Hopes for deal rise as debt fears infect markets

WASHINGTON Tue Jul 26, 2011 7:43pm EDT

1 of 3. Traders work on the floor of the New York Stock Exchange in New York July 25, 2011.

Credit: Reuters/Lucas Jackson

WASHINGTON (Reuters) - A glimmer of hope emerged on Tuesday for a compromise to break the deadlock over the U.S. debt limit as corporate America and the public betrayed growing nervousness over the risks of a credit downgrade and default.

After weeks of acrimony between Republican and Democratic leaders, similarities between rival deficit reduction plans appeared to offer some chance of a deal before an August 2 deadline for Congress to raise the government's $14.3 trillion borrowing limit.

While most expect a last-minute accord to avert the first default by the United States, the bitter partisan squabbling and absence of a political consensus on long-term deficit reduction has increased the likelihood of an unprecedented downgrade in the gold-plated U.S. credit rating.

The gridlock is unnerving investors worldwide. U.S. stocks and the dollar fell on Tuesday while gold hovered near record highs. But there was no sign of panic as markets held out hope the logjam could still be broken.

White House senior adviser David Plouffe said the plans advanced by House of Representatives Speaker John Boehner, the top Republican in Congress, and Democratic Senate Majority Leader Harry Reid could yield common ground.

"The Boehner and Reid proposals have quite a lot of similarities," he said. "You can see how there could be the contours of compromise."

Lawmakers from both parties also said a compromise was possible. But the polarizing debate has laid bare the ideological divide in Washington as each side seeks to blame the other for persistent economic and fiscal woes ahead of the November 2012 election, when Obama is seeking a second term.

Republicans control the House and Obama's Democrats control the Senate.

"TIME TO ACT IS NOW"

Even if a default is avoided, a credit downgrade would undermine confidence in U.S. solvency, stunting economic recovery prospects and sending negative ripples through the international financial system where U.S. bonds are bellwethers. The world's largest economy risks being viewed as a dysfunctional giant with feet of clay.

A Reuters poll showed that 30 of 53 economists surveyed over the past two days said the United States will lose its top-notch credit rating from one of the three big ratings agencies -- Standard & Poor's, Moody's and Fitch. Most said the wrangling already has damaged the economy.

Executives from Standard & Poor's and Moody's Investors Service are scheduled to testify to Congress on Wednesday on attempts to reform the credit rating industry and the role it is playing in the U.S. debt ceiling debate.

With the deadline for raising the government's borrowing authority a week away, Congress was in a state of suspended animation before an anticipated Wednesday vote in the House on Boehner's deficit reduction plan.

The outcome of that vote is in question as Boehner battles an insurrection on the right. Conservative groups warned lawmakers that a "yea" vote would be held against them.

No more than 22 Republicans can vote against the bill if it is to pass without Democratic help. At least 10 Republican lawmakers aligned to the fiscally conservative Tea Party movement have told Reuters they plan to vote against the bill.

Boehner had another setback when the non-partisan Congressional Budget Office said his plan would save $850 billion over 10 years, not the $1.2 trillion he claimed.

Boehner and Reid remained in touch, aides said, but no serious discussions were likely until after the House vote.

Even if Boehner's plan passes the House, it is "dead on arrival" in the Senate, said Reid, who is delaying action on his own bill.

But several lawmakers noted the similarities between the two plans. "The commonality is pretty apparent," said Jon Kyl, the No. 2 Republican in the Senate.

The stalemate in Washington is already having an effect on investors, with some starting to take cash out of the market and shifting away from some long-term investments.

"The time for Congress to act is now," the U.S. Chamber of Commerce, the world's largest business federation, said in a letter to House members.

PUBLIC CONCERN

Further underscoring the risks, United Parcel Service Inc, the world's largest package delivery company, cited the stalled debt ceiling talks as a reason for business uncertainty in its quarterly earnings report.

There were clear signs too that ordinary Americans were beginning to wake up to the dangers of the debt deadlock.

Obama, in an address to the nation late on Monday, warned that a default would mean the government would not be able to pay bills including monthly Social Security checks, veterans' benefits and contracts with thousands of businesses.

A Reuters/Ipsos poll found Americans are overwhelmingly concerned about the debt crisis and a majority back the type of compromise pushed by Obama to end the impasse.

It showed 56 percent said lawmakers and Obama should agree to a combination of tax hikes and cuts to government programs -- the strategy the president has promoted and Republicans have rejected.

After an appeal by Obama for Americans to make their voices heard to avert a "reckless and irresponsible default," people crashed websites with emails and flooded the telephone lines of lawmakers in Washington with thousands of calls.

Big banks are preparing for the real possibility that the United States will lose its top credit rating, which they said would cost the country $100 billion in higher interest payments and hurt consumers and the economy.

"That's an environment where hiring is going to be much less likely than it otherwise would be," Mike Hanson, senior U.S. economist at Bank of America Merrill Lynch, said on a conference call organized by a Wall Street trade group, the Securities Industry and Financial Markets Association.

(Additional reporting by Laura MacInnis, Alister Bull, Caren Bohan, Rachelle Younglai, Christopher Doering, Deborah Charles, Kim Dixon and Lily Kuo in Washington and Andy Bruce in New York; Writing by Matt Spetalnick and Pascal Fletcher; Editing by John O'Callaghan)