Fed Offers to Provide Backstop For State & Local Investment Pools

WASHINGTON - The Federal Reserve yesterday offered to provide a backstop for state and local government investment pools by making them eligible for its Money Market Investor Funding Facility, marking the first time during the financial crisis that the federal government has shown a willingness to provide direct assistance to municipal issuers.

Market participants have repeatedly asked for help from both the Fed and the Treasury Department.

"The inclusion of local government investment pools seems to be a step forward in the actions of the Fed with respect to state and local governments," said Paul Maco, a partner at Vinson & Elkins LLP here.

The announcement comes after the Fed and Treasury this fall rejected appeals by Rep. Paul Kanjorski, D-Pa., to provide grants, loans or guarantees for state and local governments. Neither of the agencies said they could offer any assistance to states and localities, with Fed officials suggesting the governments seek help from the Treasury, and Treasury officials insisting that they ask for aid from the Fed. Kanjorski's spokeswoman was not immediately available for comment on the Fed action yesterday.

The Fed's facility was launched Nov. 24 to provide a backstop for money market mutual funds. Though it has not yet been tapped by eligible participants, the facility was designed to purchase short-term assets from money market funds like commercial paper and certificates of deposit. The intent was to provide confidence to investors by insuring that the funds would not "break the buck" - or see their net asset value drop below $1 per share - if they needed to quickly sell off their assets to meet investor redemptions.

"It's a positive development that they're opening this program up to non-money market participants and will help provide the same type of stability to those investors that money market funds and their shareholders have," said Michael Decker, co-chief executive officer of the Regional Bond Dealers Association.

But a source who manages a local investment pool said such pools are unlikely to tap the Fed's expanded facility because their net asset values do not fluctuate as much as money market funds. LGIPs usually hold large quantities of Treasury bills and are unlikely to face widespread redemptions, the source said. Still, Florida saw more than $10 billion of its $27.1 billion local government investment pool withdrawn in just two weeks in late 2007 stemming from concerns about the fund's exposure to subprime mortgage securities, one market participant noted.

To participate in the Fed's facility, eligible LGIPs must maintain an average portfolio maturity of 90 days or less, carry the assets until maturity under usual circumstances and hold only investment-grade assets.

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