Standard and Poor continued to downgrade bonds linked to the U.S. government after downgrading the long term federal debt after debt ceiling talks concluded last week. As Sarah Frier and Michelle Kaske reported:

The rating company assigned AA+ scores to securities in the $2.9 trillion municipal bond market including school- construction bonds in Irving, Texas; debt backed by a federal lease in Miami; and a bond series for multifamily housing in Oceanside, California. Olayinka Fadahunsi, an S&P spokesman, said he couldn’t provide a dollar figure on the affected debt.

S&P also cut ratings on securities backed by Fannie Mae and Freddie Mac, prerefunded issues and munis repaid by using federal assets, also known as defeased or escrow bonds. No state general-obligation ratings were affected and the company said some may remain unchanged.

“It’s expected, but nobody is happy about it,” Bud Byrnes, chief executive officer of Encino, California-based RH Investment Corp., said in a telephone interview. “No one that I know thinks it was justified to cut the U.S. bonds to AA+. Once that happened, you knew that any prerefunded bonds or escrowed bonds would be downgraded too. It’s a domino effect.”

Byrnes said funds required to invest in AAA bonds would be most affected by the downgrades and may be forced to liquidate some holdings. “They will have a hard time replacing that yield,” he said.

Some analysts have looked to the financial stability of these municipal bonds which have been downgraded, and have questioned whether some U.S. towns could go bankrupt as a result. As Suzy Khimm explained, that might necessarily happen.

Standard & Poor’s announced another wave of downgrades on Monday,lowering the credit ratings that affect thousands of cities, school districts, public housing and transportation projects directly linked to federal funds. The municipal bond downgrades ranged far and wide -- from financing Jets Stadium to building a high school in Montana’s Hill County -- but all were “explicitly linked to federal funds or are paid from funds appropriated at the federal level,” says Gabriel Petek, a senior S&P analyst. The muni bond market weakened on Tuesday after the list was released. Will this mean higher lending rates for states and cities? And will it push towns already on the brink of financial collapse over the edge into default?

Not necessarily. Overall, Chapter 9 filings by municipalities have actually gone down in the first half of 2011, as compared to 2010 and 2009, as have municipal defaults overall, defying popular predictions last year that the U.S. would soon experience “a tsunami of municipal bankruptcies and defaults.”  

And so far, cities and states may have avoided the worst fallout of a sweeping credit downgrade: S&P hasn’t changed its credit rating of entire states or local governments as a direct result of downgrading the U.S. government, and they’ve tried to affirm that state and local finances are largely independent of the feds. “In our view, the institutional framework for U.S. public finance is among the most stable and predictable in the world. ...U.S. state and local governments function with a high level of revenue independence,” S&P wrote in a report released late Monday, explaining that some states and cities could retain an AAA rating even though the U.S. as a whole has been downgraded.

As global stock markets attempt to handle the shocks of deficit worries in the United States, a widening public debt crisis in the Euro zone and export worries in Asia, Washington has stepped its blame game into high gear. As David Nakamura and Rosalind S. Helderman reported:

First, the Asian markets tanked. Then Europe. Then the Dow, S&P, Nasdaq and all the other indexes, as the financial situation across the world grew increasingly dire.

The nation’s political leaders — the ones whose intransigence was blamed for the credit downgrade that led to the global sell-off — responded by doing exactly what they’ve been doing, only more so.

As the markets headed lower in the morning, President Obama announced he would make a statement at the White House at midday to address the situation. Speaking to reporters in the state dining room, Obama reiterated his call to reduce the country’s deficit through a “common sense” compromise on tax reform.

“It’s not a lack of plans or policies that’s the problem here. It’s a lack of political will in Washington,” the president said. “It’s the insistence on drawing lines in the sand, a refusal to put what’s best for the country ahead of self-interest or party or ideology. And that’s what we need to change.”

A short while later, House Majority Leader Eric Cantor (R-Va.) made it clear that Republicans were not about to compromise, sending a memo to his caucus urging that they not give in to pressure to do so.

Cantor took direct aim at the president, saying the Obama administration’s “anti-business, hyper-regulatory, pro-tax increase agenda . . . has led to dangerous uncertainty in our economy.”

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