Municipal bonds, also called "munis", have until recently been viewed as a safe haven for conservative fixed income investors because they offer significant taxation benefits. Lately the market for munis, like other credit market instruments, has been frozen by the spreading global credit crisis.
Municipal bonds are long-term debt instruments issued by state and local governments to fund public-works projects - debt that matures in one year or less is generally called notes. For muni holders, the interest they earn on the bonds is exempt from federal income taxes while in most states they are also exempt from state and local taxes.
The U.S. muni market began seizing up in September 2008, when only a handful of deals were made in periods when a hundred would be expected, putting financing pressure on local governments across the country. Borrowing using munis is expected to drop while more deals are being done with floating rather than fixed interest rates.
In early October 2008 fixed-rate muni sales dropped to around $800 million per week compared to an average weekly rate for 2008 for $6 billion. Yields on AAA-rated, 30-year munis recently rose to 5.35%, up 53 basis points (bp) from mid-September and 140 bp above the yield on 30-year treasury bonds, following similar routs amongst commercial paper and corporate debt markets.
Reports surfacing at the beginning of 2011 have a mixed outlook on municipal bonds. Rising interest rates including a peak on Dec.15 at 4.85% for the 30-year triple A rated bonds have brought uncertainty to this market. Those levels on yields have not been seen since March 2009. The yield on 10-year bonds hit 3.27%, the highest since June 2009 and closed out the year at 3.16%. The 30 year municipal bonds closed out at 4.68%.
Another factor impacting the municipal bond market is the Build America Bonds program, in which state and local governments issued federally subsidized taxable bonds in an effort to reinvigorate the economy. The lower borrowing cost of these bonds made the instrument a big hit and more than $165 billion was borrowed since the program began in April 2009. At the end of the year, the fate of the program was unknown so local governments who were eager to lock in the subsidy hit the market at the end of 2010. However, the program was not extended into 2011. This program and the rise in Treasury rates drove down bond prices but increased yields. 
- The Advantages of Tax Exemption. InvestingInBonds.com.
- Municipal Bonds Freeze Up. BusinessWeek.
- Treasuries Rally as Stocks Tumble, Company Bonds, Munis Falter. Bloomberg.
- Munis Got Upended in 2010, and the Outlook Is Mixed. Wall Street Journal.