The Supreme Court heard arguments last week in a case seeking to eliminate a state's right to issue tax-free municipal bonds for paper concerning its own state, but to tax out-of-state municipal bonds.

A Kentucky court ruled out the practice last year. If the Supreme Court upholds that decision, it could upset the $155 billion state municipal bond market and lead to the demise of single-state bonds.

By several reports, the justices appear to be leaning in the industry's favor, likely to overturn the Kentucky decision. Given the fact that bonds issued by New York, which would be subject to high taxes if the Kentucky decision is upheld, are commanding a premium, "the market is telling you that the Supreme Court is going to overrule the ruling in Kentucky," Dan Loughran, a manager of several municipal bond funds at OppenheimerFunds told The Wall Street Journal.

Should the justices decide that capital financing is a critical part of a state's sovereign authority and that Kentucky is merely trying to give its own funds an advantage, they will uphold the status quo.

"These are the kind of trade barriers and trade retaliation that we don't want states to be entangled in," said Eric Brunstad, a partner with Bingham McCutcheon who argued against the Kentucky decision.

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