Municipal bonds were once viewed as quintessential investments for the tax-conscious and risk averse. But they’ve become virtual pariahs in the fixed-income universe.

That’s hardly surprising given the revenue crunch facing many issuers and the demise of almost all but one monoline insurer. This leaves no one but the investor to take the hit in a default event. Big-city mayors have predicted bankruptcies, and even the “Sage of Omaha” Warren Buffett has voiced doubts that state and local governments would be able to meet their obligations.

Yet despite the negativity, a wave of municipal defaults has not occurred, though there have been some isolated cases.

The most notable default came early this year when the Las Vegas Monorail Corporation filed for Chapter 11 bankruptcy protection. The project had been troubled from its start and consistently missed its own revenue projections. Additionally, about $2.5 billion in Florida real estate development finance bonds are in trouble, but that’s hardly unexpected.

The municipal issuers staring default in the face are much like the Las Vegas Monorail: They took the wrong path before the financial crisis even began.

Harrisburg, Pa. required an expedited payment of $4.4 million from the Commonwealth of Pennsylvania to make a required municipal bond payment–an announcement that shook municipal bond markets.

Harrisburg is in an unfortunate position. It was the second guarantor on a series of general obligation bond issues that raised money to build and operate a trash-to-energy incineration facility.

Since the facility was constructed in the 1970s, it’s been nothing but a boondoggle of cost overruns and environmental concerns. These higher-than-expected costs have made it all but impossible for the first guarantor on the bonds–the Harrisburg Authority–to make the coupon payments. The responsibility has fallen upon the city, which is experiencing its own fiscal woes.

Jefferson County, Ala. is another troubled municipality. The county issued bonds in the early 2000s that relied on complex and esoteric interest rate swaps to protect against rising interest rates. When the economy tanked, the swaps exploded, saddling Jefferson with rising debt-service payments.

While the likes of Jefferson and Harrisburg find themselves stressed, the overall picture isn’t all that bleak.

A large proportion of municipalities face spending cuts, but most are positioned to make due with weaker tax revenues. The average debt load carried by states falls in the mid-single digits of total state product, the localized equivalent of gross domestic product. The highest ratio of annual debt-service-to-budget expenditure is 13 percent, though 3 percent is average.

Those are manageable debt levels for most municipal issuers.

There are also clear catalysts that will create new demand for tax-advantaged municipal bonds.

The leading edge of the Baby Boom Generation turns 64 this year and while some of these folks have opted for early retirement, the wave of Boomer retirements will begin in earnest around 2012. Unfortunately, taxes are likely to increase substantially around that time.

Although the jury is still out on whether the Bush-era tax cuts will sunset, the fact is that if the US is serious about addressing the bulging federal deficit, the government must take in more revenue than it spends. Global buyers of US Treasury bonds won’t tolerate America’s spendthrift ways forever. All of this means higher taxes.

That’s going to lead to a revival of interest in municipal bonds as investors in or near retirement look for ways to lower their tax bills–a benefit few other investment types offer.

Resurging demand for municipal bonds will certainly generate capital appreciation, but supply constraints will push the tape even higher.

Created under the American Recovery and Reinvestment Act of 2009, Build America Bonds (BABs) have become a popular alternative to traditional municipal bonds. While BABs generally carry no tax advantage for investors, municipalities favor them because in most cases the federal government will subsidize 35 percent of the interest paid on the bonds.

As issuers rushed to take advantage of the program, BABs grew to account for more than a quarter of available municipal bonds by the end of 2009. The program was scheduled to end by Jan. 1, 2011, but there is a bill before Congress to extend it for another year. This would further diminish the supply of tax-advantaged municipal bonds.

Given the convergence of poor sentiment, a favorable supply and demand situation and reasonably attractive tax-advantaged yields, this is an excellent time to add municipal bonds to your portfolio.

Marshall Intermediate Tax-Free (MITFX), conservatively-managed fund that frequently appears in The Rukeyser 100, is one of my favorite national municipal funds.

Managers John Boritzke and Duane McAllister generally avoid poor credit quality and highly volatile sectors while maintaining an intermediate duration.

The fund tends to underperform when junk bonds rally, but shines in weak markets. Marshall Intermediate Tax-Free’s returns ranked it in the top 6 percent of its category in 2007, and the fund outperformed two-thirds of its peers in 2008.

In addition to its low expense ratio of 0.55 percent, the fund offers a solid 3.5 percent yield, which equates to almost 5 percent on a federal tax-exempt basis for those in the 25 percent tax bracket.

For those who want a bit more juice and can tolerate higher risk, T. Rowe Price Tax-Free High Yield (PRFHX) offers an almost 7 percent taxable equivalent yield. The fund achieves this by stepping down a bit on credit quality. With an average rating of BB, the portfolio includes riskier issues such as tobacco bonds.

That said, manager James Murphy doesn’t take undue risks in the portfolio; the fund is a solid middle-of-the-road offering, though it does entail more volatility.