Sept. 19 (Bloomberg) -- The U.S. government will set aside as much as $50 billion to temporarily protect investors from losses in money-market mutual funds caused by the meltdown of financial markets.

The Treasury will insure for a year holdings of publicly offered money-market funds that pay a fee to participate in the program. Retail and institutional funds are eligible, the department said today in a statement.

Money-market funds are considered the safest investments after U.S. Treasury debt and bank deposits because they strive to guarantee that shareholders can always get all their cash back. Confidence in the $3.35 trillion industry was shaken this week when Reserve Primary Fund became the first in 14 years to break the buck, or drop below $1 a share, exposing investors to losses on debt issued by Lehman Brothers Holdings Inc.

``They're putting up a firewall,'' said Paul McCulley, managing director at Newport Beach, California-based Pacific Investment Management Co. ``It's the ultimate nightmare to have a run on the money markets -- that is truly the Armageddon outcome -- and they're not going to allow that to happen.''

Investors pulled a record $89.2 billion from money-market funds on Sept. 17, according to data compiled by the Money Fund Report, a newsletter based in Westborough, Massachusetts. The withdrawals totaled a decline of 2.6 percent in money-market assets.

Critical to Stability

``Money-market funds play an important role as a savings and investment vehicle for many Americans,'' the department said in the statement. ``They are also a fundamental source of financing for our capital markets and financial institutions. Maintaining confidence in the money-market fund industry is critical to protecting the integrity and stability of the global financial system.''

The program, from which no fund has yet to draw, is eligible for all funds regulated by Rule 2a-7 of the Investment Company Act of 1940. The rule limits the funds to holding highly rated securities that mature in 13 months or less.

The government will make investors whole for any losses using the Treasury's Exchange Stabilization Fund. The $50 billion fund, which was used in the bailout of Mexico in the 1990s, is one way the Treasury secretary can spend money without consent of Congress. President George W. Bush approved using the fund to insure money-market funds.

`Nick of Time'

``This came just in the nick of time,'' Peter Crane, president of Crane Data LLC in Westborough, Massachusetts, which tracks money-market funds, said in an interview. ``We were likely going to see more funds halt redemptions'' and break the buck.

Bolstering confidence in money funds is more important than the danger that the move will encourage funds to make riskier investments to boost yields.

``This has got moral written all over it, but as has been case throughout crisis, now is not tine to worry about moral hazard,'' he said.

Putnam Investments LLC said yesterday it closed its $12.3 billion institutional Putnam Prime Money Market Fund after an undisclosed amount of withdrawals. The Boston-based company said the fund closed at $1 a share and would return all cash to investors.

Bank of New York Mellon Corp. said yesterday that a $22 billion institutional fund was hit by losses on Lehman, an event that jolted the money-market industry and triggered panic selling of asset-management stocks.

BNY Mellon

BNY Institutional Cash Reserves, a private fund that invests cash deposited by clients who borrow securities from BNY Mellon, fell to $0.991. BNY Mellon said it also entered into agreements with four of its Dreyfus money-market funds to support their net asset values.

State Street Corp. and Federated Investors Inc. said yesterday that none of their money-market funds had broken the buck.

Lehman, once the fourth-largest U.S. investment bank, filed for Chapter 11 bankruptcy on Sept. 15.

The Federal Reserve said it will lend to banks to meet demands for redemptions from money-market mutual funds and plans to buy agency debt from primary dealers to aid financial-market liquidity. The Fed said in a statement it will extend loans to banks to purchase ``high- quality'' asset-backed commercial paper from money market funds.

To contact the reporter on this story: Christopher Condon in Boston at ccondon4@bloomberg.net;

Last Updated: September 19, 2008 09:27 EDT