On Tuesday, two muni auctions failed to find buyers, and experts said that was the first time this had ever happened. Conditions have only worsened since then, they explained.
As a result, states, counties, cities and towns around the nation now are being forced to pay sharply higher short-term interest rates, in some cases as much as 15 percent.
Investors, meanwhile, are flocking to U.S. Treasurys, which are backed by the U.S. government.
"In the financial system ... we are just getting hit from all sides here," said T.J. Marta, fixed income strategist with Royal Bank of Canada Capital Markets in New York. "That is adding to the positive tone for Treasurys."
The regulator for U.S. municipal bonds may soon intervene to force greater transparency in a more than $300 billion corner of the market that investors have shied away from in recent weeks.
The Municipal Securities Rulemaking Board is considering asking banks that package so-called auction-rate securities to share more information about that troubled part of the market, Lynnette Hotchkiss, executive director of the Alexandria, Va.-based group, said Friday.
Hotchkiss said the board could make the request sometime within the next month, with the goal being "to increase transparency in that market."
- Video: Learn More About Auction-Rate Securities
Credit market turmoil that started last summer with rising defaults among risky mortgage loans has spread to auction-rate securities, in part because the bond insurers that back them face downgrades by credit rating agencies. The bonds underlying the securities -- a popular way for companies, municipalities and pension plans to store cash -- are generally speaking not considered to be at risk of default.