Municipal Bonds Thrive, Financing State, City Deficits

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STATES and municipalities across the United States are facing mounting budget difficulties this year. But at least, in most cases, they are having no trouble financing their deficits. The demand for tax-free municipal bonds is up substantially.

"April was one of our very best months since January 1990, in terms of asset gains for state tax-free municipal bond funds," says Heidi Baxter, marketing manager for the tax-free funds of Fidelity Investments in Boston. The funds are benefiting, she says, from a "combination of higher taxes, declining interest rates - which makes existing bonds more valuable, diversification, and the possibility of tax benefits."

"We're getting a lot of very happy (muni-bond) shareholders these days," says Thomas Moles, a managing director for J. & W. Seligman & Co., an investment management firm. Despite recent highly publicized problems regarding municipal bonds in jurisdictions such as Colorado, California, and Philadelphia - with some bonds being put on credit watch - municipal bonds continue to attract investors.

Because of these problems, Mr. Moles notes, both individuals and portfolio managers of municipal bond funds are engaged in "a flight to quality" - they are looking for bonds given better gradings by the bond rating services. Moles, with more than $1.4 billion in tax-exempt securities under his management, is senior portfolio manager of both Seligman Select Municipal Fund and Seligman Tax-Exempt Fund Series. Seven of Seligman's tax-exempt funds were top fund performers in 1990, according to Lipper Analytical Services.

Bond experts note that the Tax Reform Act of 1986 not only simplified the US tax code, but left municipal bonds as one of the few remaining tax shelters for individuals. …