Ongoing talks over the so-called fiscal cliff and speculation of removing the tax-exempt status on municipal bonds has pressured muni bonds and exchange traded funds, although they recovered somewhat last week.

ETFs such iShares S&P National AMT-Free Municipal Bond ETF (NYSEArca: MUB) fell hard in mid-December but have bounced a bit recently. [Muni Bond ETFs: Year in Review and 2013 Outlook]

The tax hoopla has depressed municipal bonds, with high-grade 10- and 30-year munis comparably yielding as much as taxable Treasury securities at 1.79% and 2.73%, respectively, writes Randall W. Forsyth for Barron’s. [Muni ETFs Extend Losing Streak on Tax Jitters, Bond Flood]

According to reports from trading desks, bids have become more scarce as a greater number of investors are sitting on the sidelines and waiting it out as the fiscal cliff goes down to the wire.

Congress has reportedly proposed levies on high-income investors in munis as part of of the deficit plan.

More pessimistic muni observers are wondering if taxes could be imposed retroactively on tax exempt securities. George Friedlander of Citi, though, believes this is a “pernicious concept” that could destroy confidence in the federal government’s ability in the capital markets.

Friedlander has also pointed out that if there were a limit to the value of tax-exemption on munis to up to a 28% cap, yields would rise 0.4% to 0.6%, which would devalue munis by $200 billion. Looking at the recent correction in muni ETFs, the potential tax hikes may have already been priced in.

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