, or TALF, has some similarities to the liquidity facility for money funds. But it is directed toward different investors, like hedge funds, and will lend them money to buy student, auto and other asset-backed loans. As cash flows into money funds again, debate is swirling over their future: Should such funds keep capital reserves and be regulated like banks? Or should they operate more or less as they did before the Reserve Primary Fund broke the buck? "If they are going to talk like a bank and squawk like a bank, they ought to be regulated like a bank," Paul Volcker, head of President Barack Obama's Economic Recovery Advisory Board, said recently. The Investment Company Institute, a fund-industry trade group, has opposed such a move. Money funds were born in the early 1970s as a higher-yielding alternative to bank deposits. The early money funds invested in Treasury bills and bank certificates of deposit. To boost yields, they later began investing in high-yielding assets such as commercial paper and asset-backed securities. The Reserve Primary Fund started buying commercial paper in 2006. By 2008, commercial paper comprised half its portfolio, including a $785 million investment in Lehman paper. When Lehman filed for bankruptcy, the Reserve fund's net asset value fell by three cents, and investors began fleeing. As panic spread, investors pulled out nearly $350 billion from prime money funds in just two weeks in September. A good chunk went into government and Treasury-oriented money funds, but a net $123 billion left money funds altogether, according to the Investment Company Institute. On Sept. 19, the government guaranteed money-fund assets, and money soon began flowing back into them. Since November, nearly $230 billion has moved into prime funds, also partly because yields on Treasury-money funds have declined close to zero. Meanwhile, managers of some prime funds who had been investing heavily in government securities in the fall started inching back into commercial paper. They have also started to increase the maturity of the investments they buy. "We're able to invest in a more typical fashion," says Robert Litterst, manager of Fidelity Cash Reserves fund, the largest retail-oriented money-market fund. Vehicles such as the $150 billion JPMorgan Prime Money Market Fund and the Federated Prime Obligations fund were among those that bought more asset-backed paper after the Federal Reserve announced its liquidity facility. Some money managers continue to hold large positions in government securities. Vanguard Prime Money Market Fund is nearly half in Treasurys and agency securities, up from just 10% in early 2007. Amid the recession, "your gut tells you, this is not the time to take a lot of risk," says manager David Glocke. Write to Shefali Anand at shefali.anand@wsj.com