* Late yesterday, I linked this story from the Sun-Times…

Speculation is that, if S&P downgrades the 50 states’ ratings, Illinois overall rating would drop to A2-Minus, which could mean a one-half of 1 percentage point increase in interest rate payments on future bond issues. For a $2 billion to $3 billion capital plan bond issue such as the state is planning this fall, such an increase would cost hundreds of millions more in interest.

* That “speculation” appears to be coming from the governor’s budget office…

Having to pay higher interest rates on future state bond issues – possibly ½ of 1 percent — is a possibility, said Kelly Kraft, spokeswoman for Gov. Pat Quinn’s Office of Management and Budget.

“However, at this time Illinois has not been downgraded, and we are not issuing bonds until September, which allows the market to digest the situation,” Kraft said in a statement. “If we were downgraded as a result of S&P’s downgrade of federal debt, the other 49 states would be downgraded as well. Therefore, until S&P indicates how states will be affected, offering more specifics on the ripple effect would not be prudent.”

Kraft said the state expects to issue $2 billion to $3 billion in general obligation bonds in September.

* Confusion was the order of the day yesterday…

Scott Pattison, executive director of the National Association of State Budget Officers, said he had been talking with state financial officers throughout the day Monday and there was no consensus about how the S&P action would affect states.

A state’s reliance on federal assistance “would be a factor to consider” for a rating agency, but Pattison said some states might be able to offset those concerns by showing they have a strong rainy day fund or have been willing to make spending cuts to keep their budgets in line with dwindling tax revenue.

“The downgrade is certainly not good news. But on the other hand, we’re really uncertain at this moment as to the direct effect, whether it will have a direct effect or not,” Pattison said. “I think it’s going to be a case-by-case basis.”

* But, as subscribers know, S&P offered up a bit of clarity late last night…

While the worldwide markets continue to decline in a vortex, Standard & Poor’s offers a nugget of good news for U.S. states and municipalities.

Despite S&P’s August 5 downgrade of the long-term U.S. sovereign debt, some state and local governments will maintain or even achieve AAA ratings, according to Standard & Poor’s. That’s in contrast to a slew of entities and companies, including Fannie Mae, Freddie Mac, several private insurers, such as New York Life and Northwestern Mutual, who were downgraded Monday in the aftermath of the government downgrade.

A S&P press release cites a report, “State And Local Government Ratings Are Not Directly Constrained By That Of The U.S. Sovereign,” which explains the factors that allow for this situation to occasionally occur.

“The report notes that many U.S. state and local governments function with a high level of revenue, treasury, finance, and debt management independence compared to their global counterparts,” the press release stated.

The report said much more than that, and some of it certainly applied to states like Illinois which don’t have AAA ratings, but you’ll have to subscribe to find out what that was.

* The biggest problem, however, is not so much the impact of the S&P federal rating on Illinois, but what happens with the economy. And the future ain’t too bright right now…

But the bigger cloud hanging over the municipal bond market is the prospect of evaporating federal support to states and cities at a time when another economic swoon is possible, observers say.

In the current political climate, observers say states cannot count on another stimulus package, for instance, if tax receipts begin to plummet again. For fiscally wobbly states, such as Illinois, a deepening squeeze can translate into higher borrowing costs.

“The market is worried about whether the economy will slip into another recession in 2012,” said bond expert Richard Ciccarone, managing director at McDonnell Investment Management LLC. “That is causing some skittishness, more so than the rating downgrade.”

What we’ve got is a real conundrum, caused mainly by national partisan politics. The economists and business types I’ve been reading are saying that we need a short term stimulus to keep the country on track and long term cuts to prevent real problems down the road. This is from Terry Belton, the head of fixed income strategy for JP Morgan Chase…

“I think, on the fiscal side, what we need — and we have sort of missed the boat here — a little bit of the opposite of what we got. We need long-term reform. We need to deal with entitlements reform and tax reform. That lowers the deficit in the long run. But we actually need stimulus now.

“We’re almost getting the opposite. Coming in to next year, we’re going to have quite a fiscal drag kick in as the 2011 tax cuts run off. That’s going to hurt growth a lot next year.”

What Belton (and loads of other like-minded folks) said makes a lot of sense, but it’s not easily sold in the excruciatingly loud and divisive DC echo chamber. “You want to spend more and cut more? Ridiculous!” Also, try cutting the long term growth of Medicare and see how far that gets you in politics. It ain’t just liberals who will beat you over the head.

* And now a warning: Do not drag your goofy DC talking points into the comment section. I will not be kind to mindless rehashing.

* Related…

* Durbin struggles to find bipartisan solution to financial crisis

* VIDEO: Dick Durbin Refuses to Play the Blame Game - The senior senator from Illinois wouldn’t fault either party directly for the credit downgrade.

* IL lawmakers react to nation’s credit downgrade: “The one that I would blame is Standard & Poor. I think it’s a political ploy by them. They didn’t recognize the crisis that we had with the mortgage bank securities. I think they’re making up for that,” Biggert said.

* Kirk wants Congress recalled to cut spending

* World stock markets stabilize after deep dives

* Panic Selling Across European Markets

* A lot at stake for small-town America - Rural America could be disproportionately affected by efforts to reduce federal spending.

* Illinois proves an amendment doesn’t guarantee balanced budget

* Kotowski grades effect of state budget reform

* Aldermen not warming up to proposed school property tax hike

* Brizard Defends Proposal To Raise Property Taxes For CPS

* Outlook for corn, beans varies widely around state