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US avoids default but fails to dispel economy fears

2011-08-03 11:35

* Obama, lawmakers say debt deal is "important first step"  

* Moody's puts US debt on negative outlook  

* Fitch does not rule out future downgrade for US  

* Wall Street indexes fall more than 2 percent  

WASHINGTON - The United States stepped  back from the brink of default on Tuesday but congressional  approval of a last-ditch deficit-cutting plan failed to dispel fears of a credit downgrade and future tax and spending feuds.  

President Barack Obama and lawmakers from across the  political divide expressed relief over the hard-won compromise  to raise the country's borrowing authority after weeks of  rancorous partisan battles.  

Nevertheless, US stocks tumbled, turning negative for the  year, as investors shifted their attention to the increasingly  grim state of the US economy and the potential for a  downgrade of America's gold-plated debt rating.  

That risk grew when one of the three major ratings agencies  said it was affirming the US government's AAA-rated sovereign  debt but slapping it with a negative outlook.  

The announcement by Moody's Investors Service after US  markets closed could lead to a downgrade within 12 to 18  months. That could raise borrowing costs for US companies and  consumers as the economy risks slipping back into recession.  

The Senate's approval by 74-26 votes of the $2.1 trillion  deficit-reduction plan warded off the immediate specter of a  catastrophic US debt default.  The bill passed the  Republican-controlled House of Representatives on Monday.  

Obama immediately signed it into law, lifting the $14.3  trillion debt ceiling with just hours to spare before the  government was due to run out of money to pay all its bills.  

The bitter feud between Democrats and Republicans has  bruised Obama as he heads into a campaign to win a second term  in 2012.  

The $2.1 trillion deficit-reduction plan fell well short of  a $4 trillion 'grand bargain' that was nearly agreed last month  between the White House and congressional leaders.  

Another ratings agency, Standard & Poor's has said $4  trillion in deficit-reduction measures would be needed as a  "downpayment" to put America's finances in order.  

S&P said in mid-July there was a 50-50 chance it would cut  the US rating in the next three months if lawmakers failed to  craft a meaningful deficit-cutting plan. Investors are on  tenterhooks about the chance of a downgrade by S&P.  

The deal leaves political battles ahead over spending cuts  and tax reform as the deficit-cutting plan is implemented.  Obama and Democratic and Republican leaders said the agreement,  while a welcome first step, was not enough on its own.  

"We just kicked the can down the road ... the agreement  doesn't really do anything about what got us into debt,"  Republican Senator Lindsey Graham told Reuters Insider.  

"We had a good opportunity, we let it pass so we will keep  struggling."  

China, the largest creditor to the United States, urged Washington to act responsibly to deal with its debt issues, saying uncertainty in the US Treasuries market will undermine the global monetary system and hamper global growth.

"We hope that the US government and the Congress will take concrete and responsible policy measures ... to properly deal with its debt issues, so as to ensure smooth operation of the Treasury market and investor safety," central bank chief Zhou Xiaochuan said, in China's first official reaction to the last-minute passage of the US debt deal.  


The deal drew a line -- for the moment -- under months of  bitter partisan squabbling over debt and deficit strategy that  had threatened chaos in global financial markets and dented  America's stature as the world's economic superpower.  

The law lifts the debt ceiling enough to last beyond the  November 2012 elections, calls for $2.1 trillion in deficit  savings spread over 10 years and creates a bipartisan joint  House and Senate committee to recommend further cuts by late  November. It does not yet include any tax increases.  

International Monetary Fund chief Christine Lagarde said  the deal reduced uncertainty in the markets.  

Questions lingered about the fragile US economy and  whether the bipartisan deficit-cutting compromise could deliver  the desired results.  

Data on Tuesday showed US consumer spending dropped in  June for the first time in nearly two years and incomes barely  rose, the latest in a string of gloomy economic indicators.  

Moody's said the deal was a step towards fixing the budget  problems but the United States risked a downgrade if fiscal  discipline weakened in the coming year, if no further steps  were taken in 2013 or if the economy deteriorated.  

"We would expect that growth would accelerate in 2012 from  the first half of the year," Steven Hess, Moody's top US  analysts told Reuters in an interview. "But if it doesn't, that  means that the whole process of fiscal consolidation and the  plans to achieve lower deficits and lower debt ratios will be  made all the more difficult."  

Fitch Ratings did not rule out putting a negative outlook  on the US AAA rating when it concludes a review of the  country later this month, the agency's top analyst for the  United States told Reuters on Tuesday.  


Investors said the move by Moody's on Tuesday was expected  and did not ruffle financial markets.  

Earlier, Wall Street stocks slumped broadly by more than 2  percent, ending down for a seventh consecutive session as gloom  over the economy mounted, marking the longest losing streak  since the financial crisis period in October 2008.  

"I think that the most troubling aspect we have going on  right now is the performance of US equities. The equity  market for whatever reason seems to think that this deal is not  sufficient," said Greg Salvaggio, senior vice president at  Tempus Consulting in Washington.  

US Treasury Secretary Timothy Geithner said in an opinion  piece in the Washington Post that the debt deal should allow  room for Congress to implement short-term measures to  strengthen the economy this fall such as extending a payroll  tax cut and funding infrastructure projects.  

Obama said the sacrifices required to reduce the deficit  needed to be fairly shared, apparently nodding to anger among  many Democrats that the deal did not include tax increases and  risked hurting social programs.  

"We cannot balance the budget on the back of the very  people who have borne the brunt of the recession ... everyone  is going to have to chip in, that's only fair," the president  said in an address from the White House Rose Garden.  

He said he expected tax reform to emerge from deliberations  by the new congressional committee, and that a "balanced  approach" in which the wealthier pay more taxes was needed.  

Only moments after final passage, rival congressional  leaders were handing out their political recipes for the way  forward -- Republicans in favor of more spending cuts, and  Democrats looking for tax reform or hikes.  


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