Owners of municipal bonds issued to pay for jails might not get to pass Go--and could have trouble collecting interest payments as well. These tax free bonds don't have a monopoly on defaults, but they're well represented among failures and troubled issues among the more speculative classes of municipal bonds.

Data from Municipal Market Advisors reveals a slew of tax-free bonds issued to fund construction of privately run prisons and detention facilities in states from Texas to Rhode Island to Montana. The most recent example is Littlefield, a West Texas town of about 6,500 people. Located between the New Mexico border and Buddy Holly's hometown of Lubbock, Littlefield had to dip into reserves to cover payments for about $1.2 million in bonds and other debt used to finance the Bill Clayton Detention Center.

The bonds were issued in 2000, but the expected revenue stream evaporated when, after a prisoner suicide in 2008, the 310-bed private prison lost its contract to house out-of-state inmates. In 2009, the Geo Group (GEO), formerly known as Wackenhut Security, ended its operating agreement with the detention center, leaving it unoccupied.

In April, Fitch Ratings, which in 2009 lowered the bonds to BB from BBB, affirmed a negative rating outlook.

Littlefield city manager Danny Davis says the city is scrambling to avoid default on the $780,000 worth of annual payments and plans to cut police and fire service while dramatically raising property taxes when the new fiscal year begins Oct. 1. The property could be sold or could be taken over by the state, though neither option is certain.

"It's going to be difficult," he says. "In the meantime, we're just trying to keep our heads above water until we get to a solution."

Bob Libal is the Texas campaign coordinator for Grassroots Leadership, a nonprofit group which opposes for-profit prisons, and the editor of the blog Texas Prison Bid'ness. He says many small towns agree to build "speculative prisons" to be run by private contractors using municipal bond financing but that many of these projects in a post-Sept. 11 boom have had trouble.

Libal criticizes the development groups that get paid up front for building detention centers thus saddling the bond-issuers (usually special public facilities corporations created solely for those projects) with risky debt.

"They go after a lot of towns without a lot of sophistication and resources to do the due diligence," Libal says. "If they let the bonds go under, it's very difficult for them to issue any more debt."

Matt Fabian, director of research at Municipal Market Advisors, cites similar bond woes in Central Falls, R.I.; Hardin, Mont.; and Baker County, Fla., where about $105 million in total debt has run into trouble because the prison projects haven't worked out as expected.

"The incarceration rates drives speculation," he says. "There's an idea that you can profit from this prison trend."

Investors in these increasingly-insecure jail bonds have certainly had to assume more risk, even though they get higher yields. The $99 million Central Falls Detention Facility bond issue of 2005 entered technical default in 2009 when it drew on its reserves to make payments. The bonds, issued at par with a yield of 7.25%, last traded at the end of 2009 at 85.3 cents to the dollar, with a yield of 8.69%.

Municipal revenue bonds issued in 2002 that funded the West Alabama Youth Services detention facility defaulted in 2005. The bonds last traded in February at 9 cents to the dollar with a yield of 73.6%. Fabian says some of the biggest private prison busts are unlikely to have simple resolutions. A shopping center is easy to repurpose; a detention center is not. "It's hard to restructure," he says. "Even the land underneath a prison isn't worth as much as it was."

Even with a resurgent effort by the private prison industry to use their facilities to detain illegal immigrants and an attempt by the U.S. Immigration and Customs Enforcement agency to overhaul detention procedures, problems persist.

The Baker Correctional Development Corporation, created to finance a correctional facility and immigration detention center west of Jacksonville, Fla., dipped into reserves for its August payment to holders of bonds issued in 2008.

With those bonds trading last at 71.25 cents to the dollar with a yield of 20.73%, investors looking to lock up their money should probably seek less risky types of municipal bonds.

Correction: Grassroots Leadership is a nonprofit organization. A previous version of this article identified it as a lobbying group.