By Lisa Lambert

WASHINGTON (Reuters) - New U.S. rules intended to prevent runs on money market funds are already sending tremors through markets and sparking debates on Capitol Hill, even though they are still weeks away from coming fully online.

Mutual funds face an Oct. 14 deadline to comply with Securities and Exchange Commission rules inspired by the 2007-09 financial crisis, when the net asset value of a large money market fund fell below $1 per share and spooked large investors into rapidly pulling money from the funds.

The rules require institutional prime money market funds, which primarily invest in corporate debt, to have floating net asset values, but allow other funds, such as those invested in government securities, to have a stable $1 per share value.

New data from a federal monitor for financial risk showed that money is racing out of prime funds into government ones, and the pace has picked up as the deadline nears. That is having a knock-on effect in financial markets, as demand from prime funds for commercial paper and banks' certificates of deposit shrinks.

Assets of prime funds have decreased more than $700 billion since the start of the year, and those of government funds have increased by the same amount, according to the Office of Financial Research, created after the crisis to monitor risks to the financial system. It added that the trend accelerated at the end of August.

The impending rules are having the effect of a wrecking ball on money market funds, said Pennsylvania Representative Keith Rothfus, a Republican, at a hearing on Thursday.

Rothfus said institutions that have to buy investments with stable net asset values are rushing out of prime funds as well as tax-exempt ones composed of short-term municipal debt, driving up borrowing costs for cities, counties, universities and hospitals.

The rule is stimulating demand for debt issued by the federal government and the government-sponsored enterprises Fannie Mae and Freddie Mac, he said at a hearing with Treasury Security Jack Lew.

"We have been monitoring the flow of funds and I don’t think the impact we’ve seen is as dramatic as what you’re describing," said Lew, adding he believes the rules will enhance financial stability.

"We’re not seeing dislocations in the marketplace on a broad basis," he said. "We're not seeing problems arising in the market where funding needs can’t be met."

(Reporting by Lisa Lambert; Editing by Meredith Mazzilli)