UPDATE 1-U.S. lawmakers ask Fed for muni lending facility

(Adds details, background)

WASHINGTON, March 20 (Reuters) - A group of Democratic lawmakers on Friday urged the U.S. Federal Reserve to create a temporary lending facility for the municipal bond market, saying it could help state and local governments access the capital markets.

“This is a limited market with low underlying credit risk and it is likely the mere presence of a federal financing backstop alone would bring investors back and limit the need for the Federal Reserve to actually purchase bonds,” the lawmakers said in a letter to Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner.

House Financial Services Chairman Barney Frank and Representatives Paul Kanjorski, Michael Capuano and John Adler signed the letter, which said the Fed has the power to “provide immediate and dramatic assistance” through a federal financing backstop.

The lawmakers noted that issuance of municipal debt dropped toward the end of 2008 as interest rates soared.

“While conditions have improved somewhat, it is still difficult for many state and local governments to access the market at attractive terms,” the letter said, adding that borrowing for construction projects could spur creation of “desperately needed jobs.”

The municipal market for more than a year has been hit by the credit crunch, which stripped most bond insurers of their top ratings. That left a big chunk of munis to trade on their underlying ratings at a time when issuers’ financial situations have deteriorated.

This has led various state and local governments to plead for help from the federal government to ease their borrowing costs. (Reporting by Karey Wutkowski and Karen Pierog in Chicago; Editing by Dan Grebler)