ORANGE COUNTY IN BANKRUPTCY : Investors Weigh Their Options : Muni Bond Values Slump but Few Trade at Fire-Sale Prices

Municipal bond values slumped across the country on Wednesday as investors responded fearfully to Orange County’s bankruptcy.

But mutual fund companies said there was no rush on the part of individual investors to sell California muni bond funds. Meanwhile, federal regulators said some funds’ parent companies plan to buy Orange County bonds now in fund portfolios to calm public jitters.

Traders reported that some Orange County bonds and bonds of the county’s municipalities were being priced in the market at just 50 cents to 80 cents on the dollar Wednesday--but that virtually no bonds were actually changing hands at those prices.

“Nothing is trading at these levels,” said Robert Gore, a muni bond trader at Crowell Weedon & Co. in Los Angeles. Instead, most investors continued to sit on the sidelines, he said, with bond owners angry and frustrated but unwilling to let go of their securities at fire-sale prices.

Other California muni bonds unrelated to Orange County also fell in price, though most were down only moderately, and even then few bond owners were willing to sell.

Major mutual fund companies, meanwhile, said they were getting an above-average number of calls from investors who own California muni bond funds, but that most investors were asking questions rather than redeeming shares.

“There’s very little activity in terms of redemptions,” said Steven Permut, a manager at the Mountain View-based Benham Group, which manages two California muni money-market funds and five California muni bond funds.

Jack Haley, portfolio manager at Fidelity Investments in Boston, said there was “no noticeable cash outflow” from its California funds related to the Orange County crisis.

Many mutual fund companies attempted to halt concerns about potential losses by reporting that their exposure to bonds of Orange County and its municipalities was minimal, generally comprising less than 5% of individual California bond fund holdings.

In addition, some fund companies took the position that under Chapter 9 bankruptcy rules, the Orange County bonds they own aren’t technically in default.

The default issue is key for short-term muni money-market funds, because under Securities and Exchange Commission rules defaulted money-market securities are supposed to be quickly sold--which could cause a loss for heavily exposed funds, threatening to reduce their share prices below the normally stable $1 level.

Barry Barbash, head of the SEC’s mutual fund division in Washington, said the agency has not taken a stance on whether Orange County bonds are officially in default, instead instructing mutual funds to make that legal determination themselves.

Barbash also confirmed that the SEC has received inquiries from more than seven fund companies about having the parent companies buy questionable Orange County debt from their money market funds--a move that would protect shareholders’ investment and remove the stigma attached to ownership of Orange County securities.

Putnam Investments said it bought $3.5 million in county notes held by its Putnam Tax-Exempt Money Market Fund, eliminating the fund’s exposure to the notes.

Several fund firms took the same step with “derivative” securities that threatened to cause problems for money funds last summer.

But Benham’s Permut said his firm doesn’t see a need to remove the Orange County notes in its two California muni money funds. He said the holdings make up less than 2% of the funds’ assets.

Meanwhile, in the muni bond market outside California, traders said prices of many longer-term bonds were down 1% to 3% on the day, reflecting investors’ jitters that other financially troubled municipalities could follow Orange County into bankruptcy.

The market’s concerns were heightened by a report from Moody’s Investors Service economist John Lonski, who said about 135 other local governments and eight state governments operate investment funds that have invested in derivative securities similar to those owned by the busted Orange County fund.

But analysts believe many or most of those other funds’ losses on their derivatives are probably small compared with Orange County’s situation. The state of Texas, for example, said its state and agency funds have less than 5% of assets in derivatives.

Still, Wall Street is leery about the possibility of municipal investment fund losses heretofore masked by those investors’ often-liberal accounting practices.

As they did on Tuesday, some investors sought refuge Wednesday in the safest possible securities: short-term U.S. Treasury bills. The yield on three-month T-bills dropped to 5.80% from 5.93% on Tuesday as investors rushed into them. Longer-term T-bond yields, in contrast, rose slightly.

Also weighing on the bond market were hints by Federal Reserve Chairman Alan Greenspan about future interest rate hikes.

Testifying before Congress on the strong economy, Greenspan gave no indication that the Fed might hold back on additional interest rate increases simply to help troubled institutional investors whose bond portfolios have been slammed by higher rates this year.