Muni bond insurance is no safety net

— -- Q: Is municipal bond insurance still not considered to be an adequate safety net for investors?

A: Municipal bond investors used to have it made. They could invest in a city or state's bonds, collect tax-free interest payments and rest easy.

After all, even if a state or city had trouble repaying interest on a bond, many securities were insured. A number of companies stood behind the muni bonds and guaranteed to make payments if the borrower couldn't. Having that insurance around created somewhat of a floor for the muni bond market.

Following the credit crunch that erupted in 2008, though, the game changed. Rising defaults from subprime mortgages eroded the financial strength of the insurers. Muni bond investors suddenly found themselves on the financial high wire without a safety net.

But you're asking about now, four years after the crisis started. Have muni bond investors started paying more attention to muni bond insurance? No, says Bill Larkin, a bond investor with Cabot Asset Management. Muni bond insurance is still considered to be "completely worthless," he says.

While individual investors used insurance as a "crutch" when buying muni bonds, that safety net is gone, he says. Now, professional investors will avoid certain muni bonds if they're not able to get adequate information on them. "You need to do thorough research," he says. "It's a dangerous marketplace."

Periodically, some of the companies involved in the muni bond insurance field might adjust credit ratings. And when they do, investors want to pay attention.

But thinking muni insurance will be there if the system short-circuits again would be a mistake, he says.

Furthermore, muni bonds are at risk if the economy takes another tumble. "People who understand the risks are being very careful," Larkin says. "People who are buying recklessly will get hurt."

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Follow Matt on Twitter at: twitter.com/mattkrantz