States and cities are laying off workers and shaving budgets to right their finances, and defaults on local debt, although not likely, could conceivably disrupt financial markets, says Mark Zandi, an economist at Moody's Analytics.

While overall economic recovery can help at the local level, it won't happen quick enough to offset more layoffs and budget cuts.

That leaves room — even if just a little — for the danger that some state and local governments may decide they won't be able to pay the interest on their debt.

"It is hard to get to a scenario where the defaults undermine the financial markets, but it is a risk," Zandi tells the Christian Science Monitor.

Zandi is less fearful of such a scenario as star analyst Meredith Whitney, who recently predicted that defaults at the state and town levels could reach hundreds of billions of dollars.

Nevertheless, revenues at the state level are on the rise again.

In the third quarter of 2010, 42 states took in more from personal income taxes and sales taxes than during same period in 2009, according to the Rockefeller Institute of Government.

"That's good news," Don Boyd, a senior fellow at the institute, tells the Christian Science Monitor.

"But it is still below the levels needed to finance the spending commitments the states have."

Still, worries are lingering.

"When people hear 'defaults,' they imagine bankruptcy like a Madoff event, with their money gone," Lewis Altfest, a New York financial adviser, tells the Chicago Tribune.

"It's difficult for individuals psychologically because they think of bonds as their safe area, their no-worry zone."