What does Standard & Poor's credit downgrade have to do with states and localities? Nothing, says Robin Prunty, a senior director in S&P's Public Finance Ratings Group. "Obviously," she adds, "there are funding interdependencies and that is something we would continue to evaluate. There will be fiscal consolidation at the federal level, and there is potential impact related to those decisions."

But, when all is said and done, there is no direct linkage. In a report released Tuesday, S&P spelled out its criteria for maintaining or lowering AAA-rated states and localities in light of the lowering of the U.S. rating. The report did not, as feared, downgrade hundreds of muni bonds.

The U.S. credit rating issue aside, fiscal pressures on state and local governments continue. Last month, Moody's issued a report noting that downgrades of U.S. public finance credits outnumbered upgrades for the 10th consecutive quarter. In a move that foreshadowed S&P's reasoning for downgrading the U.S., Moody's and Fitch put Minnesota's credit rating on negative watch, citing "political intractability" as one of the reasons for the action.

The factors complicating state and local ratings are deepening. To get a sense of the rating challenges states and localities face, I talked to Robert Kurtter, managing director for Moody's U.S. State and Regional Ratings. Here are some of the key points he made:

The dangers of a U.S. credit rating downgrade. There is a relationship between the U.S. sovereign debt rating and state and local governments. Around the world, it is rare for a lower unit of government -- a sub-sovereign, like a state or municipality -- to have a higher rating than the sovereign government itself. There are circumstances where that occurs: It has a lot do with the dependence of local economies on that nation's economy, on the federal government's interaction with the banking sector and the degree to which government creates an environment that allows lower governments to be stronger than the parent. But if the parent weakens and can't support a banking industry in distress, that has implications for lower units of government in that country.

Given the circumstances and approach to ratings globally, Moody's looked at states that have a AAA rating. There are 15 of them, and we applied a series of screens to those states to try to identify, based on certain characteristics, which of these states might be vulnerable to downgrade if a downgrade of the U.S. rating should occur. We looked at a variety of things, including economic sensitivity to the U.S. macro economy, vulnerability to capital market disruption and vulnerability to reductions in federal spending either through programmatic support, such as Medicaid, or just state spending. We also looked at the ability to mitigate some of these risks. As a result of this analysis, we identified five of the 15 states that would be vulnerable to a change in a federal government rating. They are Maryland, New Mexico, South Carolina, Tennessee and Virginia. We have resolved and confirmed their AAA rating, and assigned them a negative outlook. We'll be reviewing each of these states individually to further refine their degree of vulnerability to a federal rating change, and will have some further conclusions when their reviews are finalized.

Fallout from the Great Recession. States are facing a revenue and spending crisis, not a debt crisis -- most states and localities are not highly leveraged. They do, however, face significant budget imbalances. In order to address those imbalances, state and local governments have had to cut programs that previously were off the table, like Medicaid and K-12. Of course, when states make cuts, there are downstream impacts on local governments. It's stressful for the local economy and puts credit pressure on local governments to absorb those cuts or to raise taxes to fill the gap. Moody's has had negative outlooks on the state and local government sectors for three years.

But just when states and localities were seeing an uptick in revenue and employment, they are now faced with a new set of problems: The rapidly rising risk of a new recession and the prospect of deep significant federal spending reductions.

The uneasy economy. Economists have been ratcheting down forecasts for economic growth for the U.S. since the beginning of the year, but recent events surrounding the spreading of the debt crisis in Europe and the debate here over the debt ceiling have obviously caused investors, as well as economists, to be much more concerned about the course of the economy. Recent data released about a slowdown in consumer spending (which accounts for close to two-thirds of the GDP), the continued weakness in the housing market and anemic job growth have created concerns that another recesssion is probable.

That creates challenges for state and local credit ratings. The past few years were characterized by unprecedented credit stress and problems for state and local governments in balancing budgets and meeting obligations. Now it looks like they may not be out of the woods yet.

GASB's proposed accounting rules to make pension liabilities more transparent. The Governmental Accounting Standards Board (GASB) has issued an exposure draft and a solicitation for comments. They may make changes and modifications before they issue rules, and there will be a phase-in period for complying. We are still a bit away from seeing results. Moody's is very supportive of increased disclosure and transparency, and of providing more information for all kinds of market participants about the nature of these liabilities. We have done our own analyses and taken into account the impact of funding pension obligations in our ratings. We have accounted for and identified those circumstances and situations where negative pressure of funding those obligations have had an impact on credit ratings. But, we don't see any immediate repercussions to a credit from this new rule.

Impact of the declaration of bankruptcy by Central Falls, R.I., and and the talk of bankruptcy in Jefferson County, Ala., and Harrisburg, Pa. Defaults among general governments are rare. These three instances are evidence of the rarity of this. The U.S. Census counts some 90,000 municipal entities. Moody's has ratings on 18,000 of them. If we look at the defaults in the past three and a half years among the municipalities we rate, we saw five defaults in 2008, one in 2009 and three in 2010 and two this year. This is a higher instance than we've seen historically -- between 1970 and 2009, we had 54 defaults. We've seen a few more than we would expect during a period of stress, but we expect defaults to continue to be low. These three instances are important, notable events. but they also are relatively rare. Moody's views them as being part of the legacy of the Great Recession and not so much a portent of what's coming.