People like former U.S. Secretary of Labor Robert Reich and NYTimes economy columnist Paul Krugman are increasingly ringing loud alarm bells about the growing municipal bond crisis and the danger of a double dip recession. While both are fundamentally loyal to the capitalist system, they argue that a decrease in the consumer power of the U.S. public sector worker can exacerbate the depressionary features of the economy, tending towards over-production and over-capacity. These are neither the only nor the loudest alarm bells being rung by economists in relation to the U.S. public sector.

The biggest economic worry related to the public sector is the municpal bonds market.

Municipal bonds are issued by the governments of cities and towns to offset bankruptcy and pay for local spending. “Health bonds,” “education bonds” and “bridge bonds” are issued to investors, promised with full payback at interest in a few years, a decade, or even more than 40 years. Once considered a risk-free investment, these bonds are encountering gargantuan trouble.

An estimated $2.8 trillion is locked up in the municipal bond market, equal to 22% of U.S. GDP. An inability to pay back investors could bring about severe consequences, not just for city and state budgets, but for the economy as a whole.

“If some states and local governments fail to meet this requirement, jeopardizing their ability to pay creditors, it could seriously damage municipal bond markets, a cornerstone of U.S. capital markets, potentially precipitating a new financial crisis,” (Financial Times, 1/14/11).

Although the potential payoff for investors wouldn’t come for decades, local governments are required to give the approximate value of the bonds issued every year. In the last three years, over 40% of bonds on the market have not been valued at all in order to avoid investors’ panic at the fact that most bonds would be valued well below what was initially paid for them. Municipal bonds are often guaranteed by states or bought by states. The Securities and Exchange Commission is investigating the bond valuing and trading in California and Illinois, two states with extreme ongoing budget problems, (Wall Street Journal, 1/26/11).

The worry about U.S. municipal bond markets is beginning to turn to panic. Meredith Whitney, one of the few big-time capitalist economists to warn about the 2008 U.S. crash before it took place, is at the forefront of the concerns. Whitney still refuses to produce a full version of her well-researched report about state and local budgets’ relation to the municipal bond market for fear that it will trigger a massive crisis.

Along with an Irish default, a Spanish banking collapse and a Chinese housing implosion, a collapse of municipal bond markets is pointed to as a potential detonator for a bomb that could send world markets into a second tailspin of this Great Recession. While the current shallow, jobless recovery could be prolonged for months or even years, further serious problems loom on the horizon for the world’s capitalist system, and a collapse in the municipal bond market could lie at the center of that situation.

Already, many hedge fund managers are betting on the collapse of municipal bonds that were only a few years ago considered risk-free investments. Now, bondholders are getting calls from big investment firms offering to buy bonds at 50% of the original value, telling individuals that they may want to get out before the defaults and ensuing collapse take hold.

Susie Madrak, Democratic Party machine staffer turned blogger, says “Municipal bonds are where all the serious money is hidden – where politicians get kickbacks, where political deals are made, and even where the big bribes are.” The financing of vital services are within those bonds as well.

The coming cuts and ensuing convulsions in markets will have dire consequences not just for workers and the poor but also for the medium-term prospects of the capitalist system’s markets.