Obama, congressional leaders seek leverage from economic jolt

Reporting from Washington— 

The jolt to America's prestige as an economic superpower so far has only hardened positions in Washington, as President Obama and congressional leaders are seeking to use the downgrade in America's credit rating to gain leverage in the next round of the battle over the federal debt.

Obama spoke Monday at midday, as the Dow was skidding toward a 634-point drop, and portrayed Standard & Poor's decision to downgrade U.S. credit on Friday as proof that political paralysis "could do enormous damage to our economy and the world's."

In his first public comments since S&P cut America's coveted AAA credit rating to AA+, Obama said the nation could reduce its deficit and jump-start the economic recovery if there was "political will in Washington." He called upon the nation's political leadership to stop "drawing lines in the sand."

But by day's end, there was no indication that compromise was in the offing. Indeed, House Majority Leader Eric Cantor(R-Va.) sent a memo to House Republicans on Monday urging them to hang tough.

"There will be pressure to compromise on tax increases. We will be told that there is no other way forward. I respectfully disagree," Cantor wrote. Spending, he said, must be reduced: "This is why we were elected."

The No. 3 Democrat in the House, James E. Clyburn of South Carolina, made clear his party's view that a deficit reduction package must involve "shared sacrifice" — code for tax revenue increases.

Congressional leaders have until next week to appoint a "super committee" of 12 lawmakers — six from each party — to come up with a proposal to cut the federal deficit by at least $1.2 trillion by Nov. 23. If the new committee deadlocks, or if it makes recommendations that Congress fails to pass, 10 years of cuts in federal agency budgets would be triggered automatically, including a steep decline in Pentagon spending.

With differences over spending and taxes appearing unbridgeable, it may take the 2012 election to end the impasse. Voters may provide the answer to a question that has consumed Washington for months: Which side has the best approach to relieve the U.S. debt crisis?

A foreshadowing of the 2012 race may come Tuesday in Wisconsin as voters go to the polls: Half a dozen Republican state senators face a recall election that could put Democratsback in control of the upper chamber.

The contest in Wisconsin, an important swing state, is partly a referendum on the policies of Republican Gov. Scott Walker, who signed a bill this year stripping many public workers of collective bargaining rights. But both sides have also cast the fight as part of the larger, national struggle between Democratic and Republican approaches.

Obama, speaking from the White House State Dining Room, said he hoped the rating downgrade would prod both parties to seek a compromise. He also sought to reassure nervous investors that the U.S. remains a "AAA country."

People seem worried. A CNN poll released Monday found that 60% believed the U.S. remained in an economic downturn with conditions continuing to worsen. Only 36% believed that in April. Just 24% believed things are going well in the U.S., compared with 75% who believed things are going badly, the poll showed.

Both parties say they want to create jobs, but again, there is no consensus on how to go about it.

Obama reiterated his call for extending a payroll tax cut that expires at the end of the year. He also called for extending unemployment insurance benefits and reviving the hard-hit construction industry by rebuilding the nation's highways, bridges and ports.

Republicans already have dismissed some of the proposals this year. And GOP lawmakers have no appetite for anything that smacks of new spending.

"On job creation, we need to reduce the regulatory burden, prevent tax hikes and make it easier — not harder — for job creators to start hiring again," said Sen. Mitch McConnell of Kentucky, the Republican leader, in a statement after the president's remarks. "The country needs economic growth and fiscal responsibility, not higher taxes and new Washington spending and regulations."

Action will have to wait, though. Congress is in recess until after Labor Day, and Obama is not asking lawmakers to come back early.

Some wish he would take that step.

Robert Reich, who was Labor secretary under President Clinton, said in an interview: "For the good of the country and for his own political future, he's got to be seen as making jobs his first and major priority. And I fear he's not doing that."

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."