With tax-free interest rates at record high levels, many persons are eager to purchase long-term, tax-exempt bonds.

But maybe now is not the time.

The municipal market is a market in upheaval -- a market undergoing structural changes, a market where the supply of new issues outstrips the demand, a market where uncertainties are rampant and, consequently, a market where the risks of purchasing long bonds far outweigh the potential rewards.

There is a fundamental change taking place in the tax-free market and that change is a byproduct of the Reagan administration's budget cuts and tax cuts. That change is the shifting of the debt burden from the federal government onto state and local governments.

The budget cuts will curtail certain grants in aid that the federal government had been supplying to state and local governments. Loss of these funds will force the state and local governments to consider raising this lost money, either by increasing taxes or by floating bond issues. With taxes already high, it seems probable that a bond issue would be used, which would simply add to the supply of municipals.

In the past two decades, a lot of abuses in municipal financing emerged. Industrial development financing and single-family mortgage financing are two examples that come to mind. ongress is now wrestling with legislation to curb these two abuses, but the effects will not be immediate. And surely some compromises will allow more of the same financings to occur before they are curtailed.

In fact, recent legislation by the House ensures at least $8 billion more of single-family mortgage housing financing before their issuance is phased out in December 1983.

On the other side of the supply situation is the demand for tax-exempt bonds. Until the mid-1970s, commercial banks were the principal buyers of municipals, buying 40 to 60 percent of the new-issue volume each year. Fire and casualty companies were next, followed by households and mutual funds.

The situation has changed radically during the past two years. Commercial banks, because of their ability to make tax-free industrial development loans, to take tax credits for their overseas operations and to reap tax benefits from their domestic leasing businesses, no longer need tax-exempt income from municipals.

The fire and casualty insurance companies who had become large buyers of tax exempts now find themselves in a down cycle of earnings. They are seeking rate increases that will enable them to increase their profits and allow them once again to buy tax exempts.

Currently households are purchasing 50 percent of the new issues. The total new issue volume in 1970 was $17.7 billion; in 1975, $29.3 billion; and in 1980, $47.1 billion. Mutual funds and unit investment trusts have become large buyers of municipals. In fact, the UITs purchased approximately 9 percent of the new issues in 1980 and most of the purchases were 15-year maturities and longer. They have been the main factors in the long market in 1980 and 1981. The buyers have changed along with the demand.

There are several other areas for major concern in the municipal market. The most recent of these is the fate of the Washington Public Power System -- Projects #4 and 5 (WPPSS). In the public power area, there are many major projects under construction that will cost billions of dollars and take years to complete. These include new nuclear facilities, as well as the conversion of existing oil facilities to other fuels, especially coal.

Recently the WPPSS projects declared a year's moratorium on construction. The question is now being raised concerning the future not only of the WPPSS project, but of all the various public power projects under construction. Will they be completed? Or to put it another way: Are these various projects going to be able to raise the money necessary to finish their construction? According to Leon Karvelis of Merrill Lynch Municipal Research, "this could have a large effect on the method and the ability of public power issuers to come to market."

Recent tax initiatives on the part of taxpayers have presented other dilemmas. Proposition 21/2 in Massachusetts and 13 in California have become the rallying point for taxpayers against an ever-increasing personal property tax, which is one of the main sources of revenue to service general obligation bonds.

Voters have had tax reduction initiatives placed on the ballot and, when these initiatives were voted in, public officials, to say nothing of the holders of the outstanding general obligation debt, where placed in a quandary. For the public officials the question became: Do we meet operating costs or pay the debt service?

Because the revenue pie is shrinking (less funds from the federal government as well as state legislatures), officials in cities like Boston and Detroit must decide whether to cut police and fire fighters from the payroll or to stop paying the debt service on their outstanding debt.

The voters, by their actions, are writing tax legislation and are retrospectively tampering with the debt contract between issuer and buyer. By this act they are changing, if not the willingness, then the ability of the public officials to make good on their debt service. I might add that in California's Proposition 13, the outstanding debt was protected from tax reductions. This was not true in Massachusetts, where the surprise was the size of the reductions.

With the many uncertainties raised, investors are probably wondering where they may turn for direction in purchasing tax-exempt bonds. To that question, Peter Gordon, who manages Rowe Price's tax exempt funds, replies, "not the rating agencies." For whatever the reasons may be, Gordon says, "the rating agencies are followers of what's going on (with the various municipal credits) and are not leaders."

He points to the oversight in the early 1970s of New York City's fiscal mess, and the fact that Boston was only recently lowered to a BA rating months after the tax initiatives were passed.

To Gordon's way of thinking, "the WPPSS affair was the most disheartening case of all." He further feels that the rating agencies should be current with various situations and give adequate warnings to investors of impending problems.

"If the services are unable to obtain the information they need from the various bond issuers so that intelligent credit evaluations may be made, then their ratings should be withdrawn and a red flag will be raised," Gordon concludes.

The "all savers" amendment that just passed Congress poses another threat to the municipal market. This plan to aid the thrift institutions will allow thrifts to issue a special one-year Treasury bill. Interest earned will be tax exempt up to $1,000 in the case of an individual and $2,000 for a family. These certificates, being deposits, will also be federally insured against losses.

A recent study by John Peterson of the Municipal Finance Officers Association provided the following information: Individuals purchase 50 percent of all publicly issued short-term, tax-exempt securities. During the second quarter of 1981, the average yield figured at 70 percent of the one-year Treasury bill was 272 basis points higher than the return on government-backed tax exempt housing notes.

Peterson felt that the yields on short-term notes would have to increase as much as 280 basis points to compete with the certificates while yields on long-term bonds would have to rise as much as 100 to 140 basis points. A Treasury study, however, suggests thst short rates would rise only 12 to 20 basis points.

The MFOA report estimates that the rise in yield would increase the costs to issuers anywhere from $625 million to $1.1 billion a year. The study further concludes that a swing of up to $10 billion from tax-exempt securities to these government-backed "all savers" certificates would occur.

Consequently, the municipal market finds itself threatened by higher rates because of the competition, a loss of support in favor of the new certificates and increased costs to the municipalities who have to pay the higher interest rates -- again, more uncertainties and disruptions in the tax-exempt market.

This is not to say that when we experience a cyclical decline in interest rates, the municipal market will not advance in price. What I am saying is that, when rates fall, the price movement of the municipal market will lag the Treasury and corporate markets. Many of the usual participants will be out of the market and, when prices do improve, many of those no longer needing tax-exempt income will sell into the rally.

In a market that's in a state of upheaval and likely to remain so for several years, investors should build defensive portfolios. Floating rate and variable rate bonds, whose coupons are periodically pegged according to short or long Treasury rates, are a natural. So are "put" bonds that can be sold back to the issuer at the issue price after the bond has been outstanding five to 10 years. It is important that the credit-worthiness of the guaranteeing bank be closely examined in a "put" issue.