Some actuarial experts believe an 80% level of funding is adequate because these are long-term liabilities, though others place it closer to 95%. Funding rates typically vary from year to year depending on a number of factors, including equity prices and contributions. The fact that some states are switching from defined-benefit pensions to defined-contribution plans and others are requiring higher employee contributions also is encouraging.

As events in Wisconsin revealed, workers in the private sector are becoming increasingly skeptical since public workers enjoy pensions that dwarf theirs. A recent study by Spectrem group found that while public employees represented only 15% of the nation's workforce, they held 37% of the nation's retirement assets.

State and municipal revenues are improving, albeit off a small base, Ryon says. In the third quarter of 2010, revenues were 4.9% higher than the corresponding period of 2009. That trend could be accelerating, since early reporting states in the fourth quarter of 2010 were 6.9% ahead of the final quarter of 2009.

Furthermore, state and municipal payrolls now have 400,000 fewer people than they did in mid-2008. "Both the revenue and expense sides are moving in the right direction," Ryon claims. "I don't want to sound Pollyannish. There are lots of issues out there and it takes longer than people expect to get everyone on the same page."

It may seem strange, but Ryon also finds the changing political climate comforting. New Jersey Gov. Chris Christie has given "a lot of other governors more political backbone" to address pension and benefit issues, and politicians in both parties are hitting "the difficult issues and taking on the unions."

Yet if one talks to the folks at Doubleline Capital LP, the fact that Whitney may have missed the mark with her predictions of total doom may not matter. Jeffrey Gundlach, the firm's CEO and CIO, has mentioned the possibility of soft or polite defaults where bondholders get paid eventually but some promises, particularly pensions, get modified.

University of Pennsylvania law professor David Skeel outlined one option earlier this year. If Congress amended Chapter 9 of the federal bankruptcy code to allow states and municipalities to modify their obligations, it could spark a wave of selling in the muni market.

Even if it never becomes law, mere talk of giving states and other entities the right to renegotiate existing contracts with the flick of a pen could spawn a panic. The negative feedback loop could get much worse. "If a few states start defaulting, all states will start to ask why shouldn't they?" Gundlach says.

Despite the hysteria Whitney created and the subsequent sell-off, Gundlach worries about the complacency among muni investors, whom he believes are largely in a state of denial. Accordingly, he thinks prices could decline 15% or more at some point this year.

Structural changes could bring the stresses and strains in the market to a head very soon. In April and May, the muni market is expected to see a big uptick in the supply of new issues. Two avenues of funding-the auction-rate securities market and Build America Bonds-no longer exist. So they'll have to sell billions of dollars worth of new bonds "to a traditional investor base that is increasingly skittish," said Greg Whitely, portfolio manager at Doubleline.