Orange County Calif.'s bankruptcy declaration Tuesday helped knock municipals back a point to 11/2 points yesterday, rudely cutting short what many had hoped was the long-awaited supply shortage rally.

"What exacerbates the whole thing is that here we are, it looks like we are about to turn the corner, and boom you get sucked in at the top of the market," a municipal trader said. "It's really disheartening."

Orange County announced late Tuesday that it was seeking protection under Chapter 9 of the U.S. Bankruptcy Code. In a release, the Orange County Board of Supervisors said it took the action after various investment banks declined to roll over or renew existing reverse repurchase agreements held by investors totaling $1.2 billion. That refusal resulted in a default on the agreements, which "necessitated immediate action," the release said.

The trader noted that many buyers have "major exposure" to California credits. And, aside from Orange County, all the other counties, cities, school districts, and agencies that put money in the county's investment pool could face trouble as well. That means many portfolio managers are concentrating on what kind of exposure they have, instead of what's happening in the municipal market.

"That's taking a lot of people off the desk, which means that you are not going to sell bonds to people today," he said.

A second trader said the municipal market could not blame all of its troubles on Orange County.

"I guess its effect on the market as a whole is to dampen things just a little bit, but we had come a little bit too far, a little bit too fast anyway," he said, adding that the Orange County situation should have some interesting effects on the market.

"There's [187] different municipalities involved in the pool. That makes this bankruptcy a lot more interesting that others have been," he said, "The intrinsic value in a general obligation bond or any other bond that has a guaranteed revenue stream hasn't really been tested with a municipal bankruptcy with a number of participants before."

The workout process is likely to drag on "interminably:' and the full impact on the municipalities or agencies that invested in the pool remains murky, he said.

"The fact of the matter is you don't know what the exposure of some of these agencies is/If this is the cash they had intended to make interest payments with in the near near future, you could see that interest payment in danger," he said.

If that is the case, investors will have to wait a long time before those issuers "have the ability to levy charges, fees, taxes or any other revenue producing scheme in order to fund their debt service requirement," the trader said.

While the depth of the investors' exposure remains unclear at this point, one thing is a virtual certainty, the trader said.

"They'll all come out swinging. Everyone of them will feel as if they are entitled to get all there money back. Therefore none of them will get any of their money back until all the lawyers have been paid," the trader said, "That much I can guarantee you."

He also noted that amid the turmoil, there is a silver lining for one segment of the market - the bond insurers.

The insurers may not be happy about losing, money, "but if you've got two bonds and one is insured and one is uninsured, and the insured one's paying money, that's the cheapest, most effective advertising they can get."

In light secondary activity yesterday, yields on high-grade bonds rose by 10 basis points, while dollar bonds lost 11/2 points. In debt futures, the March municipal contract was down 11/2 points to 8321/32. Yesterday's March MOB spread was negative 488 compared to negative 466 on Tuesday. In the government market, the 30-year bond was down 1/2 point to yield 7.89%.

A municipal bond trader said that among those likely to be most disheartened by yesterday's plunged are the mutual funds who liquidated two weeks ago at rock bottom prices.

They wanted to reload, but decided to take their time. Then, "the market snaps back 40 basis points, so they get very little invested. But then, they chase it this week. They buy it and now they're down again," he said.

In addition, with no paper around, some funds decided to buy the contract hoping to enjoy the price appreciation. Yesterday, futures dropped 11/2 points.

"I'm telling you people are about ready to jump out the windows," the muni bond trader said, "It's like whatever you want to do, do the opposite because you'll probably be right."

The bankruptcy is particularly unsettling because it happened to Orange County, one of the richest counties in the nation, the trader said.

"It's kind of like: Wait a minute. We look at our triple B hospitals, but we didn't think we had to worry about double-A Orange County, Calif.," he said.

Another trader agreed, saying the county's predicament is surprising because of the level of sophistication there.

"You naturally wonder why they would get themselves into this sort of a predicament," he said, "As Moody's and Standard & Poor's do their reviews, maybe they'll be a little bit more disclosure as to what the status of the situation is."

Standard & Poor's Corp. yesterday downgraded $1.58 billion of Orange County. California debt to junk yesterday as a result of the County's filing for protection under Chapter 9 of the bankruptcy code. The county previously had enjoyed a AA-minus rating on some of its debt.

"The triple-C ratings are based on bankruptcy filing procedures that may allow the county to continue paying its obligations pursuant to the court's direction," the rating agency said in a release.

Standard & Poor's also revised its Credit Watch implication to "developing"' from negative "due to the lack of specific detail regarding the process by which the county may attempt to restructure it's financial obligations."

"During the past week, there has been a paucity information emanating from the county," the release said, "S&P has asked to meet with county officials as soon as possible, and will keep investors informed to the extent possible as the situation develops."

In the new issue, market, the bankruptcy impact was felt in the negotiated sector as an $88 million Michigan Municipal Bond Authority deal scheduled for yesterday was postponed.

"We wanted to a avoid any turmoil," a source familiar with the offering said. Late yesterday, the issuer was in the process of deciding how to proceed with the deal, he said.

In the competitive arena, the market conditions resulted in postponements of the a $7.5 million Folsom-Cordova Unified School District deal and an $8.5 million Sacramento County Office of Education offering, both of which had been scheduled for yesterday.

Christopher Ailman, chief investment officer with the Sacramento County Treasurer's office, said while his deals have nothing to do with Orange County, they were postponed because of market conditions related to the filing.

"We were told this morning that on the muni side bids were very weak if not non-existent for California paper, and that in terms of a day to issue, this was not the key day," he said.

Ailman said Sacramento will "wait for the hysteria to die down and the market to return to some level of normalcy, and then we'll issue them."

Asked when that might be, he replied, "We'll just have to watch market conditions, I heard this morning that even California insured GOs were down in value, now how that relates has got me a little baffled."

The 30-day visible supply of municipal bonds totaled $2.77 billion yesterday, down $445.2 million from Tuesday. That comprised $1.226 billion of competitive bonds, down $96.4 million from Tuesday, and $1.545 billion of negotiated bonds, down $348.8 million.

Standard & Poor's Blue List of municipal bonds declined $230 million yesterday to $1.22 billion.

In other news, New York State plans to issue $60 million in general obligation bonds on dec. 13 through a competitive bid. The proceeds of the bonds will be used to finance project under the state's 1986 Environmental Quality Bond Act.

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