(Bloomberg News) Florida is firing 1,300 workers. New York is cutting education funding and freezing public employee wages for three years. Arizona is slashing Medicaid coverage. And municipal bondholders are having their best year since President George H.W. Bush was in the White House.

Over the past six months, governors and lawmakers balanced their fiscal 2012 budgets and protected their credit ratings on the backs of public employees, school districts, cities and Medicaid recipients, all of whom bore the collective brunt of budget-cutting in states from New Jersey to Wisconsin to California.

While deficit pressure produced deep cuts in services to taxpayers, bondholders who placed their bets on municipal debt reaped the benefits of the market's best second-quarter performance since 1992, even after analyst Meredith Whitney predicted as many as 100 municipal defaults valued in the "hundreds of billions of dollars."

States are "making a lot of true cuts," said Justin Hoogendoorn, managing director of the strategic analytic group at BMO Capital Markets in Chicago. "You're seeing it in health care, human services, education. There is definitely some pain in those budgets."

Two Pictures

As the fiscal year began July 1, contrasting portraits of states and the $2.9 trillion municipal market emerged. So far in this calendar year, the number of municipal defaults tracked by the publication Distressed Debt Securities Newsletter -- 25 defaults on $752 million in debt -- is less than that seen in the first half of 2010, which saw 60 defaults on $2.87 billion, said editor Jack Colombo in a phone call from Miami Lakes, Florida.

Investors who guessed that predictions of widespread municipal defaults made at the end of last year were wrong saw their bets pay off in the first half of 2011 as states cut expenses.

"There is some credit pressure, given the circumstances, but not to the degree we're seeing with sovereign nations across the pond," said Mark Stockwell, director of municipal research at PNC Advisors in Philadelphia, which has $7 billion in municipal assets under management. "The governors and legislatures are making the tough decisions."

Bank of America Merrill Lynch's Municipal Master Index, which measures price changes and interest income, has returned 4.45 percent since March 31. That's the most since the index of tax-exempts gained 4.47 percent in the same period in 1992, according to data compiled by Bloomberg. Munis outperformed corporate debt and Treasuries in the quarter and in the half- year, according to Merrill indexes.

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