Orange County Bankruptcy Rattles Investors In Bond Market

UNITED States financial markets are struggling to recover from the $1.5 billion in investment losses in Orange County, Calif.

But that won't be easy. Several Wall Street investment houses, including Merrill Lynch & Co., have direct financial links to California's turbulent municipal-bond market. Many here are concerned some houses may incur losses based on their California associations or be subject to lawsuits from bondholders. Moreover, investors suspect that there may be other political jurisdictions that have also made unwise or potentially disastrous investments.

Hildegard Zagorski, an analyst with Prudential Securities Inc., in New York, sees two crucial factors at work:

* Investors will watch the next meeting of the Federal Reserve Board's Open Market Committee Dec. 20. If the Fed raises interest rates again, this might help stabilize the bond market, where investors are worried about the strong pace of economic expansion and a potential renewal of inflation. But higher interest rates could be a negative for stocks, which are losing investors to bonds.

* Other ``Orange Counties'' could imperil the fragile investing climate here.

Meanwhile, the stock market turned downward last week, following the county's bankruptcy announcement. Stocks fell Thursday and rose slightly Friday, indicating that mutual funds may be selling stocks to cover redemptions by investors.

MANY investors are now fleeing stocks for cash or buying ``safe,'' short-term fixed instruments such as money funds and Treasury bills, or high-yielding, long-term instruments, Ms. Zagorski says.

``Stocks look vulnerable and shaky ... but there's an important [capital] flight to quality bonds,'' says Harvey Hirschhorn, chief economist at Chicago-based investment-management firm Stein Roe & Farnham Inc.

While investors usually consider stocks better long-term investments than bonds, Mr. Hirschhorn believes that bonds will do better in months ahead, given questionable fourth-quarter corporate earnings. This is the first time since just prior to the October market crash that bonds have seemed better positioned than equities, he says.

But many bond experts note the distinction must be made between corporate, Treasury debt, and municipal bonds, for example. The Orange County situation involved mainly municipal issues.

Despite last week's stock slump, prices for the benchmark 30-year bond rose one-quarter of a point, meaning that prices moved upward more than $2.50 per $1,000 of face value. Moreover, even the municipal-bond market seems poised for gains, says Tom Moles, managing director of J. & W. Seligman & Co., a New York investment bank and mutual-fund company. Given market turbulence, ``there are some real buying opportunities'' for municipal issues, he says. With supply down, prices are expected to rise. Still, bondholders are not courting all municipal issues. ``If [one has] `California' on it, it's just not moving for now.''