WASHINGTON, March 7 (Reuters) - Individual investors fled U.S. municipal bonds in 2012, pulling a record $238.1 billion out of the market in the final quarter of the year, according to Federal Reserve data released on Thursday.
The amount, smoothed out for seasonal fluctuations, was slightly more than the $221.9 billion investors shed in the third quarter. In all of 2012, households only put money into the market in the second quarter, acquiring $21.6 billion bonds after getting rid of $95.1 billion in the first quarter.
When the amounts are not adjusted for seasonal variations, households still pulled out a record sum, $133.4 billion, over the course of 2012.
The large withdrawals left the municipal debt that households held at the end of last year at the lowest level since 2007 - $1.679 trillion, not seasonally adjusted.
Federal Reserve data on the flow of money in the municipal bond market dates back to 1945.
At the end of 2012, President Barack Obama and Congress considered limiting the tax exemption for interest paid on municipal bonds as a way to boost revenues during their negotiations on avoiding the "fiscal cliff" - automatic cuts in government spending and increases in tax rates that were set to kick in on Jan. 1 if an agreement could not be reached.
Unsure of the tax status of their bonds, investors fled the market. While bond funds, which are popular with retail investors, had seen steady inflows for most of 2012, they reported massive weekly net outflows in the final days of the year, according to Lipper, a unit of Thomson Reuters.
Mutual funds continued to sweep up bonds in the fourth quarter, although at a much slower rate. They acquired $69.9 billion, about two-thirds the $107.2 billion bonds they bought in the third quarter, the Federal Reserve Flow of Funds Accounts report showed. Exchange-traded funds added $4.0 billion in the fourth quarter.
In the fourth quarter, insurance companies mostly dropped their municipal bonds. Property-casualty insurance companies shed $4.2 billion in municipal bonds after acquiring $1.8 billion in the third quarter. Life insurance companies dropped $3.4 billion, after buying $4.7 billion municipal bonds.
Banks acquired $44.4 billion in municipals, roughly half the $90.7 billion they took on in the third quarter.
While the federal government did not cap the tax exemption, and the chairman of the House of Representatives Ways and Means Committee has signaled he is not interested in changing the tax break, issuers of municipal bonds remain on alert. Last week, mayors and civic officials pressed Congress and the administration to keep the tax exemption, saying they would have to pay billions more in borrowing costs if it were changed.
Altogether, the amount of outstanding U.S. municipal bonds dropped slightly in the fourth quarter of 2012, to $3.714 trillion from $3.719 trillion in the third quarter, as states, local governments and agencies raced to refinance debt at record-low interest rates.