In its bid to change from its agricultural roots and reinvent itself as a tony tourist destination, Stockton, Calif. issued several municipal bonds. The city incurred the debt to finance buildings like a marina and a stadium, expecting a payoff from its gamble. But it was not to be. Crashing real estate prices (which severely lowered income from property taxes) and high pension benefits for retired city workers greatly strained finances.
In 2012, Stockton filed for bankruptcy. It became the biggest city in U.S. history to default on its debts, a move that caused a ripple of concern among those who'd long believed city government bonds were a failsafe investment [source: Kristof].
Stockton isn't alone. Between 2010 and 2012, 31 local governments and city authorities (such as improvement districts) have declared bankruptcy. And that's only in the 22 states that allow municipalities to seek bankruptcy protection [source: Governing]. Despite the rash of defaults, they're still relatively rare -- about 0.3 percent annually [source: Kristof].
If you're planning to invest in municipal bonds, it pays to do some research. Here are some key details:
Check the record: Does the municipality have a history of paying on time? It's surprisingly easy to find out. Visit the Municipal Securities Rulemaking Board's Electronic Municipal Market Access portal.
Check the credit rating: What is the bond's credit rating? Look for bonds rated BBB or better by Standard & Poor or Fitch, or rated Baa or better by Moody. Even better, look for those that earn the highest rating from Moody (Aaa), Standard & Poor (AAA) or Fitch (AAA).
Check the call risk: A "call" means a bond can be redeemed (paid off) whenever the issuer decides, even if it hasn't reached maturity. This often happens when interest rates fall because it can save the issuer money. For investors, this means you run the risk of lost money, either in interest payments or capital. Most bonds, however, are non-callable [source: The Securities Industry and Financial Markets Association].