One risk for buyers of weaker credits is that economic growth may falter, putting more pressure on cities that are still rebounding from the 18-month recession that ended in 2009, said Mansour.
"If another recession hits in two or three years, their choices are going to get even grimmer," he said. "That's what scares us."
Most economists project growth to continue. The U.S. economy will expand 2.3 percent this year, compared with 1.7 percent in 2011, a Bloomberg survey of banks and securities companies shows.
The extra yield on issues from California, the lowest-rated U.S. state by Standard & Poor's, fell to 0.82 percentage point last week, matching the smallest since December 2008, according to data compiled by Bloomberg. On May 14, Brown said his state's deficit had grown to $15.7 billion from $9.2 billion in January. The state's debt has returned 4.7 percent this year, compared with 4.1 percent for the broader muni market, S&P index data show.
Shielding Alabama
The appetite for risk is also cushioning Alabama municipalities, which had already been paying an extra 0.25 percentage point to borrow because of the proximity to Jefferson County, said Barnett in Birmingham. The county in November filed the biggest municipal bankruptcy in U.S. history.
The Alabama House last week refused to consider allowing the county to raise taxes, which may lead to further service cuts and more missed bond payments. The development won't force up yields, Barnett said.
"With nominal levels where they are, everybody is attracted to any extra yield they can get," he said. "That's working to bring down any penalty for Alabama paper."
Rockland County, New York, is also drawing demand, even after having its rating cut three levels on May 10 by Moody's Investors Service because it hadn't closed a deficit of more than $40 million.
The county of about 312,000 across the Hudson River from Westchester County has had its bond grade cut twice this year by a total of five levels, to Baa3, the lowest investment grade.