Municipal bond mutual funds are hemorrhaging cash at historic rates due to a fearful investor reaction to the public drubbing of state and local government debt.

Municipal funds that report their figures weekly posted a net outflow of $548.1 million during the week ended Dec. 8, according to Lipper FMI. The decline represents the fourth consecutive weekly outflow.

All muni funds, including those that report their figures on a monthly basis, collectively have reported a record average weekly outflow of $2.5 billion the past four weeks. The new numbers easily outstripped the prior record high for the four-week moving average of $1.82 billion, which was established in January 2000. The previous runner-up averaged $1.18 billion in November 2008.

Funds are growing pale from asset losses as the municipal market is getting hammered by a variety of factors, including the uncertain future of the Build America Bond program. BABs are set to expire Dec. 31.

“With prospects for BABs renewal declining, we suspect continued outflows over the near term as investors speculate on the potential impact on tax-exempt valuations,” JPMorgan analyst Chris Holmes wrote in a note to clients.

The iShares S&P National AMT-Free Municipal Bond Fund, which seeks to replicate returns on a national tax-exempt index, is already down 2% this month.

Municipal funds posted a $7 billion loss on their holdings for the first week in December. Since the end of September, muni funds have posted nearly $17 billion in market losses, or 3.2% of their assets.

Preliminary data from the Investment Company Institute suggests November might have been the worst month for municipal fund flows in history. Muni funds posted $8 billion in outflows last month, according to ICI data representing a sample of all funds.

Previously, the worst month for outflows had been October 2008, which saw $8.4 billion of outflows.

Between outflows and market losses, municipal funds are bleeding assets at a rapid clip.

They hemorrhaged $10.5 billion in assets last week — the third-heftiest loss ever — to finish at $502.48 billion. The $13.7 billion they lost four weeks ago represents the second worst week ever recorded.

The funds have lost $25 billion in assets since they peaked in late October.

Investors earlier in the year were pouring money into municipal bond funds as tax-exempt yields fell and expectations were high that tax rates would increase in 2011 for those in upper-income brackets.

Investor psychology has since been turned on its head as the demise of the BAB program would portend an increase in tax-exempt supply and the Bush administration tax cuts are now expected to be extended.

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