Effect of downgrading monoline on the underlying municipal bond securities

This is a big issue, and Moody’s tried to explain.  A municipal security apparently will then carry whichever rating is higher (its own or the monoline).

“If a security is wrapped by a financial guarantor, and has a published underlying rating that is higher than the guarantor’s rating, what is the Moody’s rating on the security?

A: The Moody’s rating is the higher of (i) the guarantor’s financial strength rating and (ii) any published underlying rating (i.e., absent consideration of the guaranty) on the security. For US municipal securities, we also consider any enhanced rating based on a state credit enhancement program. For structured finance securities, we also consider any published rating on a pari passu (i.e., at the same level of seniority) non-sequential tranche or more junior tranche of the same transaction.”  Read the entire Moody’s explanation on the Bond insurers/monolines page.