Fed May Tap $540 Billion To Help Out Money Funds

The Federal Reserve could lend as much as $540 billion in a new facility aimed at restoring liquidity for money market mutual funds, senior Fed officials said.

The Fed announced earlier Tuesday that it was launching the new facility to buy certificates of deposit and commercial paper from money market mutual funds, which have been under pressure as skittish investors demand withdrawals.

Many companies rely on commercial paper for short-term funding needs to pay workers and buy supplies. The situation has led to an intense credit crunch for these companies.

The Fed is tapping its Depression-era emergency powers and creating a new facility to buy a vast array of commercial paper from the funds.

Five special purpose vehicles set up under the new facility would be authorized to fund up to $600 billion in assets, the officials told reporters. The Fed would provide senior financing up to 90 percent.

JPMorgan Chase is the sponsor and manager of the conduits, an official said.

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"The short-term debt markets have been under considerable strain in recent weeks as money market mutual funds and other investors have had difficulty selling assets to satisfy redemption requests," the Fed explained.

"By facilitating the sales of money market instruments in the secondary market," the Fed added, the facility "should improve the liquidity position of money market investors, thus increasing their ability to meet any further redemption requests and their willingness to invest in money market instruments."

The New York Fed will provide senior secured funding to a series of special purpose vehicles to finance purchases of certificates of deposit and commercial paper from U.S. money market mutual funds and others, the central bank said.

Eligible assets include dollar-denominated CDs and commercial paper issued by highly rated financial institutions and having remaining maturities of 90 days or less.

Eligible investors include U.S. money market mutual funds but may over time include other U.S. money market investors, the Fed said.

By doing so, the Fed hopes to improve conditions so that banks and other financial institutions will be more inclined to lend to each other and to consumers and businesses.

Not everyone cheered the Fed's latest move.

"We are in a very bizarre market," said Brian Dolan, chief currency strategist for Forex.com. "This latest move by the Fed is a blow to the market's psychology. It means that money market funds are having difficulty meeting redemptions and investors are still putting their money in their mattresses."

© 2012 CNBC