Federal Reserve to use $540B to shore up money market funds

— -- In its latest move to rescue money market funds, the government is once again indicating the important role of confident savers in the credit crisis.

The Federal Reserve announced Tuesday that it would provide up to $540 billion to buy troubled assets from money market mutual funds so they could meet redemptions from fleeing shareholders.

Money funds invest in short-term, highly liquid securities issued by banks, corporations and the U.S. Treasury. They try to keep their share prices at $1 so investors don't lose money.

Prime money funds have been slammed by nearly $500 billion in redemptions since August. Most of those redemptions have been by institutional investors. Although the stampede out of prime funds has slowed substantially in recent weeks, the Fed is worried that the funds won't have enough reserves to handle another one.

The Fed will make the purchases via a complex series of special purchase vehicles, or SPVs, that it will help fund. Eligible for purchase: bank CDs and commercial paper, which is short-term debt issued by large, highly creditworthy companies.

The Fed is worried about money funds because they are some of the largest buyers of commercial paper. Funds battered by redemptions have ceased buying commercial paper altogether and invested only in ultrasafe Treasury securities.

Many companies rely on commercial paper to meet their short-term funding needs without having to get bank loans. Without this source of funding, companies could have trouble making payroll, buying inventory or paying suppliers.

The government reassured investors in September by offering a limited guarantee of money fund shares. And, by temporarily increasing federal deposit insurance, it has sought to make sure banks have plenty of savers' money available to lend.

The credit markets have been comforted by the government's actions, says Deborah Cunningham, chief investment officer for money market investments at Federated Investors. The London Interbank Offered Rate is a key short-term interest rate that banks charge each other. One-month Libor has fallen a full percentage point this week, to 3.53% from 4.58%.

"Everything we've seen … is making a whole lot more sense at this point," Cunningham says.