HARTFORD, Conn. (AP) – Connecticut sued three of the nation’s leading credit rating firms Wednesday, alleging they gave artificially low credit ratings to cities and towns that ultimately cost taxpayers millions of dollars in unnecessary insurance and higher interest payments.

State Attorney General Richard Blumenthal and state Consumer Protection Commissioner Jerry Farrell Jr. filed the lawsuit in Hartford Superior Court against Moody’s Corp., Fitch Inc., and the McGraw-Hill Cos., the parent company of Standard & Poor’s.

The lawsuit accuses the agencies of having a dual ratings system that gives lower credit ratings to bonds issued by states, municipalities and other public entities than corporate debt.

“This rating charade created a Wall Street shell game constructed by the ratings agencies for the benefit of the bond insurers, which enabled the bond insurers to profit from unnecessary premiums and interest paid by taxpayers,” Blumenthal said.

Blumenthal said at a news conference that municipal finances are backed by the state, which will not permit bankruptcy or a municipality’s failure to pay bills. The General Assembly in 2001 took over Waterbury’s finances and bailed the city out of a $60 million deficit.

“Municipal debt is far more creditworthy than Wall Street is giving it credit for,” Blumenthal said.

Anthony Mirenda, a Moody’s spokesman, said Wednesday that company officials had received the lawsuit and were reviewing it. “Based on our understanding of the allegations as it relates to Moody’s, it is entirely without merit and we expect it will be dismissed expeditiously,” Mirenda said.

Fitch released a statement calling the lawsuit “an unfortunate development.” The company said Blumenthal knows that it has been reviewing its municipal finance ratings system for several months and expects to report its findings to the market on Thursday.

“Fitch believes the suit is without merit and intends to defend itself vigorously,” the statement said.

“Fitch rates Connecticut and all states based on our forward-looking opinion as to their financial capacity to pay their debts as they come due – not based solely on historical rates of default,” the company said. “Since 1999 Fitch has made public a number of comprehensive studies examining the credit risk of municipal issuers, including several referenced in the complaint.”

McGraw-Hill Cos. also said the lawsuit had no merit and the company intends to fight it.

“The lawsuit filed in Connecticut this morning is simply a case of a state attempting to use litigation to dictate what bond rating it receives,” a company statement said.

If allowed to stand, Blumenthal’s claims would lead to ratings determined by the government or the threat of litigation, McGraw-Hill said. The result would be a loss of analytical independence and investor confidence in the market, the company said.

State and local governments issue bonds to raise money for costly projects such as building new schools and upgrading sewer plants. Lower bond ratings mean higher interest payments.

New Haven taxpayers, for example, paid $2.2 million in unnecessary bond insurance premiums on nine general obligation bonds issued from 2003 to this year, because of the low “A3” rating it received from Moody’s, Blumenthal said.

Danbury Mayor Mark Boughton said he could not understand why the rating agencies refused to give the western Connecticut city a rating higher than its current AA2.

“‘Guys, what’s the problem?”‘ he said he asked rating agency officials he invited to Danbury to tour economic development projects. “‘What have we got to do to get a triple-A?’ No one could tell you. The rating is so nebulous, so subjective.”

Waterbury Mayor Mike Jarjura said the city has failed to persuade rating agencies to give the city more than its current BBB+ despite its long road back from the financial brink seven years ago.

“No matter how much we did, it seemed they wanted to keep us in the penalty box,” he said. “We got upgrades, but it was like pulling teeth.”

AP-ES-07-30-08 1506EDT