Global policy actions fail to halt stocks rout

(Reuters) - Political leaders failed to halt a global stock market rout that gathered steam on Monday as investors lost confidence that Europe and the United States can rein in their budgets quickly and fear spread of a double-dip recession.

The European Central Bank swept into the bond market to buy up Italian and Spanish debt and sling a safety net under the euro zone's third and fourth largest economies. But bickering persisted in Europe over a longer-term rescue plan.

In the United States, President Barack Obama called for urgent action on the U.S. budget deficit but his proposal on taxes was promptly rebuffed by Republicans.

The G7 finance ministers' and central bankers' pledge on Sunday to help smooth markets if needed provided little solace.

Selling that began in Asia and Europe accelerated in the United States, where the broad Standard and Poor's 500 index plunged 6.7 percent to close at 1,119.46, its worst sell-off since December 1, 2008. The DowJones shed 634.76 points to 10,809.85.

A huge blow to investor confidence was the Standard and Poor's downgrade of the U.S. sovereign credit rating late Friday, which compounded spreading concerns that the worsening euro-zone debt crisis and a faltering U.S. economy heighten the risks of a double-dip recession.

"People are asking, can the economy still grow in face of all this?" said John Carey, portfolio manager at Pioneer Investment Management in Boston, with $260 billion under management.

Realization on both sides of the Atlantic that the political obstacles to quick budgetary reform are so huge and the monetary options so limited, it has deepened the pessimism.

The worsening market turmoil puts significant pressure on the U.S. Federal Reserve at its regular policy meeting on Tuesday to announce some fresh measures of support for a damaged U.S. economy.

"If the Fed does nothing, it could prove to be a disappointment at this point," said JP Morgan analysts.

Stock losses have wiped more than $3.8 trillion from investor wealth globally in the last eight days and sent investors rushing for safety in the Swiss franc, the Japanese yen and gold. In the United States, estimates of recession risks are rising. Goldman Sachs had put them at one in three last week, before the latest sell-off.

"This massive move in the equity market does dim the economic outlook for the next six months," said Carl Riccadonna, senior U.S. economist at Deutsche Bank in New York. "We would put the recession odds at about 40 percent and about two weeks ago they were at about a 10 percent chance."

The G7 financial policymakers from major industrialized nations said on Sunday they stand ready to provide extra cash if markets seize up, are consulting regularly and could cooperate to smooth volatile FX markets if needed.

Particularly worrisome was a more than 20 percent plunge in the shares of Bank of America, the largest U.S. bank. AIG sued it for $10 billion for allegedly deceiving investors, on top of mounting concerns about the size of its potential losses from mortgages litigation and questions about management. The bank has shed nearly one third of its market value in three days.

ECB TO THE RESCUE

On the political front, Obama said he hoped that Standard and Poor's stripping the United States of its prized AAA credit rating would add urgency to U.S. budget cutting plans.

Standard and Poor's cut the ratings of credits tied to the U.S., sovereign debt to AA-plus, namely government mortgage agencies, clearing houses and insurers. The Treasury market soared on Monday despite the downgrade as investors fled stocks.

Obama called for both tax hikes and cuts to welfare programs as part of the $1.5 trillion in deficit reduction that a special committee would deliver in late November. But Republican House Speaker John Boehner once again rejected the call, saying tax hikes were "simply the wrong approach."

Obama also spoke with Italian Prime Minister Silvio Berlusconi and Spanish President Jose Luis Zapatero, welcoming measures by their governments to address the economic turmoil in Europe.

Traders estimated the ECB bought about 2 billion euros in Italian and Spanish debt after it agreed on Sunday to broaden its bond-buying program for the first time to halt an attack on the Mediterranean countries.. Italian and Spanish yields declined sharply.

"The intervention by the European Central Bank this morning seems to have been working," Irish Finance Minister Michael Noonan told RTE public radio.

"Last week the risk was that as bond rates in Italy went toward 7.0 percent, they'd be driven into some kind of bailout program. They have fallen by almost one percent this morning so they are well out of the bailout territory now."

But French sovereign credit default swaps hit a record high of 160 basis points as the U.S. rating downgrade raised questions about how long other AAA countries, such as France, could hold onto their top-notch ratings.

The ECB move was seen as only a temporary solution however, due to the sheer size of Italy's bond market -- $1.6 trillion. European stocks sank to their lowest in nearly two years, with the German DAX closing down 5 percent as doubt about governments' ability to deal with the euro zone debt crisis and its impact on economic growth emerged.

A bailout of Italy would overwhelm Europe's emergency fund. Germany has so far opposed expanding it, a view unchanged on Monday, but French Finance Minister Francois Baroin said: "The allotment is 440 billion (euros) and we've already said if we need to go further we will go further."

Obama officials attack S&P's credibility after downgrade

(Reuters) - The Obama administration attacked the credibility of the analysis underlying Standard & Poor's decision to downgrade the United States' top credit rating on Friday, saying it had found a $2 trillion error.

S&P was forced to remove the number from its analysis after Treasury officials discovered that the rating agency's estimates of the government's discretionary spending was $2 trillion too high, sources familiar with the discussions said.

There was evident dismay, and some anger, within the Obama administration at S&P's decision to downgrade U.S. debt despite the errors officials said they had found in the calculations.

"A judgment flawed by a $2 trillion error speaks for itself," a Treasury spokesman said after S&P cut the long-term U.S. credit rating by one notch to AA-plus on concerns about growing budget deficits.

The comment marked the first time the U.S. Treasury had publicly chastised S&P. Administration officials have privately grumbled that the rating agency's understanding of the U.S. political system was unsophisticated.

David Beers, the top S&P official behind the ratings decision, told Reuters in an interview that any change in the rating agency's calculations would have been taken into consideration before the decision was made public.

Sources familiar with talks that took place between S&P and the U.S. Treasury on Friday afternoon said the rating agency had wanted to see $4 trillion sliced from future budgets as part of a hard-fought deal secured earlier this week to lift the nation's debt limit. That agreement would reduce deficits by $2.1 trillion over 10 years.

Even after the error was pointed out, the rating agency declined to hold off on its downgrade, sources said.

With the threat of a downgrade looming, Treasury officials earlier in the week had played down the potential impact and said markets already were aware it was under consideration and that two other agencies were maintaining their triple-A rating.

The Federal Reserve effectively shrugged off the downgrade, saying it would not affect the operation of the central bank's emergency lending window or its buying and selling of Treasury securities to conduct monetary policy. The Fed can only extend emergency loans to banks against good collateral.

PLENTY OF FINGER POINTING

Treasury officials, who spoke on condition of anonymity, said on Wednesday that top bond dealers were questioning S&P's credibility, which took a heavy blow during the 2007-09 financial crisis when mortgage-related debt lost much of its value after originally being awarded high ratings. The reputations of two other big rating agencies, Fitch and Moody's, were also tarnished.

Ian Lyngen, a senior government bond strategist at CRT Capital Group in Connecticut, agreed S&P now had more than just a credibility problem.

"The fact that they have now downgraded the United States suggests to me that they are now going to be dealing with a relevance issue," he said. "Because the fact of the matter is that 10-year (Treasury note) yields are near 2.5 percent, and that in no way suggests a lack of sponsorship for U.S. debt."

Yields on U.S. 10-year notes, a benchmark for borrowing rates throughout the economy, fell as far as 2.34 percent on Friday -- their lowest since October 2010 and very low by historical standards.

POLITICAL POINT SCORING

Lawmakers used the downgrade to square off over how best to rein in the nation's budget gap, with Democrats saying more revenue was needed and Republicans focusing on spending cuts.

S&P's action "reaffirms the need for a balanced approach to deficit reduction that combines spending cuts with revenue-raising measures," said Senate Majority Leader Harry Reid, a Democrat from Nevada.

House of Representatives Speaker John Boehner, a Republican from Ohio, called the downgrade "the latest consequence of the out-of-control spending that has taken place in Washington for decades."

Sen. Jim DeMint, a leading conservative, went further, saying Treasury Secretary Timothy Geithner should resign.

The White House maintained silence, but Dan Pfeiffer, Obama's communications director, signaled the administration's strategy -- to put the blame on the Republicans -- when he added bits of media commentary to his Twitter.com feed, an increasingly common vehicle for transmitting the White House viewpoint.

One "retweet" he sent from a Washington Post columnist said, "This didn't happen because an earthquake wrecked our factories or a plague hit our workers. It was Congress. Particularly (Republicans)in Congress."

Another "retweet" from a Fox News reporter read: "Remember President Obama pushed for a 'Grand Bargain' that would have cut approximately $4 trillion in debt, but Speaker John Boehner walked."

A Republican-led congressional panel is probing whether the administration had tried to influence S&P before the rating agency revised its outlook on the U.S. debt rating to negative in April.