It’s a situation we see often in the financial world.

Harrisburg, Pa. required an expedited payment of $4.4 million from the Commonwealth of Pennsylvania to make a required municipal bond payment. The announcement caused some weakness in municipal bond markets earlier this week.

That’s hardly surprising because many investors fear a tsunami of municipal defaults amid falling tax revenues. I don’t believe–and the numbers don’t seem to suggest–that we’ll see a catastrophic wave of defaults.

There are isolated cases of issuers such as Harrisburg facing a potential default, but they’re much like my sidewalk–built on shaky ground.

Harrisburg is in an unfortunate position. It was the second guarantor on a series of general obligation bond issues which was used to build and operate a trash-to-energy incinerator facility. Since the facility was constructed in the 1970s, it’s been nothing but a boondoggle of cost overruns and environmental concerns. Those 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 which relied on complex and esoteric interest rate swaps to protect against rising interest rates. When the economy tanked, the swaps exploded, miring Jefferson in 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–think of it as localized gross domestic product (GDP). 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.

If you’re holding shares in a well-diversified muni bond exchange-traded fund (ETF), there’s little downside risk, aside from the initial market jolt triggered by an unexpected default.

Munis are still attractive for income investors. Despite fiscal worries, municipal funds remain fairly valued and the market is already beginning to price in higher tax rates.

One of the best municipal ETFs out there is iShares S&P Short-Term National AMT-Free Municipal Bond (NYSE: SUB). The strategy is simple: The fund offers a short, 2.2-year duration and a weighted average maturity of 2.3 years, limiting its sensitivity to interest rate changes. The fund also invests in issues with coupon payments that aren’t subject to the alternative minimum tax.

Build America

Build America Bonds (BAB), a new form of municipal bond, were authorized by the American Recovery and Reinvestment Act of 2009.

Unlike traditional municipal bonds, which are usually tax-exempt, interest received on BABs is subject to federal taxation. However, as is the case with municipal bonds, most states don’t tax the interest paid on a BAB if the holder resides within the issuer’s jurisdiction.

So what’s the allure of BABs?

For starters, they offer significantly higher yields than standard muni bonds; many of these longer-dated bonds yield over 7 percent, thanks to government subsidies.

Under the direct payment variation, the government provides the issuer a subsidy equal to 35 percent of the interest payments on the bond. More often than not, issuers pass much of that subsidy along to bondholders in the form of higher interest payments.

The direct payment option is the most popular with issuers and is therefore the most common form of BAB available.

These new bonds have been popular with investors because–if you believe the ratings agencies–they’re reasonably safe and carry ratings from A to AAA.

These qualities make the bonds extremely attractive for institutional investors. Pension funds and other tax-exempt organizations have scooped up these bonds because they offer high yields with little risk. The popularity of BABs has grown to the point that they’re displacing an ever-growing slice of traditional bonds in government debt issuance.

All this means it’s nearly impossible for retail investors to get a piece of individual issues.

The best way for you to get in on the action is through PowerShares Build America Bond (NYSE: BAB), which holds a sampling of the bonds that make up the Bank of America Merrill Lynch Build America Bond Index. This index tracks only direct-pay BABs; holding the ETF doesn’t convey any tax benefits.

But the yield currently trumps that of the S&P 500 by almost 4 percent, and the fund carries an expense ratio of just 0.35 percent.

What’s New

Indexing powerhouse Vanguard Group rolled out nine new index ETFs last week that will directly challenge offerings from iShares and SPDR, two other major indexing shops. The new offerings are listed below:

• Vanguard S&P Small-Cap 600 Value (NYSE: VIOV)
• Vanguard S&P Small-Cap 600 Growth (NYSE: VIOG)
• Vanguard S&P Small-Cap 600 (NYSE: VIOO)
• Vanguard S&P 500 Growth (NYSE: VOOG)
• Vanguard S&P 500 Value (NYSE: VOOV)
• Vanguard S&P 500 (NYSE: VOO)
• Vanguard S&P Mid-Cap 400 Value (NYSE: IVOV)
• Vanguard S&P Mid-Cap 400 Growth (NYSE: IVOG)
• Vanguard S&P Mid-Cap 400 (NYSE: IVOO)

Perhaps the most significant is Vanguard S&P 500, which will compete against SPDR S&P 500 (NYSE: SPY), the oldest and largest ETF on the market.

That will be a tough nut to crack. But Vanguard’s offering may have an edge because the fund carries an annual expense ratio of just 0.06 percent, compared to the 0.09 percent charged by SPY. The remaining eight funds are also attractively priced. The core funds carry a price tag of 0.15 percent, and the highest expense ratio among the bunch is 0.2 percent. The funds are cheaper than 80 to 90 percent of the competition, in line with Vanguard’s reputation as a provider of low-cost index funds.

Given that there’s very little trading volume behind these new funds as of yet–with the exception of Vanguard S&P 500, which averages around 65,000 shares daily–I’d hold off for now.

But we won’t have to wait long for volume to pick up; Vanguard brokerage customers will be able to trade the funds commission-free. These funds may mark a major coup for Vanguard.