Latest Fitch Ratings move illustrates spiral of US debt downgrades and their effects

Deterioration in the credit cycle has taken a new twist, as Fitch Ratings warned Friday a number of bonds might be downgraded _ because the bonds' insurer is facing a downgrade from Fitch.

Standard & Poor's made the same move earlier this week, downgrading hundreds of municipal bonds after it had downgraded the insurer of those bonds, ACA Capital.

It is a cycle that could continue as rating agencies warn bond insurers, such as MBIA Inc. and Ambac Financial Group Inc., might not have enough capital to cover claims.

Earlier in the week, Fitch warned MBIA will need to raise an additional $1 billion on top of the $1 billion (euro700 million) capital investment private equity firm Warburg Pincus pledged earlier in the month. The money is needed as a safety net in case insurance claims rapidly rise in 2008.

Unless insurers _ considered the last line of defense protecting investors from defaulting bonds _ can meet rating agencies' standards to stabilize capital and guarantee they have enough money to pay out potential future claims, the number of bond downgrades may climb.

As that continues, investors may avoid buying new debt because it is too risky without the added insurance, leaving the credit markets locked up.

The tightening of the credit markets began over the summer with an avalanche of downgrades of asset-backed securities, collateralized debt obligations and other debt tied to rising mortgage defaults.

Asset-backed securities are groups of consumer loans and mortgages packaged together and sold in pieces to investors. Collateralized debt obligations, or CDOs, are complex financial instruments that combine slices of debt, many of which are in part backed by mortgages.

Until recently, a majority of asset-backed securitizations were backed by subprime mortgages and home equity loans and lines of credit. Those types of home loans have increasingly gone delinquent and into default in recent months.

Because of those rising delinquencies, investors and credit rating agencies have worried the securities and CDOs backed by the troubled loans will default as well. That spurred rating agencies to start mass downgrades of the debt.

Fitch, S&P and Moody's Investors Service have all downgraded billions of dollars worth of debt over the past six months. S&P was the latest to announce a mass downgrade, lowering ratings on Thursday of 793 classes of securities underpinned by nearly $23 billion (euro16 billion) in home loans.

Many of those downgraded deals _ that investors and rating agencies are now worried might default _ are insured by companies like MBIA.

The problem is, because credit rating agencies downgraded so many instruments, there is a now a fear bond insurers will not have enough cash to cover potential defaults. That has led ratings agencies to place warnings on and downgrade the insurers.