WASHINGTON - The House Financial Services Committee is taking a three-pronged approach in addressing some of the bond insurance, liquidity, and credit rating issues that led to or are a result of the turmoil in the municipal market, a congressional source said.

The committee is looking at the possibility of a federal "backstop" to address liquidity concerns following state efforts to address bond insurance problems, and exploring issues that fall under the Securities and Exchange Commission's oversight, such as credit ratings process, the source said.

A federal liquidity provider would essentially allow the federal government to reinsure municipal securities. The Federal Reserve Board is a liquidity provider for other markets, but it is unclear if the committee will ask the Fed to serve in a similar capacity for the municipal market.

The source, who is familiar with the committee deliberations, stressed that it is still premature to say how a possible backstop might be structured, who would operate it, and whether it would provide only temporary relief.

"It's a big question if it would be temporary," the source said. "None of this has been discussed yet."

In the meantime, a number of committee members and governmental groups have urged Congress to pass a pending tax bill that would allow the 12 Federal Home Loan Banks to issue letters of credit on tax-exempt bond transactions. The lawmakers have urged the House Ways and Means committee to vote on the legislation, which is pending in both houses.

Rep. Paul Kanjorski, D-Pa., described the bill Wednesday as "a surgical procedure to restart the municipal bond operation" until muni insurance is more widely available.

A Ways and Means spokesperson said yesterday that the committee is aware of the comments made during the Financial Services Committee hearing Wednesday on the FHBL bill, and that committee members are taking them under consideration. He declined to say whether the committee will take action on the proposal.

Financial Services Committee chairman Barney Frank, D-Mass., and other lawmakers were quick to criticize the relatively low ratings that munis receive compared to corporate debt, considering that they are much safer investments. Frank and other committee members are worried about a "disconnect" in terms of the municipal ratings and their risk of default, the source said.

But going forward, the committee would prefer to see the rating agencies resolve the perceived disconnect on their own, without congressional legislation or new regulations.

"The question is, should there be any legislation or more of some sort of prodding for the [rating] agencies to take action," the source said. "[Or] the rating agencies could act on their own to change their ratings so that they approach the [municipal] ratings in more realistic ways in terms of risk and default."

A spokesperson at Standard & Poor's yesterday said: "The hearing raised a number of important issues and we look forward to working with all interested parties to address their concerns and further explain how we develop our ratings. We believe that it is important to have one global rating scale that is widely understood, which is why we use the same scale across all sectors."

Representatives from Fitch Ratings and Moody's Investors Service could not be reached for comment.

At Wednesday's hearing, lawmakers harshly criticized the rating agencies, with one committee member, Rep. Chris Shays, R-Conn., arguing that he sees "no value" in their ratings, and another, Rep. Michael Capuano, D-Mass., referring to the rating process as "legalized blackmail."

But Erik Sirri, the SEC's director of markets and trading, urged Congress to give the existing legislative framework, under which the commission has had increased oversight over the rating agencies for only the past nine months, time to work.

He said that the SEC would propose rules on rating agencies later this year and is also in the midst of investigating into whether the rating agencies were unduly influenced by issuers and underwriters to give subprime mortgage-backed bonds ratings that were higher than warranted.

"There is a framework under which credit rating agencies are governed," he said. "I think this will play out over time."

The committee also is debating the role of monoline insurers, including whether they are needed for most muni bonds, the source said. On Wednesday, Frank blasted muni bond insurers for acting on "grievous misjudgment" by exposing themselves to subprime mortgage risk that has, in turn, let to "unfair excessive costs" for issuers.

He insisted that insurance of general obligation bonds, which rarely if ever default, "is like asking a vampire to buy life insurance" because in either case, the insurers are never going to have to pay.

The source said the committee is closely watching New York insurance superintendent Eric Dinallo, who said Wednesday that he is reworking regulations for insurers that would prohibit monolines from guaranteeing certain collateralized debt obligation products or that would either limit the amount of structure business that a bond insurer could back or require the insurer to hold certain levels of capital for structured exposure.

Peter Schroeder contributed to this story.

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