States Going Direct to Consumers with Municipal Bonds to Raise Cash

California last week raised $5 billion dollars to avert a cash crunch stemming from the credit meltdown. The most interesting thing about it is they skipped the big investment banks and went directly to their consumers and taxpayers.

Bloomberg reports that:

"Demand from individuals helped California avoid asking for emergency help from the federal government, a prospect Governor Arnold Schwarzenegger said may be needed as the credit crisis gripping the world economy deepens. It also left the state less dependent on the Wall Street firms, hedge funds and other institutions that have retreated from the $2.66 trillion market, underscoring the growing importance of individual investors.

Households increased their municipal holdings to $912 billion at mid-year from $900.4 billion in the first quarter, according to the most recent Federal Reserve data. That gives them 34.3 percent of the market, making them the largest single group of investors.

The interest by individuals contrasts with waning demand from institutional investors and decreased support from banks and securities firms beset by $660.8 billion in writedowns and credit-market losses since the start of 2007, according to data compiled by Bloomberg."

This shift appears to be one repurcussion of the credit crunch and is something that could accelerate over time as a large wave of baby boomers look for a place to park their money.

Municipal bonds are generally quite safe and offer tax advantages for residents of the states in which they are issued. I do believe that the credit crisis poses some challenges to municipal bonds. As tax revenue declines in many cities and towns, the cash flow used to finance these bonds will become less secure. Therefore, investors investigate the financial condition of the muncipality that is doing the offering. Is there real estate base secure? Do they have a strong tax base? You would not want to buy bonds from a town like Merced, California. Even wealthy towns like East Hampton is having trouble paying the bills.

Still, if you do your homework and pick stable cities and towns, munis can offer a safe, decent return. And it appears that cities and states are increasingly interested in your money.

• Learn more about municipal bonds.