Treasury pulls out stops to support money markets

WASHINGTON (Reuters) - U.S. officials rushed to shore up ailing money markets on Friday after signs that this long-safe corner of financial markets, home to some $3.5 trillion of deposits, was at risk of falling victim to the year-old credit crunch and bring the crisis to Main Street.

The U.S. Treasury Department said it would use $50 billion to back money market mutual funds whose asset values fall below $1 a share. Separately, the U.S. Federal Reserve said it would lend even more money directly to financial institutions so they could purchase certain assets from money market funds.

The latest government efforts come after the credit crisis, which had largely been seen as problem for Wall Street risk takers, threatened to spill over into Main Street after some super-safe money market funds buckled.

"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 Treasury said in a statement.

President George W. Bush approved use of the Exchange Stabilization Fund to guarantee payments, Treasury said. The fund, which traces its roots to the Gold Reserve Act of 1934, allows the Treasury to conduct various transactions with the Treasury secretary's authorization.

The surprise moves comes as the Treasury and the Federal Reserve consider broad government intervention to prevent the collapse of the financial system, shaken in recent days by a crisis at insurer American International Group that required a $85 billion government rescue and the bankruptcy of investment bank Lehman Brothers Holdings Inc.

The move shows authorities are trying to get out in front of problems before another institution is pushed to the brink of failure, an analyst said.

"It is probably a testament to how bad things really are when you look beneath the hood," said Weston Boone, vice president of listed trade, Stifel Nicolaus Capital Markets, in Baltimore.

"The markets are frozen," he said.

News of the backstop for money market funds had instant impact in stock, bond and currency markets.

U.S. equity index futures, already soaring on optimism for other measures authorities are taking to contain the spiraling credit crisis, shot to session highs, indicating Wall Street will add to gains after its best day in six years on Thursday.

Rates on U.S. Treasury bills shot higher, too. They had fallen to near zero earlier in the week as investors panicked and rushed for the safety of government securities after the oldest U.S. money market fund "broke the buck," or fell below $1 net asset value.

The dollar, meanwhile, rose to a one-week high against the Japanese yen as investors regained an appetite for risk amid all the steps being taken to address the credit crunch.

The Treasury said concerns about the net asset value of money market funds falling below $1 have exacerbated global financial market turmoil and caused severe liquidity strains in world markets.

"Maintaining confidence in the money market fund industry is critical to protecting the integrity and stability of the global financial system," the Treasury Department said in a statement.

The panic in money markets began Tuesday, when the Reserve Primary Fund, a money-market mutual fund whose assets have tumbled 65 percent in recent weeks, fell below $1 a share in net asset value, because of its losses on debt issued by Lehman Brothers Holdings Inc.

In the industry, money money funds whose net assets drop below $1 a share are said to have "broken the buck".

(Reporting by Mark Felsenthal; writing by Dan Burns, Editing by Chizu Nomiyama)