Losing their Triple A rating could be devastating for the bond insurers because it could prevent them from drumming up new clients and possibly force them out of business.
States and cities that issue municipal bonds, meanwhile, could see their own bonds downgraded because of questions about the insurers' ability to back up those bonds.
Banks could also be hit. According to Meredith Whitney, banking analyst at Oppenheimer, U.S. financial institutions could face fresh write-downs of as much as $70 billion if the bond insurers lose their top rating.
For that reason, the issue of downgrading bond insurers has become politically sensitive.
The bond insurers haven't completely escaped downgrades. Late Thursday, S&P cut its "AAA" ratings on FGIC's bond insurance arm, and placed its top ratings on the bond insurance arm of MBIA on review for downgrade. The rating agency also said it may cut the "AAA" rating of XL Capital Assurance, the bond insurance arm of Security Capital Assurance.
On Wednesday, Fitch Ratings downgraded FGIC after earlier downgrading Ambac .
Even the stock market has become worried about a potential meltdown among bond insurers. On Wednesday, a strong rally sparked by the Fed's latest cut in interest rates quickly collapsed after CNBC reported that the bond insurers could be downgraded soon and that a prominent short-seller believed their losses were bigger than reported.
During a Thursday conference call, MBIA Chief Executive Gary Dunton said the troubled bond insurer has been the target of "fear mongering" by self-interested parties. He said the company will have real and significant losses, but nothing to justify the sharp decline in MBIA's shares. He also said MBIA is in the best position to maintain Triple-A ratings among public bond insurers.
New York state insurance regulators, meanwhile, are trying to work out a bailout plan for the bond insurers and have urged the rating agencies to hold off on any downgrades. Bankers who are working on a bailout plan have given themselves an unofficial timetable of about two weeks to work something out. But people involved in the discussions say progress is slow and it's unclear if any bailout involving the banks will get done.
Late Wednesday evening, MBIA announced that private-equity firm Warburg Pincus completed a $500 million investment in the bond insurer, paying $31 a share for stock that has fallen to $13.96 a share since the deal was announced last month.