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The Insure Thing Treasury backs money-market funds as it prepares a big financial fix.

By Portfolio Staff

Before it teetered, American International Group used to be routinely called the biggest insurer in the world. That title belongs now to Hank Paulson.

In the latest step to shore up a teetering financial system, the Treasury said today that it would use $50 billion to insure money-market mutual funds whose asset values fall below $1.

Fears that nearly paralyzed the lending and flow of money this week had been stoked by the announcement by a large money-market fund-considered to be among the safest of investments-that investors might lose money because of a write-down of Lehman Brothers securities held by the fund.

Two days later, Putnam Investments said it was closing a $12.3 billion fund. In the last week, investors have pulled record amounts of cash out of money-market funds, a sign that the financial panic was spreading.

"Concerns about the net asset value of money-market funds falling below $1 have exacerbated global financial-market turmoil and caused severe liquidity strains in world markets," the Treasury said in a statement. "In turn, these pressures have caused a spike in some short-term interest and funding rates and significantly heightened volatility in exchange markets. Absent the provision of such financing, there is a substantial risk of further heightened global instability."

The insurance will be for a year, and the Treasury is using a fund established in 1934 to manage the price of gold when it still backed the value of the dollar.

Money-market funds make up a $3.4 trillion industry whose attraction is that investors are assured of at least getting their principal back. This week, that faith was shaken by the fund that started the industry, the Reserve Primary Fund, when its net asset value fell below $1 a share. (The money-market fund was co-invented by the late Henry B.R. Brown, whose hobby, as Franz Lidz described on Portfolio.com, was catapulting pumpkins. Strange, yes, but not as strange as the events of this week.)

The money-market insurance comes as Paulson and Congressional leaders move toward creating a federal agency to bail out troubled financial institutions.

The agency would likely be something akin to the Resolution Trust Corporation that liquidated hundreds of savings and loans after that banking fallout. In this case, such an agency would take the bad debt off the balance sheets of troubled financial institutions so that they can return to a more normal course of business. Think of it as a government-sponsored structure-investment vehicle.

Stock markets around the world have surged on word of a possible toxic-debt Superfund and the money-market insurance plan should provide additional confidence to investors.

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