While the world watches and ponders on the USA’s sovereign debt problems there is another crisis brewing under the surface.

It is thought that as many as fifteen US states could lose their triple A credit status on the back of Standard and Poor’s downgrade of USA sovereign debt on Friday.

According to the Wall Street Journal these could include Maryland, New Mexico, South Carolina, Tennessee and Virginia.

These states are particularly vulnerable because they rely on state funding such as Medicaid or have a high level of public sector employees.

Any downgrade would have an effect on the costs of their borrowing and so drive their municipal bond yields higher.

Not only that there is the concern of having states within the USA with a higher credit status than the USA as a whole, something the rating agencies will no doubt ponder on.

According to Bloomberg the municipal bond market is getting ready for ‘hundreds and hundreds’ of downgrades within its $2.9 trillion dollar bond market.

The Guardian reports on the tiny city of Central Falls in Rhode Island, home to just 18,000 people, which has already gone bankrupt. The report quotes a senior research fellow at the Mercatus centre at George Mason University, Eileen Norcross, who says that Los Angeles, New York and Chicago could go the same way within ten years. She thinks that Central Falls could well be "the canary in the coalmine".

According to Robert Flanders the cities central receiver, the city has significant shortfalls and "Short of someone dropping the cash in our laps, I don't see what we can do”.

Some public sector retirees will see their pensions slashed and services are being cut. This could drive people away as jobs and services dry up and slowly kill the city.

Even if the states in peril don’t lose their status immediately, S&P has put the USA on negative outlook for six to 24 months and said that there is a one in three chance of a further downgrade. That would then surely push the municipal bonds further into the debt mire.

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