September 22, 2008 / 12:47 AM / 10 years ago

UPDATE 2-Treasury: tax-exempt funds can use new guaranty

(Recasts, adds official comment par 6, detail, pars 9-10)

By Mark Felsenthal

WASHINGTON, Sept 21 (Reuters) - U.S. Tax-exempt money market funds won’t lose their tax-exempt status if they shelter under a newly announced government backstop program, the Treasury Department said on Sunday, adding to efforts to soothe rattled financial markets.

“Participation in the temporary guaranty program will not be treated as a federal guaranty that jeopardizes the tax-exempt treatment of payments by tax-exempt money market funds,” the Treasury Department said in a statement.

Worry about withdrawals from money market mutual funds prompted the Treasury to announce early on Friday that it would back such funds, a bedrock of conservative savings, with up to $50 billion of government funds.

The Federal Reserve shortly thereafter announced it would open its discount window to financial institutions to enable them to purchase certain assets from money market funds, further underscoring the importance of maintaining confidence in the funds.

The timing of the weekend statement, when U.S. financial markets are closed, but as markets in Asia are beginning their week, suggests the Treasury Department’s strong desire to placate any concerns markets may have about the soundness of money market funds.

“We just wanted to get clarity out as soon as possible,” to markets in general, a government official said, speaking on condition of anonymity.

Problems with money market funds were a troubling new development last week in an overall crisis in financial markets that led President George W. Bush to announce on Friday his administration was willing to devote massive amounts of government cash to absorb toxic mortgage assets. The government is now negotiating with Congress a plan to use to $700 billion of funds to cleanse the financial system of assets tainted by delinquent mortgages.

Both taxable and tax-exempt money market funds are eligible for the Treasury safety net, Treasury said in its Sunday announcement.

However, the safety net will only be designed to provide coverage to shareholders for amounts held by them in money market funds as of the close of business on Sept. 19, the Treasury added.

Banks have complained about the government backstop for money market funds, saying it removes an advantage bank accounts — which are guaranteed by the Federal Deposit Insurance Corp — have over money market funds, which normally have no backstop. (Reporting by Mark Felsenthal; Editing by Louise Heavens)

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