Tax-exempt money market funds began recovering some of the nearly $30 billion of outflows they suffered in the past seven days, but market participants say there's still a feeling of queasiness among traders and investors in the midst of a disconnect between municipal and Treasury securities as the government bailout program unfolds.

"Confidence is not completely back in the money market fund sector until the bailout package gets approved and there's more clarity about whether the money funds are going to be insured and what the package will do for the security of money funds," said one New York short-term trader.

Meantime, the Securities Industry and Financial Markets Association municipal swap index rose to 7.96% Wednesday, extending its increase from 5.15% last week and from 1.79% the week before.

"We have seen money come back into the market for daily general market variable-rate demand notes," she said, noting that VRDNs were at 5.98% yesterday, after spiking to 9.20% on Monday.

"People just want to stay short until the end of the quarter," she said. "If they get a request for liquidation, they can sell [the notes] right away and not wait for the seven-day settlement on a weekly VRDN."

Meantime, the weekly VRDO general market rate was 7.96% yesterday down from 8.10% Tuesday, according to Municipal Market Data. Short-term tax-exempt paper remained cheap to commercial paper. The ratio between 30-day tax-exempt and taxable commercial paper was 104.4% yesterday down from 110.6% Monday, according to MMD. During one of the most historically-volatile weeks for the financial industry, tax-exempt money market funds saw a whopping $29.01 billion of outflows and settled at $486.43 billion for the week ending Sept. 22, according to The Money Fund Report, a service of of Westborough, Mass.

A massive flight to quality in the Treasury market caused skittish investors to pull a record $120.45 billion from both tax-exempt and taxable money market funds in the last week, which was capped off by the Treasury offering to insure all money market mutual funds in a temporary guaranty program as part of an historic $700 billion bailout of troubled financial institutions.

"There has been a general fear that has permeated the area since the Federal Reserve's announcement," said Connie Bugbee, managing editor of the Money Fund Report. "When the oldest money market mutual fund declared that it was breaking the buck and investors were getting 97 cents on the dollar that really shook the industry."

The 555 tax-free and municipal funds in the report posted a significant drop in assets compared to the prior week when they lost $8.67 billion and settled at $515.44 billion, according to the report. The average seven-day yield of tax-free funds rose substantially to 3.67% from just 1.36%, the most ever for a one-week period. The boost in seven-day yields was largely due to variable-rate demand notes approaching 8% after being put back to dealers by tax-free and municipal money market funds, according to the report.

She said the yields on the tax-exempt and taxable money market funds have been all over the place on certain days and out of traditional ranges in many cases on other days. "It's partly due to redemptions among most of the funds that are holding tax-exempt VRDNs. They have been putting these back to dealers, so [dealers] have to make them attractive to find a market for them," she explained.

The seven-day average maturity for tax-exempt funds increased to 35 days from 32 days.

Tax-exempt money market funds saw only short-lived inflow cycle for the week ending Sept. 8, during which they took in $9.84 billion in assets. That led to a slow, but steady decline in assets, Bugbee noted.

Back on Sept. 12, the daily assets of tax-free money market funds totaled $516.47 billion and fell to $486.41 billion as of Monday, according to the report.

The largest decline in assets was from Wednesday to Thursday of last week when the tax-free funds lost $9.406 billion at the same time that the financial markets began free falling on the news of Lehman Brothers' bankruptcy, the sale of Merrill Lynch & Co. to Bank of America, and the bailout of American International Group Inc., topped off by the federal government recovery plan.

"This week, so far, the outflows are slowing down, probably because of the hope and expectation that the Treasury is going to do something for money funds as the [bailout] program gets worked out," Bugbee said.

Taxable funds, on the other hand, saw assets drop by $91.44 billion to settle at $2.839 trillion for the week ended Sept. 23, compared with last week when they suffered outflows of $80.71 billion and settled at $2.931 trillion in assets - ending its all-time record high of $3.011 trillion set just two weeks ago.

Overall, the 1,860 funds in the report lost $120.45 billion, resulting in total assets dropping to $3.32 trillion, after losing $89.38 billion in assets the prior week and settling at $3.446 trillion.

Treasury prices were mixed yesterday afternoon as negotiations over the government's rescue plan got closer to being completed and stocks rallied.

Though slightly improved, the market scenario is not much better than last week when short-term Treasury yields plunged noticeably lower, while tax-free money market yields rose, as a result of a massive flight to quality, analysts said.

Some large mutual funds companies that manage tax-free money market funds were tight-lipped and declined to comment on the current activity given the disconnect in the overall financial markets, including Charles Schwab Investment Management and Evergreen Investments. Other firms, such as Wells Capital Management, did not return calls seeking comment at press time.

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