When banking analyst Meredith Whitney appeared on the CBS show "60 Minutes" in December and predicted a wave of local government bankruptcies this year, her comments triggered a sell-off of municipal bonds. Investors pulled an unprecedented $25 billion out of municipal bond mutual funds within a month, according to the Investment Company Institute in Washington, D.C.

The trend has continued. From mid-November to mid-April, shareholders cashed in $41.7 billion from municipal bond funds in response to concerns that state and local governments may be unable to pay their bond-related debt and the growing likelihood of those bonds falling in value if interest rates rise.

"Although prices for municipal bonds have crept up over the past couple of months, the volume of trading on the secondary market has been generally weak," said Patrick Fisher, an investment adviser with Schneider Downs Wealth Management Advisors in the Strip District.

While cities across the nation, including Harrisburg, are facing budget shortfalls that have made them unable to make all or part of the principal and interest payments on their bonds as scheduled, none have gone into bankruptcy this year as Ms. Whitney predicted.

But the municipal bond sector has had one of its worst quarters on record and many financial advisers are urging individuals to be extremely careful when investing in this asset class.

"There is a lot of anxiety and fear in the municipal bond market due to investors questioning the true merits of the bond," said Mike Saghy, director of investments at PNC Financial Services, Downtown. "We actually think the municipal bond market is very attractive at the moment if you do your muni bond due diligence."

Municipal bonds allow state and local governments to raise money for private projects by selling debt to private investors. The advantage in buying municipal bonds is that the income received from interest payments is free of federal and state tax as long you live in the state where the bond is issued.

Generally, municipal bonds are more suitable for high-income earners making more than $200,000 a year. People who make less than $200,000 are not likely to benefit as much from the tax break municipal bonds provide.

The most popular municipal bonds are general obligation bonds, which finance parks, schools and other projects that improve the quality of life for residents in a municipality. General obligation bonds are backed by the full faith and credit of the taxpayers of a municipality. Bondholders can sue a city that defaults on general obligation debt and states are required to bail them out, although investors may have to wait for their money longer than expected.

Riskier municipal bond investments tend to be those funded by revenues from a specific project, such as a stadium, a toll road or an aquarium. Those projects can and do default.

Despite concerns, the municipal bond market is not as bad as it was last year.

James Rieger, vice president of fixed income indices at S&P Indices in New York, said that from Jan. 1 to April 15 of this year there were 13 monetary defaults on $285 million worth of municipal bonds nationwide. For the same period last year, there were 30 different municipal bond issues in monetary default on $1.7 billion worth of municipal bonds.

He said a monetary default occurs when the municipality does not make a scheduled debt payment on time or is unable to make a full payment to investors.

"There are a number of factors impacting the municipal bond market today," Mr. Rieger said. "New issue supply is down over 50 percent for the first quarter of this year compared to the first quarter of 2010."

The financial crisis of 2008 revealed some fundamental flaws in the way municipal bonds are rated.

Rating agencies automatically gave municipal bonds a AAA rating, the highest possible, as long as the municipality carried an insurance policy that could cover the payments in case of a default.

But when insurers started going out of business at the height of the credit crisis, it exposed the true credit quality of municipalities because, without insurance, some struggled to repay their bond debt and bondholders faced a higher risk of not receiving regular payments.

Harrisburg is a high-profile example of how tough times are impacting municipalities across the country.

The city sold $280 million worth of municipal debt to investors to rebuild an incinerator. The city had hoped it would collect enough trash to repay the debt and make a profit, but it has proven to be a losing proposition.

Investors are now receiving their principal and interest payments on a delayed basis rather than on the scheduled initially agreed on.

"The bigger problem for Harrisburg is they overreached with this incinerator project," said Alan Schankel, director of fixed income research at Janney Montgomery Scott in Philadelphia. "Money would still be tight, but without this incinerator project, the city would be OK.

"Now the city is looking at options that include selling or leasing their parking assets such as their garages and parking meters to private investors."

It seems every level of government is in danger of carrying too much debt.

Unlike state and local governments, however, the federal government has the power to create more money if necessary.

With the national debt at $14.3 trillion, Congress soon will vote on raising the debt ceiling in order to borrow more to pay its bills. If no more borrowing is allowed, the country could be forced to default on its debt obligations.

Jonathan Bergman, vice president of Palisades Hudson Financial Group in Scarsdale, N.Y., said he is recommending his clients protect themselves from an individual state default by investing in multistate municipal bond funds.

"Just like the U.S. government, states have made promises to retirees which they may not have the tax revenue to support indefinitely," Mr. Bergman said.

"Investing in a national municipal bond fund will reduce the risk posed by a single state defaulting," he said. "It's worth paying a bit more in state income tax for that protection."