CDS swaps on muni bonds

A report from the Bond Buyer:

Anyone considering buying a taxable municipal bond might want to get a quote on some municipal credit-default swaps first.
Chances are, the CDS is a ­higher-yielding way to play the municipal market.
Consider Illinois. According to Bloomberg LP, it costs 290 basis points a year through a CDS contract to insure the state’s five-year debt, which itself yields 2.85%.
This is in flagrant violation of the “law of one price,” which states that the same cash-flow streams with the same risk should cost the same in different markets.
An investor with $10,000 could buy a five-year Illinois taxable bond yielding 2.85%. Or, he could buy a $10,000 five-year Treasury note yielding 1.53% and sell a CDS on Illinois yielding 291 basis points, collecting 4.44% for the same investment and the same theoretical risk as Illinois’ cash bonds.

The deal here is to buy federal debt, and put that up as collateral to insure a muni bond holder against default. There is more money, temporarily, in insuring risky muni debt then in holding it.

One might ask, why doesn't the muni bond rate reflect risk? The local/federal government goods channel is screwed up and neither the federales nor the locals can get the rates and quantities quantized properly. So the mismatch has to be handled by the insurance companies. You can blame this situation on stupid politicians. What is my evidence? The stimulus, it went mostly to rebalancing the federal/state funds flow, indicating an imbalance likely created by unfunded mandates.