To municipal bond investors, small is not beautiful. Amid growing concerns that these steady sources of tax-free income are increasingly at risk, many smaller bond issues have made headlines with recent troubles.

As the economy continues to languish, times remain tough for most state and local governments, as well as other quasi-governmental organizations that can issue tax free bonds. Budget cuts, furloughs and the outright elimination of some services remain the norm for governments feeling the pinch, and in many cases, the smallest players appear most vulnerable.

In Wisconsin, $22 million in outstanding bonds that were backed by revenues from a power plant in the town of Menasha went into default, tangling the finances of the town of 17,000, about 100 miles north of Milwaukee.

In Buena Vista, Va., about 75 miles southwest of Charlottesville in the Blue Ridge Mountains, the town of 6,500 may lose possession of its own city hall, which was pledged as collateral for a $9.2 million bond issue to refinance its municipal golf course. The town is struggling to make payments from the bond reserves.

And in Bell, Calif., a city of 39,000 between East Los Angeles and Long Beach, a recent ratings downgrade by Standard & Poor's pushed bonds into junk status amid a local government scandal. The city could lose land it hoped to develop into a rail depot, using $35 million in lease revenue bonds.

In the $2.8 trillion municipal bond market, these tidal waves to local finance don't even make ripples among most investors, since those who didn't buy the bonds directly probably won't find them in the portfolios of their municipal bond mutual funds. Richard Saperstein, managing director and partner at HighTower Advisors, says smaller issues often portend more trouble than they are worth, even if they offer high yields.

"Quite often there is a lack of transparency in their reporting, and larger issues will have more frequent and timely report on their financials and other news releases," he says. "And typically, smaller issues have more concentrated risk. Whether it's an incineration facility, a golf course, a toll road or a steam plant, the investor assumes project-specific risk."

The troubled bonds mentioned above were all issued to back ideas that made sense in better economic times, but the potential downsides may not have been as well considered, says Michael McDonough, a Wedbush Morgan investment adviser in Roseville, Calif.

Small-town governments are usually made up of a few professional administrators and part-time politicians, he says.

"They don't get into these [bonds] on their own," he says. "Municipal bankers will advise the city on the practicality of the bond, and you've got attorneys drawing up the statement and reviewing them, and a lot of these [politicians] don't have any experience with municipal bond finance."

In a dismal economy, these lessons can have big price tags.

Tom Dresslar, a spokesman for California State Treasurer Bill Lockyer, noted in local news reports that the Bell scandal, which involved egregiously high salaries paid to top administrators, will make it difficult for the city to borrow at reasonable rates in the future.

While he's quick to point out that conventional, general obligation municipal bonds very rarely default, it's a tough time to count on steady income from taxes and other sources.

"California and its municipalities are in the same position as its counterparts are across the nation," he says. "The economic downturn has devastated state and local economies, and that's eroded revenue sources for state and local governments. The consequent budget problems can lead to negative actions by ratings agencies."

McDonough says he warns clients to avoid golf course financing bonds in his own state, and says many of them went to market with high yields and overly optimistic revenue projections. Now, many of these financing and development projects are underwater, a legacy of a time when spiraling real estate values helped get small bond issuers into deep seas.

"It's part and parcel of the whole real estate bubble," he says. "They were talked into it by someone who said 'You can build houses on the 19th hole and you can put in a hotel, and you can have all this development, and they bought into it, and now they're upside down."

Saperstein says the speed with which focused projects backed by muni debt can go wrong is a major reason for investors who buy bonds directly to pay close attention to their portfolios and keep track of what percentage of a bond issue they own.

"One of the problems with owning smaller issues is the inefficiency in pricing the securities for valuation purposes," he says. That's why bond fund managers might shy away from these names."