The financial crisis has exploded plenty of long-held beliefs, including the idea that mortgage debt is a risk-free investment. But nothing has shaken the articles of faith that underpin another massive debt market: municipal bonds. Investors in municipal bonds don't have to worry about a thing, the thinking goes, because the states and cities that issue them will do anything to avoid reneging on their obligations—and even if they fail, surely Washington will step in and save investors from big losses.

These are dangerous assumptions. Just as with mortgages, the very fact that investors place unlimited faith in a market could eventually destroy that market. If investors believe that they take no risk, they will lend states and cities far too much—so much that these borrowers won't be able to repay their obligations while maintaining a reasonable level of public services. The investors, then, could help bankrupt state and local governments—and take massive losses in the process. To avoid that scenario, investors must take a long, hard look at what they're doing. Where state and local finances are untenable, they should stop throwing good money after bad. More from The Manhattan Institute and The Wall Street Journal here.