Municipal bonds surrendered 3/4 point yesterday, and at least one portfolio manager sees more trouble ahead. "I think we're involved right now in a yearend iiquidity squeeze, and it's going to get a lot worse before it gets better," said Patricia M. Dolan, a managing director at Prudential Investment Advisors. As a result. municipals likely will "severely underperform" the taxable market going forward, she said.

Dolan said the flow of cash into tax-exempt mutual funds has been either flat or negative at a time when the Street will be getting ready to close its books for the year.

"We've been seeing cash-flow erosion all year. but it accelerated in October." she said.

There are only about 40 more trading days this year. and usually by midDecember activity has pretty much stopped, Dolan noted.

"There are very few real bidders. no aggressive bidders. and I think that municipal illiquidity becomes very, very serious as individual investors possibly sell their mutual funds to take tax losses," Dolan said.

The portfolio manager said that in the mutual fund industry, many equity and taxable funds are invested in by individuals with 401 (k) plans or Keogh plans, and those long-term investors tend to stay with those investments even during rough spots. But the situation could be different with tax-exempts, Dolan said.

"People in the municipal funds sometimes get frightened by volatile action in the marketplace, and therefore they may be more likely to liquidate shares," Dolan said.

In addition to the cash erosion the funds are facing, the Street is heavy with inventory fight now, she said. She pointed to Standard & Poor's Corp.'s Blue List. which yesterday was up $28.2 million to $2.1 billion.

Unlike equities or taxable bonds that command global attention, tax-exempt bonds rely on investors in high tax brackets. Occasionally, crossover buyers will buy them when they are cheap relative to taxables. But that's not the case right now.

Robert W. Chumberlin, a senior vice president and supervisory municipal analyst at Dean Witter Reynolds Inc. said Dolan could be right when it comes to the liquidity squeeze.

"While that could be a very strong statement. there's a very good chance that she's on target," Chamberlin said.

In yesterday's secondary market, a municipal analyst said dollar bond prices were down by 3/4 point, while yields on high-grade issues rose by seven basis points overall.

In the government market, the 30-year bond ended essentially unchanged to yield 8.04%. Yesterday's December MOB spread was negative 393, compared to negative 390 on Monday. In debt futures, the December municipal contract was down nearly 1/4 point to settle at 85 even.

Bid lists also flowed yesterday, though volume appeared to be down from Monday's $500 million tally.

"It's just been a steady stream of customer bid-wanteds really from the get-go," a second trader said. He estimated $300 million to $350 million of lists out by late morning yesterday. Later in the day, another trader said he saw about 22 lists out totaling about $300 million.

In negotiated action, a Merrill Lynch & Co. group repriced and restructured $275 million City of Chicago, Ill., Chicago-O'Hare International Airport general airport second lien refunding bonds. The MBIA4nsured offering featured a top yield of 6.78% in 2015. At the repricing and restructuring, the last serial maturity was deleted, and the 2013 term was shortened by a year to 2012, which allowed the yield to be lowered by 1 1/2 basis points. The yield on the 2015 term was lowered by two basis points.

"We had very good success today on O'Hare. Basically all the bonds from [2006] through [2009] are all going to be done on an institutional basis," said David Andersen, who runs Merrill's national underwriting desk. "It's structured fight and it's MBIA insured, so we had very strong support across the curve."

Andersen said the first two serial bonds, 2005 and 2006. ran into some resistance initially. Merrill subsequently made the 2006 maturity noncallable. Without any change on the scale. the coupon was raised to 6.75% from 6.20%. As a result, Merrill was able to get some institutional orders for that structure.

"So basically the deal's going to be well placed, there's not going to be any street float," Andersen said. The deal is all sold, he said.

Turning to competitives, a Donaldson, Lufkin & Jenrette Securities Corp. group won $65 million Connecticut general obligation bonds with a true interest cost of 5.9433%. The offering consisted of serial bonds priced to yield from 4.45% in 1996 to 6.40% in 2011. Moody's Investors Service rates the 'offering Aa, while Standard & Poor's Corp. rates it AA-minus.

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