NEW YORK — As bad news about the financial system piles up, trust — the pillar of investing — is being buried.

The most recent fears are tied to the potential failure of bond insurers, the companies that back the funding for hospitals, schools and other public works. A meltdown there could deliver another devastating blow to battered banks and force higher taxes on homeowners.

That has made it difficult for the Federal Reserve — even with its aggressive rate cuts recently — to restore confidence and quash the volatility and uncertainty.

"The biggest issue is people just don't really know how big this is," Davin Gibbins, chief investment officer at Aris Corp., said of the losses banks could face. "People don't know the size of the problem, and markets hate uncertainty."

"People are afraid to make business decisions," said Donald Light, a senior analyst at Celent.

The risk that bond insurers could lose their top-notch credit ratings comes after world stock and credit markets have already been shaken by billions of dollars in losses tied to subprime mortgages, or loans given to customers with poor credit history.

WILD MARKET SWINGS

The Fed has made two rate cuts totaling 1.25 percent in the past two weeks in an effort to spur new investments through lower interest rates. But some investors are hesitant to make any investments, regardless of price.

That uncertainty has created wild swings in the market as every bit of information is analyzed.

Stocks fell sharply in early trading yesterday as investors fretted over a $2.3 billion loss at bond insurer MBIA Inc. and the prospect of new downgrades in the industry. By the end of the day they were higher, after MBIA's chief executive pledged that the company could retain its credit rating and raise fresh capital.

Over the past few months, ratings agencies have downgraded or threatened to cut bond insurers' financial strength ratings, saying the companies — which make payments on bonds when the issuer is unable to do so — do not have enough extra cash to cover a potential spike in claims.

A downgrade from the crucial "AAA" rating would likely end the insurer's ability to book new business.

Standard & Poor's placed MBIA on a negative credit watch late yesterday and downgraded Financial Guaranty Insurance Co. Fitch Ratings had previously downgraded other bond insurers — Ambac Financial Group Inc. and Security Capital Assurance Ltd. — as well as FGIC.

INSURANCE COSTS RISING

The downgrades have led to a series of problems for municipalities who rely on the insurance. If an insurer's rating falls, bonds backed by the insurer fall as well. The lower the rating, the higher the cost.

"Clearly the cost for insurance is going up," said Richard Tortora, president of Capital Markets Advisors, which provides bond advisory services for municipalities in the Northeast.

There was about $2.6 trillion in municipal bonds outstanding as of Sept. 30, the latest figures reported by the Securities Industry and Financial Markets Association. More than half of municipal bonds carry insurance, Tortora said.

Any increased price on that insurance is "passed on to the taxpayer," Tortora said.

The Fed moves have helped to offset the higher insurance prices, so municipalities have been able to avoid higher costs from the insurance uncertainties. But if the Fed is unable to keep up, the cost to governments will rise.

Financial institutions, which already wrote down about $150 billion of subprime-related exposure last year, could be seeing billions more in losses from bond insurers.

Citigroup Inc., Merrill Lynch & Co., UBS AG and other banks may post another $70 billion in write-downs should bond insurers lose their top credit ratings, according to Oppenheimer & Co. analyst Meredith Whitney.

On top of any new losses tied to bond insurers, further losses from the subprime mortgage fallout are still likely. S&P said Wednesday that it is considering cutting the rating on more than $500 billion in mortgage-backed bonds, which could lead to further losses.

S&P estimates total mortgage-related losses at financial services firms could reach $265 billion.