A legal defeat for Ma Bell and MCI (MCIA.PK) could turn into political ugliness.

The eight-year effort to stimulate phone competition by forcing Bells to rent rivals access to local networks at cheap rates hit a

major roadblock at the White House on Wednesday. But it was good news for the Bells, whose stocks jumped after U.S. Solicitor General Theodore Olson chose not to ask the Supreme Court to consider an appeal of a prior defeat of proposed pricing rules.

And soon after the Bells --

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Verizon

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,

SBC

(SBC)

,

BellSouth

(BLS)

and

Qwest

(Q)

-- were handed the victory, the once-hotly divided Federal Communications Commission said it planned to offer no appeal. FCC chief Michael Powell vowed Thursday to draw up a new set of pricing rules, but offered no time frame for when the guidelines would be complete.

AT&T

(T) - Get Report

and MCI are the two telcos most affected by the elimination of steeply discounted access rates. Analysts and investors say that without much legal ground to stand on, the two companies face some grim decisions.

At a time when political sensitivities are running high during an election year, industry watchers fear that AT&T and MCI could announce plans to shut down consumer businesses in some states, raise prices in other areas, and possibly lay off workers, as they place the blame on the Bush administration.

Through its Neighborhood residential phone business, MCI has signed on more than 3 million local phone customers to its unlimited calling, flat-rate plan based on cheap discounts from the Bells. Similarly, AT&T has signed on customers in nearly every state to its own flat-rate plan.

AT&T says it's too early to discuss pricing decisions and job cuts. On Thursday, it filed a joint appeal with MCI of the appelate court decision with the Supreme Court.

But an AT&T representative said that if the company sees a problem, it is prepared to make a quick decision. "If we think six months from now we will lose customers because we have to raise rates, it changes things and we will have to make some hard choices."

MCI, which has plans to cut more than 11,000 jobs this year, declined to comment on any additional firing plans. A company representative said "it puts considerable pressure on our consumer business and we will be looking at raising rates and pulling out of certain markets."

Curiously, the Bells, in an apparent concession to the Bush administration, promised not to raise discount rates this year, eliminating any reason for competitors to cry foul before the election.

The gamesmanship irks some MCI and AT&T fans, who charge that the Bells deftly won favor from the White House by pushing any consumer price increases safely into the next year.

A Verizon representative said it was not a favor swap. "We said we were not raising rates because we hope to negotiate rates with wholesalers," the rep said.

But some analysts say that while MCI and its ilk were dealt a setback this week, any attempt to embarrass the Bush administration could prove to be counterproductive.

"Creating embarrassment for the White House would not change any of the decisions in the near term," says Legg Mason analyst Mike Balhoff, who has a hold rating on the Bells and no rating on MCI or AT&T. (Legg Mason has no underwriting ties to the Bells.)

Balhoff says it is likely that the new rules from the FCC will give AT&T and MCI discounts less steep than the today's 50% rate, which of course is an improvement for the Bells and better than no discount for the rivals.

He also expects the discounts will be phased out over a three-year period. This will likely give Bell competitors time to work on alternative calling strategies like voice over Internet protocol.

"This is a long, extended, competitive fight," says Balhoff. "It is important that the players not overreact at this moment in history."

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