Jennifer Zuccarelli, a spokeswoman for Dimon at the bank, declined to comment.

Market Rally

By the end of March, tax-exempt interest rates had reversed a surge that began in the previous September, just before Whitney's eponymous firm issued a report on the market. By Dec. 12, the yield on the 10-year Municipal Market Advisors index of top-rated debt fell 113 basis points, or 32 percent, from this year's high of 3.5 percent on Jan. 18. A basis point is 0.01 percentage point. Yields decline when bond prices rise.

The rally rolled through the second half even as the pace of municipal defaults quickened, highlighted by the bankruptcies of Central Falls, Rhode Island, and Alabama's most-populous county, which was weighed down by the sale of about $3.3 billion in sewer bonds led by JPMorgan. The corrupt deals led to guilty pleas or convictions of 21 people by this year.

Pace of Defaults

Richard Lehmann, the Miami Lakes, Florida-based publisher of the Distressed Debt Securities Newsletter, has predicted a record of at least $20 billion in municipal defaults this year, including some that don't involve missed payments so aren't counted as such by other analysts, according to Matt Fabian, a Municipal Market Advisors managing director. Fabian says by his count, defaults have reached $2.1 billion this year, down from about $2.8 billion in 2010. Even by Lehmann's count, the pace falls far short of Whitney's outlook.

As the year progressed, banks consummated at least $4 billion of direct purchases and private placements, identified through credit-rating reports. JPMorgan handled $500 million of those agreements, while $1 billion went to Wells Fargo & Co. in San Francisco, the third-largest underwriter among U.S. banks, by number of deals. The private deals typically aren't disclosed by borrowers until annual reports are released months later and when they are, the lender often isn't identified.

Bank of America Corp. and three other banks bought $376 million of debt directly from Missouri's Mercy Health system last month while in July the California Academy of Sciences in San Francisco privately placed $257 million. Both deals were confirmed by the nonprofit organizations. New York City has completed $350 million of the sales this year to banks including JPMorgan and Wells Fargo, according to Ray Orlando, a spokesman for the city's Management and Budget Office.

Replacing Variable Rate

The surge in lending and direct purchases is largely linked to a decline in conventional variable-rate municipal bonds, according to Adam Joseph, a managing director in public-finance capital strategies at Wells Fargo in New York. Before the credit crisis, as much as 20 percent of municipal debt was sold each year with a rate that changed weekly or monthly. Investors such as money-market funds preferred that banks acted as buyers of last resort for much of this type of security, to limit their risk.

Even before Bear Stearns & Co. collapsed and was bought by JPMorgan in March 2008, banks found themselves being forced to step in and buy the securities. As the financial system began stabilizing in 2009, some municipal underwriters opted to keep making direct loans instead of offering to serve as backup buyers for publicly marketed debt.

Owning The Asset

"We'd just rather lend out the $100 million and own the asset and that's it, as opposed to writing a contingent- liability contract that could force us to buy the asset back at an inopportune moment," said Joseph. "It's a very good place to put our money especially in the context of our relationships with the borrowers."

About half of Wells Fargo's direct purchases have covered new capital projects while the rest have been used to refinance variable-rate debt, Joseph said. Regulations have reinforced the decision because banks have to keep more capital in reserve when they back variable-rate securities, he said.