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Tax-exempt status outweighs risk of municipal bonds

Q. What can happen to municipal bonds during a recession or, worse yet, a depression? I have a number of such bonds, all of which have triple-A ratings. Should I consider selling and buying long-term U.S. Treasury bonds? A. There's no harm in considering such a move. But, assuming you are in the 28 percent or 31 percent federal income tax bracket, put that notion out of your mind. Stop worrying and keep your bonds.

The interest yield on top-quality municipal bonds is lower than the yield on Treasury bonds with similar maturities. But because municipal bond interest is exempt from federal income tax, taxpayers in those two top brackets do better with "munis."

During a recession or depression, there would be an increase in the number of munis going into default _ failing to make interest payments and/or repay principal at maturity. How much? That is anybody's guess. There is nothing resembling an exact count of muni defaults during the Great Depression of the 1930s.

Recently, such defaults have been small in proportion to the amount of bonds outstanding.

Statistics from the Bond Investors Association show $1.73-billion of tax-free debt defaulted last year.

That raised total defaults to just seven- tenths of 1 percent of the $870-billion muni bonds outstanding and compares with a 4.6 percent default rate on bonds issued by corporations.

Granted, these numbers provide no comfort to owners of defaulted munis, most notably Washington Public Power Supply System's reneging on $2.25-billion of bonds back in 1983. But such disasters don't happen often.

The triple-A rating by either or both of the rating services _ Standard & Poor's Corp. and Moody's Investors Service Inc. _ means your bonds are considered to be of the highest quality and have the smallest degree of investment risk.

Q. When I bought municipal bonds recently, the broker told me the bonds are insured by "FGIC." Who are they?

A. The initials stand for Financial Guaranty Insurance Co., one of the four major municipal bond insurers. The others are the Municipal Bond Insurance Association, Ambac Indemnity Corp. and Bond Investors Guaranty Insurance Co.

That quartet and a number of smaller firms offer insurance coverage on muni bonds. The insurance guarantees that, if an insured muni defaults, interest will continue to be paid on time and the bonds will be redeemed on their maturity date _ with the money coming from the insurer.

It should be pointed out that the insurers are corporations or groups of corporations, not a branch of government.

- William Doyle welcomes written questions, but will be able to give answers only through the column. Address questions to William Doyle, King Features Syndicate, 235 E 45th St., New York, N.Y. 10017.