Sept. 19 (Bloomberg) -- The Federal Reserve will intervene in markets for commercial paper and U.S. agency debt after money-market mutual funds holding the securities experienced record withdrawals, threatening intensified financial-market turmoil.

The Fed will extend emergency loans to banks to purchase ``high-quality'' asset-backed commercial paper from money market funds, the central bank said today in a statement in Washington. The Fed will also buy short-term discount notes issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks from Wall Street dealers. Neither program has a set limit.

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.

``This is a situation where they could not be reactive because a run on money markets would have material consequences for investor sentiment,'' said Tony Crescenzi, chief bond market strategist at Miller, Tabak & Co. LLC.

The U.S. Treasury said today it will use as much as $50 billion from the government's Exchange Stabilization Fund to temporarily protect investors from losses on money-market funds.

Federal insurance may distort the market if left in place for a long period, Crescenzi said. ``It will be very hard for the Treasury to strip the guarantee if investors get used to it.''

The Fed loans, with terms up to 270 days, will be at the discount rate, the Fed said. The rate is currently 2.25 percent.

`Competitive Auctions'

The New York Fed will conduct the purchases of debt through ``competitive auctions'' over the ``next several weeks,'' the Fed district bank said in a statement.

The actions came a day after Treasury Secretary Henry Paulson and Fed Chairman Ben S. Bernanke proposed moving troubled assets from the balance sheets of U.S. financial companies into a new institution, the most sweeping action aimed at ending the crisis.

Prime money-market funds hold about $230 billion in asset- backed commercial paper that banks can buy with Fed funds and $69 billion of the agency debt, senior Fed staff officials told reporters on a conference call. The staffers spoke on condition of anonymity.

The loan program will run through Jan. 30, the officials said. There is no end date for the agency debt purchases, they said.

The Fed officials said they believe the central bank and taxpayers are protected because the commercial paper is backed by assets. The loans are non-recourse, meaning the Fed doesn't have additional rights to borrowers' assets should the collateral's value decline, the officials said.

The Fed invoked emergency lending authority to aid the mutual funds through banks, the officials said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: September 19, 2008 10:10 EDT