Enough is enough. I’ve had it with California muni bonds.

Despite the relative safety of holding the state’s debt in the form of index funds or ETFs, when a government starts paying for prison services and laundry bills in the form of IOUs …

Don’t get me wrong. It’s not time to panic and completely bail on the state’s bond issues. If you’ve held onto them up to this point, jumping out all the way might not be the best idea. After all, long-term returns of conservatively run, ultralow-cost mutual funds like the Vanguard California Intermediate-Term Tax-Exempt Fund (VCAIX) are stellar.

The story is similar with ETFs. (We took a look at the muni bond ETF field last year in this column).

In California, one of the more popular options is the iShares S&P California Municipal Bond ETF (NYSEArca: CMF). So far this year, it’s up more than 2.4%. And it’s paying a tax-equivalent yield for someone in the upper brackets of around 6.6%. That compares with a slightly negative return on the iShares Barclays Aggregate Bond Fund (NYSEArca: AGG) and taxable yield of about 4.4%.

But in the past three months, while AGG has held its own during a rally in stocks, CMF has faltered. Its total returns are negative for the period, underscoring how quickly conditions have changed. Sentiment has been on a roller coaster this year toward California’s debt situation, which now is around $24 billion. Earlier, investors were relieved by signs that politicians would take advantage of improved market conditions to wiggle out of their fiscal deficit hole. Lately, conditions have turned worse and the legislature seems deadlocked down party lines.

A few weeks ago I wrote a bullish comment over at Bogleheads supporting the view that it was highly unlikely the state would go bankrupt. ETFs like CMF and the SPDR Barclays Capital California Municipal Bond ETF (NYSEArca: CXA) track benchmarks steeped in high-quality bonds that are guaranteed by the state’s general obligation fund. California Treasurer Bill Lockyer has said that only “thermonuclear war” could halt payments of bonds with such backing.

Still, is there anyone out there investing in California munis who hasn’t sold at least part of their positions in the face of the state’s latest bumbling? I never in my wildest dreams imagined that the eighth-largest economy in the world would ever fall into such disarray.

And now, the state is issuing IOUs to even the most common of creditors? Think about that for a bit. I’m Joe Blow and I own a small landscaping service. It’s tough times, but I’ve managed to win a bidding war for a state contract to take care of a bunch of state office sites. I keep my costs lean and even though the price given to the state was very low, there’s a bit of profit to help with cash flow. Now, I’m getting paid with IOUs?

Besides the absurdity of the situation, what’s going on with California smacks at the very basis of sound investing practices. I consider myself an investor. I take pride in the fact that part of the hard-earned money I bring in each month goes into investing in our economy and others around the world. It feels good to invest in good companies and good places where people work hard and try to get ahead.

I’m not a Democrat or a Republican, so don’t think this rant is political in nature. But there’s a fine line between being a prudent investor and remaining true to your basic reasons for putting money into bonds. I’m in the accumulation phase of my investing life, where bonds are around to smooth my family portfolio’s bumps in a supposedly more volatile stock market. Is 2-3% more in tax-protected yields worth staying invested in a state that the Wall Street Journal recently observed has become ungovernable? (And that was in a front-page news story, not an opinion piece.)

So while I’m not bailing out completely from my California muni bond fund, I am trimming aggressively. This is designed to kill two birds with one stone. First, it’ll hopefully diversify my bond portfolio greatly. I’ve been extremely lean on Treasury Inflation Protected Securities, and now seems like a good time to start stocking up as part of a longer-term strategy of devoting part of my allocations to fighting rising prices.

But shifting part of my allocation away from California munis also lets me rest easier at night knowing that in my own way, I’ve made a statement. I’m not a politician, and a vote of the people is still far down the road. Still, through my ownership rights as a bondholder in the state’s crazy bureaucracy, I’m able to take a small stand. Enough is enough.

For me, the expansion of ETFs and index funds into more and more parts of fixed-income markets is turning out to be more of a democratizing investment process than I ever imagined. Holding onto some California munis will let me reap the rewards of whatever convoluted solution results from all of this latest mess (and I’m confident there will be a solution … eventually), and will also keep me invested in my state’s economic future.

But it sure feels good not to be quite so beholden to the whims and fancies of our elected leaders in Sacramento. Who said diversification isn’t working these days?