Demand for municipal bonds may be up these days but that may reflect investors' search for yield amid times of low interest rates and not fundamental improvements to municipal finances, said star Wall Street banking analyst Meredith Whitney.

In 2010, Whitney told "60 Minutes" that municipal bond defaults could run into the hundreds of billions of dollars.

That hasn't happened yet, likely due to factors such as states taking steps to prevent defaults from even happening in the first place though still, local economies remain on shaky ground due to poor tax receipts and record-high spending levels in some cases.

Editor's Note: How You Lost $85,000 During the Last Decade. See the Numbers.

"So, for states like California, Nevada, New Jersey, they're in such deep structural decline, it's very difficult to see any type of consumer spending growth, any type of real economic growth, and that pressures the economy still further," Whitney told CNBC.

"Revenues are still pressured. For all the states, state tax receipts are still tracking just 2007 levels but spending is at record highs. There's a structural gap there. That structural gap leads to continued cuts to the budget," Whitney added.

Demand for municipal bonds has remained strong but that mainly reflects a search for yield and not an underlying improvement to state and local economies across the country.

"The municipal bond market supply and demand has nothing to do with fundamentals. Rates are incredibly low. People are desperate for yield. People want return. That's one thing driving the municipal bond market. The reality is each state is struggling uniquely," Whitney said.

"You've had three defaults so far in California. You've seen defaults in Rhode Island. You see almost defaults in Michigan and Pennsylvania. And I think those are setting the precedent for more defaults to come," Whitney added.

"Hopefully we don't see those, but what happens is if you can agree to change and where everybody takes a haircut."

Many investors today have been drawn to unrated municipal bonds in search of yield, though a Federal Reserve study shows that defaults increase when factoring those unrated bonds into the equation.

From 1970 through 2011, Moody's reported 71 defaults, while the economists at the Federal Reserve Bank of New York found 2,521 defaults when included unrated bonds, the Fed reported recently. Standard & Poor's 500 index reported only 47 defaults from 1986 to 2011, though the Federal Reserve Bank of New York study found 2,366 defaults when unrated bonds were counted.

Investors should be careful when searching for yield alone.

"You really have to be a professional to invest in that marketplace. An individual is much better suited to go into a mutual fund because a fund gives them a whole bunch of benefits," said William Larkin, fixed-income portfolio manager at Cabot Money Management in Salem, Mass., according to Bankrate.com.

"The most important thing that it gives them is liquidity. I always refer to (the municipal bond market) as a country road. The transactions are not very frequent, and liquidity can be a major problem because as a retail investor, you can get scared very easily and then try to sell. And that's when you're going to take your biggest loss."

Editor's Note: How You Lost $85,000 During the Last Decade. See the Numbers.