CORRECTED-UPDATE 4-U.S. Congress enters crucial week in budget, debt limit battles
(Corrects to show that China is the biggest foreign holder of U.S. debt in paragraph nine. The error also appeared in previous updates.)
* Treasury Secretary Lew: Congress "playing with fire"
* China tells U.S. to take steps to avoid crisis
* Wall Street drops on deadlock
* Benchmark U.S. Treasuries firm
WASHINGTON, Oct 7 (Reuters) - As the U.S. government moved into the second week of a shutdown on Monday with no end in sight, a deadlocked U.S. Congress also confronted an Oct. 17 deadline to increase the nation's borrowing power or risk default.
Republican House of Representatives Speaker John Boehner vowed not to raise the U.S. debt ceiling without a "serious conversation" about what is driving the debt, while Democrats said it was irresponsible and reckless to raise the possibility of a U.S. default.
The last big confrontation over the debt ceiling, in August 2011, ended with an 11th-hour agreement under pressure from shaken markets and warnings of an economic catastrophe if there was a default.
A similar last-minute resolution remains a distinct possibility this time.
Equities investors were unnerved by the apparent hardening of stances over the weekend. U.S. stocks opened sharply lower on Monday and European shares fell to a four-month low.
In comments on Sunday television political talk shows, neither Republicans nor Democrats offered any sign of impending agreement on either the shutdown or the debt ceiling, and both blamed the other side for the impasse.
"I'm willing to sit down and have a conversation with the president," said Boehner, speaking on ABC's "This Week." But, he added, President Barack Obama's "refusal to negotiate is putting our country at risk."
On CNN's "State of the Union" program, Treasury Secretary Jack Lew said: "Congress is playing with fire," adding that Obama would not negotiate until "Congress does its job" by reopening the government and raising the debt ceiling.
China, the biggest foreign holder of U.S. Treasuries, urged Washington to take decisive steps to avoid a crisis and ensure the safety of Chinese investments.
"The United States is totally clear about China's concerns about the fiscal cliff," Vice Finance Minister Zhu Guangyao said in the Chinese government's first public comment on the Oct. 17 deadline.
"We hope the United States fully understands the lessons of history," Zhu told reporters in Beijing, referring to the downgrade of the U.S. credit rating by Standard & Poor's in 2011.
China held $1.277 trillion of U.S. Treasuries as of last July, according to U.S. Treasury data released month.
"Who should be worrying most of a possible U.S. default?" asked Deutsche Bank analysts. "Looking at the top holders of U.S. Treasuries, recipients of U.S. social security should be most concerned, followed by the Fed and then China."
Democratic Senator Charles Schumer, whose constituency includes Wall Street and New York's financial hub, said Boehner would be forced to act as the deadline for the nation's debt ceiling gets closer, calling it "too dangerous" to not raise the U.S. debt limit and saying any default could lead to an economic "recession, depression or worse."
"The economy could collapse. Will it? No one's certain, but there's a high enough chance that no one - no one - should risk it," Schumer told CNN's "New Day."
SHUTDOWN, DEBT CEILING ISSUES MERGED
The two issues of the Federal government shutdown and the debt ceiling started out separately in the House but have been merged by the pressure of time.
Conservative Republicans in the House have resisted funding the government for the current fiscal year until they extract concessions from Obama that would delay or defund his signature healthcare law, which launched Oct. 1.
Many of the conservatives want a similar condition placed on raising the debt ceiling, but in his list of debt-ceiling demands Sunday, Boehner did not mention the Affordable Care Act, commonly known as Obamacare.
"It's time to talk about the spending problem," said Boehner, including measures to rein in costs of entitlement programs such as the Social Security retirement system and Medicare, the government-run health insurance program for seniors.
Harry Reid, leader of the Democratic-led Senate, is expected to decide soon on whether to try to open formal debate on a "clean" bill, without extraneous issues attached, to raise the U.S. Treasury's borrowing authority.
Passage of such a measure would require at least six of the Senate's 46 Republicans to join its 54 Democrats in order to overcome potential procedural hurdles that opponents of Obamacare could erect.
According to one Senate Democratic aide, the debt limit hike might be coupled with a new initiative to reform the U.S. tax code and achieve long-term savings in Social Security and Medicare, whose expenses have soared along with the population of retirees.
Republican lawmakers have floated other ideas, such as a very short debt limit increase, which would create time for more negotiations at the expense of further market uncertainty, and repeal of a medical device tax.
The tax is expected to generate some $30 billion over 10 years to help pay for healthcare insurance subsidies under Obamacare.
Some Democrats favor repealing the tax, but they insist that replacement revenues be found and repeal be considered only after the government reopens and the debt limit is raised.
MAJOR PROBLEMS IN HOUSE
Agreement in the Senate would send the tangle of issues back into the House, where the Republican caucus has adopted a hard line on both Obamacare and the debt ceiling.
There may be enough votes in the House to pass a clean bill, according to some analysts. That would require almost all of the House's 200 Democrats and about 20 of its 232 Republicans to vote in favor. But taking such a vote would require Boehner to violate his policy against bringing a vote on any legislation favored by less than a majority of House Republicans.
Reid spokesman Adam Jentleson issued a statement on Monday attacking what he called "Boehner's credibility problem," including the speaker's assertion that there are not enough votes in the House to pass a clean bill.
"There is now a consistent pattern of Speaker Boehner saying things that fly in the face of the facts or stand at odds with his past actions," Jentleson said. "Americans across the country are suffering because Speaker Boehner refuses to come to grips with reality."
For the moment, neither side is moving toward accommodation, and the stakes rise with the passage of time.
For any deal to work, negotiators probably would have to choreograph a multipronged approach that allows all sides to declare victory, even if it is one that sets up another battle in mid-November or December.
White House officials were firm on Monday that Obama will not negotiate under the threat of a default and repeated that it is up to Congress to raise the U.S. borrowing cap.
While the shutdown itself is unlikely to cause major disruption in the markets, a fight over the debt ceiling could. From July 31 thru Aug. 2 during the debt-limit standoff in 2011, the S&P 500 index lost 3 percent, and the deadlock led to a downgrade of the U.S. credit rating to AA-plus from AAA by S&P.
The outlooks from Moody's and S&P, the only agency so far to have lowered its rating on U.S. debt, are both at "stable," but Fitch Ratings has indicated a negative outlook for the U.S. debt rating.
All three agencies have said the U.S. debt profile has improved substantially over the past two years, with gross domestic product growth, while slow, proving to be persistently positive and the budget deficit trending lower.
Fitch said in a note last week that the U.S. rating is at risk in the current showdown over the debt ceiling because failure to raise it sufficiently in advance of the deadline raises questions about the full faith and credit of the United States to honor its obligations.
Political gridlock remains the greatest risk to the U.S. outlook, Fitch said in the note on Oct. 1, the first day of the partial government shutdown.
"This 'faith' is a key underpinning of the U.S. dollar's global reserve currency status and reason why the US 'AAA' rating can tolerate a substantially higher level of public debt than other 'AAA' sovereigns," Fitch said. (Additional reporting by Susan Heavey, Thomas Ferraro, Dan Burns, Ben Blanchard in Beijing and Walker Simon in New York; Editing by Fred Barbash, Claudia Parsons, Vicki Allen and Bill Trott)