What City and County Bankruptcies Mean for the Muni-Bond Market

First came Central Falls, R.I., which filed for bankruptcy Monday. Then the headliner talk this week that Jefferson County in Alabama could end up filing the country's largest municipal bankruptcy when it meets Aug. 12. All together, there have been five municipal bankruptcies this year.

Municipal-bond markets remain a relative safe haven for investors. Yesterday, after the stock market took its worst nosedive since the depths of the financial crisis, investors flooded into municipal bonds.

But municipal bankruptcies have the potential to rattle the municipal-bond market in several ways. Investors may be prone to worry about a contagion effect from municipal bonds that are in hot water, casting doubt on the financial soundness of surrounding cities, counties or state. A default also translates into higher costs throughout the market, even though investors do still get paid.

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"It is important to remember that only four to six make headlines, but 45,000 others are doing OK," Lynnette Kelly Hotchkiss, executive director of the Municipal Securities Regulation Board, tells DailyFinance. "Remember that every issuer is unique and needs to be analyzed on its own merit."

The board runs a muni-bond website, called EMMA, which allows investors to search for pricing information for bond trades, as well as official disclosures about material events that could impact bond prices. It's the only resource that makes the same information that retail investors use available to mom-and-pop investors.