September 18, 2009

Sept. 18 (Bloomberg) -- Fidelity Investments and Vanguard Group Inc. are among U.S. asset managers working on a proposal that would provide money-market mutual funds with an emergency pool of cash in the event of a run on deposits, according to two people who have been briefed on the plan.

Funds participating in the program would pay a fee to a bank, called the Liquidity Exchange Bank, to build a cash reserve that would help them handle investor withdrawals during a liquidity crisis like the one last September, the people said. The bank could also apply for emergency support from the Federal Reserve discount window.

Asset managers are preparing the plan as the Obama Administration considers forcing funds to abandon their stable price of $1 a share, a change the firms fear would undermine the attractiveness of money market funds, which currently hold $3.45 trillion. The President’s Working Group on Financial Markets, an advisory body to the White House, was also directed by the Treasury in June to consider whether a privately funded “emergency liquidity facility” for the industry is needed.

“This makes sense to the extent that the industry could take the wind out of the sails of alternative solutions that are not as appealing,” Joan Swirsky, an attorney at Philadelphia law firm Stradley Ronon Stevens & Young LLP who specializes in money-market funds, said in an interview.

Federated and Baltimore-based Legg Mason Inc. are helping to shape the industry proposal. Spokesmen for the asset managers, including Boston-based Fidelity and Vanguard in Valley Forge, Pennsylvania, declined to comment.

Breaking the Buck

The proposal is subject to revisions, said the people who asked not to be named because the information wasn’t public.

The liquidity bank is designed to provide cash to help funds meet redemptions during a run, like the one seen last September after the $62.5 billion Reserve Primary Fund fell below $1 a share because of losses from bankrupt Lehman Brothers Holdings Inc. Investors reacted by withdrawing $133 billion from money funds during the next two days.

The program won’t seek to insure money funds against losses from defaulted securities, unlike the Treasury’s emergency program that expires today, one year since its inception.

A private liquidity bank “could provide liquidity to a money-market fund that needs it -- an extremely rare occurrence but one a handful of funds confronted last September,” Deborah Cunningham, Federated Investors Inc.’s head of taxable money funds, wrote today in a commentary on the Pittsburgh-based company’s Web site.