IMF chief warns of global dangers of US default (AFP)

WASHINGTON (AFP) – IMF chief Christine Lagarde warned Tuesday the clock was ticking on a US debt deal, as the dollar slid to new lows amid concerns of a looming and unprecedented default by the world's top economy.

With a week to go before the United States hits an August 2 deadline when the government runs out of funds to pay its bills, Congress remained deeply divided on raising the $14.3 trillion debt ceiling.

In a solemn late night address to the nation on Monday, Democratic President Barack Obama hit out at what he called a "dangerous game" being played by rival Republicans.

"We can't allow the American people to become collateral damage to Washington's political warfare," Obama said, warning of a "deep economic crisis" if the United States, still emerging from recession, defaults.

But Republican House Speaker John Boehner Tuesday insisted: "We have a bill that is a reasonable approach -- we've negotiated with the Senate leadership -- that really is common sense."

Republicans have said they will only agree to raising the debt limit if there are accompanying measures to rein in the ballooning US deficit.

Obama has agreed to a raft of deep spending cuts, but Republicans emboldened by newly elected arch-conservative Tea Party lawmakers have refused his demand for matching revenue increases to be imposed on the rich and big corporations.

Lagarde, the new head of the International Monetary Fund, waded into the debate Tuesday urging the two sides to find a compromise.

"The clock is irremediably ticking, and people really have to find a solution," she said in New York.

She warned a default "would be a very, very, very serious event. Not for the United States alone, but for the global economy at large."

According to the IMF, US public debt will reach 99 percent of its GDP in 2011 and 103 percent in 2012.

World markets wobbled again as global fears spread of no end to the stalemate before next Tuesday's deadline.

US stocks fell, with the Dow Jones Industrial Average down 64 points (0.52 percent) at midday.

European equities also dropped while the dollar slid against the euro and yen, hitting an all-time low against the safe-haven Swiss franc.

"The foreign exchange market seems to be losing faith that the US Congress will reach an agreement... This has caused a sell-off in the dollar across the board," said Kathleen Brooks, an analyst at trading group Forex.com.

Boehner has proposed a two-step plan with debt increases first to February or March 2012, and later to 2013.

And Republican House Majority Leader Eric Cantor called on the party "to stop grumbling and whining and to come together as conservatives and rally behind the speaker and call the president's bluff," a Republican source said.

But Obama has rejected the idea of a temporary debt limit increase, arguing it would leave the underlying problem unresolved and risk repeating the current crisis in six months' time.

Obama has warned of "Armageddon" if the United States defaults on its debt repayments for the first time in history, which could see the US lose its coveted AAA debt rating status and plunge the global economy back into turmoil.

Washington hit its debt ceiling on May 16 but has used spending and accounting adjustments, as well as higher-than-expected tax receipts, to continue operating normally.

The United States, still recovering from the 2008 recession with unemployment hovering around 9.2 percent, would be faced with tough choices -- meeting either its debt obligations, or reneging on government checks to the poorest, most vulnerable Americans.

The political stakes are also high ahead of the November 2012 elections, and Obama appealed to Americans to "make your voice heard" to members of Congress.

Reports suggested many had heeded the call and that some congressional websites had crashed and the Congress switchboard was flooded with calls.

There are signs the standoff is exacting a political toll on both the president and Republicans ahead of next year's White House race.

Washington Post/ABC television poll showed weakening support for Obama's economic agenda, and found the percentage of people who said he has made the economy worse has jumped six points since October to 37 percent.

But about as many people blamed Republican policies with 65 percent disapproving of the GOP's handling of jobs compared to 52 percent for the president.

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Moody's warns Greek default almost certain (Reuters)

By Ingrid Melander and George Georgiopoulos Ingrid Melander And George Georgiopoulos – 2?hrs?22?mins?ago

ATHENS (Reuters) – Moody's cut Greece's credit rating further into junk territory on Monday and said it was almost certain to slap a default tag on its debt as a result of a new EU rescue package.

It was the second rating agency to warn of a default after euro zone leaders and banks agreed last week that the private sector would shoulder part of the burden of a rescue deal that offers Greece more cash and easier loan terms to keep it afloat and avoid further contagion.

"The announced EU program along with the Institute of International Finance's statement implies that the probability of a distressed exchange, and hence a default, on Greek government bonds is virtually 100 percent," Moody's said in a statement.

Bank lobby IIF, which led private sector negotiations, aims to attract 90 percent investor participation in the bond exchange plan which comes on top of the EU's new 109 billion euro bailout.

Moody's cut Greece's rating by three notches to Ca, just one notch above default, to reflect the expected loss implied by the proposed debt exchanges.

Greece now has the lowest rating of any country in the world covered by Moody's, which, like Fitch last week, said it would review Greece's rating after the debt swap is completed.

"Once the distressed exchange has been completed, Moody's will reassess Greece's rating to ensure that it reflects the risk associated with the country's new credit profile, including the potential for further debt restructurings," it said.

However, whereas Fitch pledged to quickly give Greece a higher, "low speculative grade" after its bonds had been exchanged, Moody's said it could not forecast when the rating would change or how.

"It all depends how quickly the debt exchange takes place," said Alastair Wilson, Moody's Managing Director for EMEA Credit Policy. "Once we have greater visibility over that, we will reassess the credit profile quite quickly. Whether the rating will change, that's a different question," he told Reuters.

A senior EU official said on Saturday that the aim was to start a voluntary swap of privately-held Greek bonds in late August and conclude it in early September.

Greek bank shares and the broader stock market were unfazed by Moody's action. Analysts said the downgrade and the default warning were priced in and less worrying following assurances provided by the EU deal.

"The EU Council last week effectively secured Greek banks' continued access to ECB liquidity, even in the case that PSI (private sector involvement) triggers a selective default," said Platon Monokroussos, an economist at EFG Eurobank.

The government has repeatedly criticized ratings firms for their downgrades and its spokesman threatened on Monday to end its subscriptions to these agencies as the new rescue package means Greece will not issue new bonds for years.

"All governments pay a subscription to these agencies. We, I think, do not need the reviews anymore. They have no practical value," Elias Mosialos told Radio 9. "Perhaps the finance ministry should end its subscription."

CONTAGION CONTAINED ... FOR NOW

Moody's said it would take into account the possibility of a second default while reassessing Greece's rating.

"Our experience is that relatively small restructurings have often been followed by deeper defaults," Wilson said, adding that he could not say if this would be the case for Greece.

The rescue package for Greece benefits other euro zone countries by containing near-term contagion risks but it was not necessarily positive in the longer run as it set a precedent for private sector involvement in rescue deals, Moody's said.

"The support package sets a precedent for future restructurings should the finances of another euro area sovereign become as problematic as those of Greece. The impact of Thursday's announcement for creditors of Ireland and Portugal is therefore likely to be credit-neutral," it said.

The cost of insuring most peripheral euro zone government debt against default rose on Monday on market doubts that the fresh aid package for Greece agreed last week will protect bigger economies from contagion.

Standard & Poor's and Fitch rate Greece CCC, broadly in line with Moody's rating. S&P has not yet said how the EU summit deal will affect Greece's rating.

(Additional reporting by Cecile Lefort in Sydney; Writing by Ingrid Melander, editing by Mike Peacock)

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Fitch calls default, Greece pledges no let-up on debt (Reuters)

ATHENS/LONDON (Reuters) – Fitch ratings agency declared Greece would be in temporary default as the result of a second bailout, which Athens said had bought it breathing space.

But the agency pledged to give Greece a higher, "low speculative grade" after its bonds had been exchanged and said Athens now had some hope of tackling its debt mountain, which most economists still expect to force a deeper restructuring in the future.

An emergency summit of leaders of the 17-nation currency area agreed a second rescue package on Thursday with an extra 109 billion euros ($157 billion) of government money, plus a contribution by private sector bondholders estimated to total as much as 50 billion euros by mid-2014.

Under the bailout of Greece, which supplements a 110 billion euro rescue plan by the European Union and the International Monetary Fund in May last year, banks and insurers will voluntarily swap their Greek bonds for longer maturities at lower rates.

"Fitch considers the nature of private sector involvement... to constitute a restricted default event," said David Riley, Head of Sovereign Ratings at Fitch.

"However, the reduction in interest rates and extension of maturities potentially offers Greece a window of opportunity to regain solvency, despite the formidable challenges that it faces," he said.

The summit agreed the region's rescue fund, the European Financial Stability Facility, will be allowed to buy bonds in the secondary market if the European Central Bank deems that necessary to fight the crisis.

It can also for the first time give states precautionary credit lines before they are shut out of credit markets, and lend governments money to recapitalize banks, both moves which Germany blocked earlier this year.

German central bank chief Jens Weidmann was openly critical of the package, saying it shifted risks onto taxpayers in countries with stronger finances and weakened incentives for governments to keep their finances under control.

"This weakens the foundation for a currency union based on fiscal self-responsibility," said Weidmann, a European Central Bank policymaker, although he conceded the deal could help ease financial market tensions.

As part of the package, the euro zone leaders also made detailed provisions for limiting the damage of a temporary default -- the first in western Europe for more than 40 years.

"There is a great breath of relief for the Greek economy and this will gradually pass on to the real economy," Greek Finance Minister Evangelos Venizelos told reporters. "But by no means does this mean we can relax our efforts."

Riley told Reuters Greece may languish in default for only a few days and would likely get re-rated at single B or CCC.

Among other steps, the leaders agreed to ease terms on bailout loans to Greece, Ireland and Portugal; maturities will be extended to 15 years from 7.5 and interest cut to around 3.5 percent from 4.5-5.8 percent now.

Doubts remain about whether the plan went far enough to assure not only Greece's debt sustainability but that of Ireland, Portugal and other heavily indebted nations.

The package yielded "more than expected but not enough to make us sleep comfortably," Barclays economists said. They were disappointed that European leaders did not agree to expand a euro zone rescue fund.

The wider EFSF role is designed to prevent bigger euro zone states such as Spain and Italy from being shut out of markets because of fears of a weaker country defaulting.

Funds are sufficient so far but the burden could rise substantially. A precautionary credit line for a large country like Italy might total more than 500 billion euros over several years, overwhelming the EFSF's current 440 billion euros.

German Chancellor Angela Merkel said all euro zone debtors had to act decisively to repair their finances.

"Italy's austerity program was absolutely good. But it will be a process and demands further steps in the future," she told a news conference.

DEBT MOUNTAIN

French President Nicolas Sarkozy said the measures would reduce Greece's debt by 24 percentage points of gross domestic product from about 150 percent today.

That still leaves a colossal debt for an economy deep in recession with no recourse to a competitive devaluation.

What is more, the figures are based on what analysts say are optimistic projections for growth and returns from a sweeping privatization program.

"Our estimates suggest that Greek debt/GDP ratios will fall around 25 percentage points over 5 years as a result of these measures but will still be a whopping 120 percent in 2016 even assuming that the full 50 billion euros of privatization measures are implemented," analysts at JP Morgan said.

"We therefore believe that (bond) spreads will widen again as short covering dissipates and reality sinks in."

Greek, Irish and Portuguese bonds jumped before relinquishing their gains and traders said expectations of a larger restructuring down the road were undimmed.

The European leaders' promise of a "Marshall Plan" of European public investment to help revive the Greek economy may help, though details were thin.

Ratings agencies Standard & Poor's and Moody's are likely to follow Fitch's lead since banks and insurers are set to write down the value of Greek bonds by 21 percent, with more losses maybe to follow.

"We have long thought that the most likely outcome for Greek bondholders would be that they would take a small haircut first followed by a larger one at a later date. To give Greece a fighting chance they probably need a write down close to 65 percent," said Gary Jenkins, head of fixed income research at Evolution.

Shares in Europe's banks rose as it became apparent that the major players had limited their losses on Greek bonds to just over 5 billion euros.

The summit accord was based on a common position crafted by Merkel and Sarkozy in late night talks in Berlin on Wednesday with ECB President Jean-Claude Trichet.

The ECB relented and signaled it was willing to let Greece default temporarily as long as it was strictly a one-off.

But Fitch said it would expect similar private creditor involvement in any future help for Ireland and Portugal if they had not stabilized their finances by 2013.

Many economists believe the only way out of the euro zone's debt crisis in the long run may be closer integration of national fiscal policies -- for example, a joint euro zone guarantee for countries' bonds, or issuance of a joint euro zone bond to finance all countries. Germany has opposed this.

Sarkozy, at least, is looking to more sweeping reforms.

He said France and Germany would make proposals by the end of August on how to improve the governance of the bloc, to "clarify our vision of the future of the euro zone."

Merkel said she would not allow a union of automatic transfers from richer to poorer states. "This shall not happen according to my conviction," she told a news conference.

(Writing by Mike Peacock; editing by Janet McBride/Ruth Pitchford, Ron Askew)

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McConnell: Congress committed to prevent default (AP)

WASHINGTON – President Barack Obama met for less than an hour Saturday with congressional leaders in debt crisis talks, and a leading Republican said afterward that top lawmakers were "committed to working on new legislation" to cut federal spending and avert an unprecedented U.S. default.

There were no immediate signs of a breakthrough, however. The lawmakers and Obama were unsmiling as the meeting began, and most of them avoided reporters when they left the White House.

In a statement released afterward, the White House said, "Congress should refrain from playing reckless political games with our economy. Instead, it should be responsible and do its job, avoiding default and cutting the deficit." The statement renewed Obama's insistence that any agreement tide the government over until after the 2012 elections, to avoid a rerun of the debt dispute in the heat of the campaign.

Senate Republican leader Mitch McConnell issued a somewhat more upbeat statement of his own.

"The president wanted to know that there was a plan for preventing national default," he said. "The bipartisan leadership in Congress is committed to working on new legislation that will prevent default while substantially reducing Washington spending."

House Speaker John Boehner also pledged to work for a bipartisan solution.

"As I said last night, over this weekend Congress will forge a responsible path forward," he said in a statement. "House and Senate leaders will be working to find a bipartisan solution to significantly reduce Washington spending and preserve the full faith and credit of the United States."

The meeting followed a collapse in negotiations late Friday, when Boehner announced he was breaking off talks with the president. A visibly irritated Obama summoned Boehner and three other top congressional leaders from both parties to convene Saturday and try again to find a way to raise the debt limit before an Aug. 2 deadline cuts off the government's borrowing authority.

The president was flanked at the bargaining table by Boehner and Democratic Senate Majority Leader Harry Reid of Nevada. Also at the table were Vice President Joe Biden, House Minority Leader Nancy Pelosi, D-Calif., and McConnell, R-Ky.

The president devoted his weekly radio and Internet address Saturday to the impasse and urged Republicans to make a deal.

"We can come together for the good of the country and reach a compromise. We can strengthen our economy and leave for our children a more secure future," the president said. "Or we can issue insults and demands and ultimatums at each another, withdraw to our partisan corners and achieve nothing."

Rep. Jeb Hensarling of Texas said in his party's weekly address that the Democrats were to blame.

"If we're going to avoid any type of default and downgrade — if we're going to resume job creation in America — the president and his allies need to listen to the people and work with Republicans to cut up the credit cards once and for all," he said.

Boehner and McConnell also criticized Obama and the Democrats before the Saturday meeting began.

"If the White House won't get serious, we will," Boehner's office said. A statement from the office noted that Obama has said he wants an agreement that will take care of the problem through the November 2012 elections.

"It would be terribly unfortunate if the president was willing to veto a debt limit increase simply because its timing would not be ideal for his re-election campaign," according to Boehner's office.

The Democratic Congressional Campaign Committee used the troubled talks to raise money with online appeals. An email from the group said that "after hard negotiating for two weeks" Boehner and other top GOP officials "irresponsibly just walked out of the room and quit talks with the White House."

The group said it was "launching a hard-hitting advertising campaign starting this weekend and continuing through August to hold Republicans accountable," but it gave no details.

At a news conference Friday after Boehner said he was withdrawing, Obama told reporters, "We have run out of time and they are going to have to explain to me how it is that we are going to avoid default.

Boehner accepted the invitation for Saturday's meeting even while arguing that Obama bore the blame for the collapse.

The political theater played out even as the deadline neared. Barring action by then, the Treasury will be unable to pay its bills. That could cause interest rates to rise, threaten the U.S. economic recovery and send shock waves around the globe.

The deadline pressure hasn't seemed to bring the parties closer, even though they all insist they do not want a default.

For the first time since talks began, Obama declined to offer assurances that a default would be avoided, although moments later he said he was confident of that outcome.

Obama said Boehner left a deal on the table that was better for Republicans than for Democrats, with $2.6 trillion in cuts outweighing new tax revenue of $1.2 trillion. The president said he was losing confidence that the underlying deficit problems would be dealt with even if the borrowing limit rose.

"I've been left at the altar now a couple of times," Obama said.

Still, aides on both sides said there was agreement on gradually raising the age of eligibility of Medicare from 65 to 67 for future beneficiaries, and slowing the increase in cost-of-living raises in Social Security checks.

Republican aides said Obama had upped his demand for higher taxes during the week. The aides said administration officials had tacitly agreed to $800 billion in new revenue over 10 years but that the White House backed away and wanted $400 billion more.

Aides said the two sides were not able to bridge their differences over the triggers designed to force Congress to enact both tax changes and cuts to Medicare and other benefit programs by early next year. Both sides also were apart on the size of cuts for Medicaid, the health care program for the poor and disabled.

Yet aides on both sides said the negotiations had yielded agreement for cuts of $250 billion from Medicare.

___

Associated Press writers Erica Werner, David Espo, Ben Feller and Jim Kuhnhenn contributed to this report.

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Fitch declares default, Greece pledges no let-up on debt (Reuters)

ATHENS/LONDON (Reuters) – Fitch ratings agency declared Greece would be in temporary default as the result of a second bailout, which Athens said had bought it breathing space.

But the agency pledged to give Greece a higher, "low speculative grade" after its bonds had been exchanged and said Athens now had some hope of tackling its debt mountain, which most economists still expect to force a deeper restructuring in the future.

An emergency summit of leaders of the 17-nation currency area agreed a second rescue package on Thursday with an extra 109 billion euros ($157 billion) of government money, plus a contribution by private sector bondholders estimated to total as much as 50 billion euros by mid-2014.

Under the bailout of Greece, which supplements a 110 billion euro rescue plan by the European Union and the International Monetary Fund in May last year, banks and insurers will voluntarily swap their Greek bonds for longer maturities at lower rates.

"Fitch considers the nature of private sector involvement... to constitute a restricted default event," said David Riley, Head of Sovereign Ratings at Fitch.

"However, the reduction in interest rates and extension of maturities potentially offers Greece a window of opportunity to regain solvency, despite the formidable challenges that it faces," he said.

The summit agreed the region's rescue fund, the European Financial Stability Facility, will be allowed to buy bonds in the secondary market if the European Central Bank deems that necessary to fight the crisis.

It can also for the first time give states precautionary credit lines before they are shut out of credit markets, and lend governments money to recapitalize banks, both moves which Germany blocked earlier this year.

As part of the package, the euro zone leaders also made detailed provisions for limiting the damage of a temporary default -- the first in western Europe for more than 40 years.

"There is a great breath of relief for the Greek economy and this will gradually pass on to the real economy," Greek Finance Minister Evangelos Venizelos told reporters. "But by no means does this mean we can relax our efforts."

Riley told Reuters Greece may languish in default for only a few days and would likely get re-rated at single B or CCC.

Among other steps, the leaders agreed to ease terms on bailout loans to Greece, Ireland and Portugal; maturities will be extended to 15 years from 7.5 and interest cut to around 3.5 percent from 4.5-5.8 percent now.

Doubts remain about whether the plan went far enough to assure not only Greece's debt sustainability but that of Ireland, Portugal and other heavily indebted nations.

The package yielded "more than expected but not enough to make us sleep comfortably", Barclays economists said. They were disappointed that European leaders did not agree to expand a euro zone rescue fund.

The wider EFSF role is designed to prevent bigger euro zone states such as Spain and Italy from being shut out of markets because of fears of a weaker country defaulting.

Funds are sufficient so far but the burden could rise substantially. A precautionary credit line for a large country like Italy might total more than 500 billion euros over several years, overwhelming the EFSF's current 440 billion euros.

German Chancellor Angela Merkel said all euro zone debtors had to act decisively to repair their finances.

"Italy's austerity program was absolutely good. But it will be a process and demands further steps in the future," she told a news conference.

DEBT MOUNTAIN

French President Nicolas Sarkozy said the measures would reduce Greece's debt by 24 percentage points of gross domestic product from about 150 percent today.

That still leaves a colossal debt for an economy deep in recession with no recourse to a competitive devaluation.

What is more, the figures are based on what analysts say are optimistic projections for growth and returns from a sweeping privatization program.

"Our estimates suggest that Greek debt/GDP ratios will fall around 25 percentage points over 5 years as a result of these measures but will still be a whopping 120 percent in 2016 even assuming that the full 50 billion euros of privatization measures are implemented," analysts at JP Morgan said.

"We therefore believe that (bond) spreads will widen again as short covering dissipates and reality sinks in."

Greek, Irish and Portuguese bonds jumped before relinquishing their gains and traders said expectations of a larger restructuring down the road were undimmed.

The European leaders' promise of a "Marshall Plan" of European public investment to help revive the Greek economy may help, though details were thin.

Ratings agencies Standard & Poor's and Moody's are likely to follow Fitch's lead since banks and insurers are set to write down the value of Greek bonds by 21 percent, with more losses maybe to follow.

"We have long thought that the most likely outcome for Greek bondholders would be that they would take a small haircut first followed by a larger one at a later date. To give Greece a fighting chance they probably need a write down close to 65 percent," said Gary Jenkins, head of fixed income research at Evolution.

Shares in Europe's banks rose as it became apparent that the major players had limited their losses on Greek bonds to just over 5 billion euros.

The summit accord was based on a common position crafted by Merkel and Sarkozy in late night talks in Berlin on Wednesday with ECB President Jean-Claude Trichet.

The ECB relented and signaled it was willing to let Greece default temporarily as long as it was strictly a one-off.

But Fitch said it would expect similar private creditor involvement in any future help for Ireland and Portugal if they had not stabilized their finances by 2013.

Many economists believe the only way out of the euro zone's debt crisis in the long run may be closer integration of national fiscal policies -- for example, a joint euro zone guarantee for countries' bonds, or issuance of a joint euro zone bond to finance all countries. Germany has opposed this.

Sarkozy, at least, is looking to more sweeping reforms.

He said France and Germany would make proposals by the end of August on how to improve the governance of the bloc, to "clarify our vision of the future of the euro zone".

Merkel said she would not allow a union of automatic transfers from richer to poorer states. "This shall not happen according to my conviction," she told a news conference.

(Writing by Mike Peacock; editing by Janet McBride)

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Bernanke: Default on debt would increase deficit (AP)

WASHINGTON – Federal Reserve Chairman Ben Bernanke warned U.S. lawmakers Thursday that they would deliver a "self-inflicted" wound to the nation's economy by holding up efforts to raise the government's borrowing limit.

Republicans have held up increasing the borrowing limit because of concerns of growing spending that has widened the federal deficits.

Bernanke told a Senate panel that a default on the debt would lead to even greater federal deficits. Interest rates would rise, and the government would be forced to pay higher rates on its debt. At the same time, higher rates would slow the economy and an already-weak job market. That would curtail tax revenue.

The government hit its $14.3 trillion borrowing limit in May. The Treasury Department said it will default on its debt if the limit is not raised by Aug. 2.

"I think it would be a calamitous outcome. It would create a severe financial shock," Bernanke told the Senate Banking Committee during his second appearance before Congress this week. "Treasury securities are critical to the entire financial system ... A default on those securities would throw the financial system potentially into chaos."

Bernanke was on Capitol Hill to deliver his semiannual economic report. But his second day of testimony was dominated by questions over borrowing limit impasse.

Republicans are demanding that any increase be accompanied by an equal amount of spending cuts. President Barack Obama and Democrats have insisted that tax increases be a part of any long term deficit-cutting deal, something Republicans have rejected.

On Wednesday, Moody's Investors Service said it will consider lowering the United States' credit rating because of a small but rising risk that the government will default on its debt.

A downgrade would raise interest rates on U.S. treasury bonds, increasing the interest paid by U.S. taxpayers. It would also push up rates for mortgages, car loans and other debts, which are linked to Treasury rates.

The United States pays an average of about 3 percent on its existing debt, according to the Treasury Department. In 2010, that added up to $197 billion in interest payments.

The nonpartisan Congressional Budget Office has forecast that interest payments will rise to $463 billion by 2014. That is under an assumption that the U.S. keeps its top credit rating. A reduced rating would force the government to pay higher interest rates.

The impact of a default would also destabilize U.S. and global financial markets, Bernanke said, which would weaken economic growth

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Debt talks grind on, clock ticks toward default (AP)

WASHINGTON – Budget talks between President Barack Obama and his GOP rivals are at a frustrating standstill, leading a top Republican to launch a long-shot proposal to give Obama sweeping new powers to muscle through an increase in the government's debt limit without the approval of a bitterly divided Congress.

Lawmakers return to the White House Wednesday for their four negotiating session with the president in as many days. Obama has said the daily meetings will continue until a deal is reached.

A two-hour session Tuesday produced no progress after a day of poisonous exchanges between Democrats and Republicans.

Senate GOP leader Mitch McConnell of Kentucky offered a backup plan that would, in effect, guarantee Obama requests for new government borrowing authority unless Congress musters veto-proof majorities to deny him. McConnell said he was forced to introduce the plan because he didn't see a path to an agreement so long as Democrats insist on revenue increases.

McConnell said Wednesday that his proposal was a "last resort if the president continues to shirk his duties to do something about our dire fiscal situation."

"Make the president show in black and white the specific cuts he claims to support. If he refuses he'll have to raise the debt ceiling on his own," McConnell said on the Senate floor. "But he's not going to get Republicans to go along with that."

McConnell's proposal immediately ran into stiff opposition among tea party conservatives and seemed unlikely to pass the House, but neither the White House nor House Speaker John Boehner, R-Ohio, dismissed it out of hand.

"I think everybody agrees there needs to be a backup plan if we can't come to an agreement," Boehner said in a Fox News Channel interview Tuesday afternoon. "And frankly, I think Mitch has done good work."

Under McConnell's proposal, Obama could request — and likely secure — increases of up to $2.5 trillion in the government's borrowing authority in three separate installments over the coming year as long as he simultaneously proposed spending cuts of greater size.

The debt limit increases would take effect unless blocked by Congress under special rules that would require speedy action — and even then Obama could exercise his authority to veto such legislation. But the president's spending would have no guarantee of receiving a vote.

"The American people elected (McConnell) to serve as a check on Obama's appetite for out-of-control spending, not to write him a blank check to continue the binge," said conservative activist Brett Bozell. "It's these sort of shenanigans that got Republicans thrown out of power in 2006."

Tea party favorite Sen. Jim DeMint, R-S.C., asked about McConnell's plan Wednesday on CBS' "The Early Show," said, "Republicans weren't elected last November to make it easier to spend and borrow and add to our debt."

GOP presidential candidate Newt Gingrich wrote on Twitter, "McConnell's plan is an irresponsible surrender to big government, big deficits and continued overspending."

Republicans, meanwhile, continued pushing for a balanced budget amendment that would require Washington to balance its books. McConnell said politicians in Washington have showed they can't get the job done, and "If the president won't do something about the debt we'll go around him and take it to the American people."

McConnell made his proposal public a few hours before Obama presided Tuesday over his third meeting in as many days with congressional leaders searching for a way to avoid a default and possible financial crisis.

Democratic officials who participated in the session said Obama did not reject McConnell's idea, but said it's not his preferred approach. A statement issued later by press secretary Jay Carney said the president "continues to believe that our focus must remain on seizing this unique opportunity to come to agreement on significant, balanced deficit reduction."

McConnell's plan was hatched out of frustration that Congress and Obama are deadlocked as the clock ticks toward an Aug. 2 deadline for a market-rattling default on U.S. obligations. McConnell said he still hoped a deal could be reached, but that a backup plan would show the markets and public that default is not an option.

Republicans are demanding $2 trillion-plus in budget cuts as the price for a commensurate increase in the government's ability to continue to borrow more than 40 cents of every dollar it spends. Both Republicans and Obama see the politically toxic debt limit vote as a way to seize an opportunity to cut future deficits — a move that would seem to be to the political benefit of both sides.

But GOP refusals to consider devoting any new revenue from closing tax loopholes — like those enjoyed by oil and gas companies — to cutting the deficit has led Democrats to withhold further spending cuts beyond a handful tentatively agreed to during several weeks of talks led by Vice President Joe Biden in May and June. For their part, Republicans say the White House is offering minuscule spending cuts in the near term and is pulling back from some tentative agreements on topics like requiring federal workers to contribute more to their pensions.

Staffers were meeting at the White House Wednesday morning to work out agreements on specific cuts discussed during those earlier Biden-led talks. The meeting with Obama, Biden and congressional leaders later Wednesday was expected to build on those discussions.

Obama himself upped the stakes Tuesday, telling CBS News anchor Scott Pelley that more than $20 billion in Social Security checks could be held up.

"I can't guarantee that the checks will go out Aug. 3 if we haven't resolved this," Obama said. "There may simply not be the money in the coffers to do it."

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Europe considers Greek default, leaders to meet (Reuters)

BRUSSELS (Reuters) – European Union leaders are poised to hold an emergency summit after finance ministers acknowledged for the first time that some form of Greek default may be needed to cut Athens' debts and stop contagion to Italy and Spain.

"There will be an extra summit this Friday," a senior euro zone diplomat told Reuters, suggesting policymakers have been seized with a new sense of urgency after markets started targeting Italian assets.

A French government source said Paris was in favor, although the timing was not yet fixed, and in Spain, European Council President Herman Van Rompuy said he had not ruled out a meeting.

Earlier, Germany's finance minister had said a second Greek rescue package could wait until September after euro zone finance ministers effectively accepted that private creditor involvement meant a selective debt default was likely, despite the European Central Bank's vehement opposition to such a move.

"We have managed to break the knot, a very difficult knot," Dutch Finance Minister Jan Kees de Jager told reporters.

Asked about whether a selective default was now likely, he replied: "It is not excluded any more. Obviously the European Central Bank has stated in the statement that it did stick to its position, but the 17 (euro zone) ministers did not exclude it any more so we have more options, a broader scope."

Participants said a buy-back of Greek debt on the secondary market and a German proposal for a bond swap for longer maturities were under consideration after a complex French plan to roll over bonds made no headway.

Both would likely be regarded by ratings agencies as a default, or at best a selective default, which although it would not necessarily cover all Greek debt and could be lifted quickly, would have major repercussions for financial markets.

The Institute of International Finance, the lobby group representing private creditors, said the EU and IMF needed to deliver a plan for Greece, including a debt buyback, within days to avoid markets "spinning out of control.

The increased likelihood of some form of default, and a lukewarm response from the IMF, hit European bank stocks and debt markets and propelled the euro sharply lower against the dollar although markets settled later.

Ten-year bond yields in Italy, the euro zone's third-largest economy, shot above six percent for the first time since 1997 but then subsided to around 5.7 percent, still at a level which bankers say will put heavy pressure on finances.

Borrowing costs at an Italian 12-month bill sale surged to their highest since the 2008 financial crisis, putting a Thursday bond auction firmly in focus.

There is now acute concern about contagion to Italy, where political tensions between Prime Minister Silvio Berlusconi and Finance Minister Giulio Tremonti have exacerbated concerns, and to Spain, the euro zone's fourth largest economy.

In Rome, Berlusconi tried to calm fears Italy could be swept into full-scale crisis, pledging to accelerate debt-cutting measures and run a primary surplus this year.

Willem Buiter, chief economist at Citi and a former UK central banker, said there was a clear spread beyond Greece, Ireland and Portugal, the three nations bailed out so far.

"We're talking a game changer here, a systemic crisis," he said. "This is existential for the euro area and the EU."

The euro fell to a four-month low against the dollar before recovering, in part because IMF Managing Director Christine Lagarde said the lender and its EU partners were not yet ready to discuss terms for a second Greek bailout.

"Nothing should be taken for granted," she told reporters in Washington.

FUNDAMENTAL SHIFT

While the finance ministers were not explicit about how they planned to tackle Greece's debt, saying only that proposals would be discussed "shortly," they acknowledged that the debt pile -- at around 160 percent of GDP -- had to be reduced.

"We stress the need to make Greek debt more sustainable," Jean-Claude Junker, the chairman of the Eurogroup of finance ministers, said after more than eight hours of talks on Monday.

Economists regarded Junker's words and the comments from other finance ministers as a fundamental shift.

"The euro area now seems to be moving more explicitly toward debt relief via EFSF-funded purchases of secondary market debt," JPMorgan economist David Mackie wrote in a research note, referring to the euro zone's 440 billion euro emergency loan fund, which as it stands would not have enough resources to bail out Italy.

"Greece will need debt relief at some point, but it is not clear it is much of a help now. More likely the shift toward debt relief is intended as an attempt to limit contagion."

The decision to call an extra leaders' summit helped counter negative market reaction to an apparent absence of hurry, after German Finance Minister Wolfgang Schaeuble said there was time to wait on Greece, with no new tranche due until September.

That lack of urgency prompted stern criticism from Greece's prime minister but the finance ministers did hint at the prospect of more fundamental steps to come.

"Ministers stand ready to adopt further measures that will improve the euro area's systemic capacity to resist contagion risk, including enhancing the flexibility and the scope of the EFSF, lengthening the maturities of the loans and lowering the interest rates, including through a collateral arrangement where appropriate," they said in a statement.

There was no indication, though, that they had broken a stalemate over how to make banks, insurers and other funds share the cost of additional funding for Athens.

A senior member of Germany's governing coalition acknowledged, however, that a debt restructuring was coming.

"We just need to ensure that it's as orderly a process as possible," he said, adding that it could come in the autumn.

Germany, the Netherlands, Finland and others want the private sector to provide at least 30 billion euros in a new package for Greece that could total 110 billion euros.

(Additional reporting by John O'Donnell, Leigh Thomas, Dan Flynn in Brussels, Silvia Westall in Vienna, Huw Jones in London, Stephen Brown in Berlin, Lesley Wroughton in Washington and Milan/Rome bureaus, editing by Mike Peacock)

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Exclusive: Treasury secretly weighs options to avert default (Reuters)

WASHINGTON (Reuters) – A small team of Treasury officials is discussing options to stave off default if Congress fails to raise the country's borrowing limit by an August 2 deadline, sources familiar with the matter said on Wednesday.

Senior officials, including Treasury Secretary Timothy Geithner, have repeatedly said there are no contingency plans if lawmakers do not give the U.S. government the authority to borrow more money.

But behind the scenes, top Treasury officials have been exploring ways to prevent a financial meltdown that would be triggered if the government were unable to pay its bills on time, sources told Reuters.

Treasury has studied the following issues:

- Whether the administration can delay payments to try to manage cash flows after August 2

- If the U.S. Constitution allows President Barack Obama to ignore Congress and the government to continue to issue debt

- Whether a 1985 finding by a government watchdog gives the government legal authority to prioritize payments.

The Treasury team has also spoken to the Federal Reserve about how the central bank -- specifically the New York Federal Reserve Bank -- would operate as Treasury's broker in the markets if a deal to raise the United States' $14.3 trillion borrowing cap is not reached on time.

The U.S. government currently borrows about $125 billion each month. The Obama administration wants Congress to raise the limit by more than $2 trillion to meet the country's borrowing needs through the 2012 presidential election.

The contingency discussions, which have remained a closely guarded secret throughout weeks of negotiations with Congress over the debt ceiling, are being led by Mary Miller, Assistant Secretary for Financial Markets, who is effectively custodian of the country's public debt.

Miller's team has debated whether Obama could ignore Congress and order continued borrowing -- by relying on the 14th Amendment of the U.S. Constitution -- if it fails to raise the borrowing cap.

The fourth section of the 14th Amendment states the United States' public debt "shall not be questioned." Some argue the clause means the government cannot renege on its debts.

Obama dismissed talk of invoking the amendment on Wednesday. "I don't think we should even get to the constitutional issue," he said. "Congress has a responsibility to make sure we pay our bills. We've always paid them in the past."

HINT OF PLAN B COULD HURT TALKS

The White House declined to comment on the discussions at Treasury, but administration officials sought to tamp down talk of relying on the 14th Amendment.

There has been growing speculation in Washington in recent days that the administration could use the amendment to ignore the congressionally imposed limit on the amount of money the United States can borrow.

"Despite suggestions to the contrary, the 14th Amendment is not a failsafe that would allow the government to avoid defaulting on its obligations," said White House spokeswoman Amy Brundage.

Miller's team has discussed the Government Accountability Office's 1985 assessment that Treasury has the authority to prioritize payments in the event of a default -- an option Treasury officials have been wary of.

The administration's nightmare scenario is that investors panic at the prospect of a default, triggering a crisis that eclipses the 2008 financial meltdown. That could plunge the U.S. economy into another recession, something that could doom Obama's re-election prospects in 2012.

Some conservative Republicans have argued the Treasury can prioritize payments and manage a default. The administration wants to keep lawmakers focused on the August 2 deadline, and even a hint of a "Plan B" could lessen the urgency to strike a deal by then.

"As we have said repeatedly over the past six months, there is no alternative to raising the debt limit," Treasury spokeswoman Colleen Murray said when asked to comment on the Treasury discussions.

"The only way to prevent a default crisis and protect America's credit-worthiness is to enact a timely debt limit increase, which we remain confident Congress will do."

TREASURY OFFICIALS MUM

Obama meets leaders from both parties at the White House on Thursday as he seeks to get an agreement to cut trillions from the U.S. deficit, which Republicans have demanded in exchange for their support to raise the debt limit.

The fear of any loss of momentum in the debt and deficit talks is so great that even in their private conversations with former colleagues and investors, administration officials are refusing to admit to contingency discussions.

"There has to be contingency planning," said one former Obama administration official. "But they won't even tell me that."

That view was echoed by numerous former officials from the Clinton, Bush and Obama administrations.

"You have to have a backup plan. If you are relying on Congress to avoid the possibility of an Armageddon, you can't just bet on that," said Keith Hennessey, who headed the White House National Economic Council during President George W. Bush's administration.

In August, the Treasury will take in roughly $172 billion, but is obligated to make $306 billion in payments -- meaning it cannot pay about 45 percent of its bills without borrowing more money, according to the Bipartisan Policy Center, a Washington think tank.

That would force the administration to make some difficult choices, even though officials believe emergency measures will buy little time and cannot stave off an economic catastrophe.

OPTIONS "PRETTY UGLY"

If Treasury were to decide to delay some payments, one option could be to postpone a disbursement of more than $49 billion to Social Security recipients that is due on August 3.

It would be a politically explosive step but one that could allow the government to temporarily pay bondholders to try to avoid foreign investors dumping U.S. Treasuries and the dollar.

The administration has warned that any missed payments, including those to retirees, veterans and contractors, would be default by another name, and the Treasury team still has concerns that any contingency plan would prove unworkable.

Steve McMillin, a former deputy director of the White House Office of Management and Budget under Bush, said Treasury has options but most of them are "pretty ugly."

If Treasury were to decide to delay payments, it would need to re-program government computers that generate automatic payments as they fall due -- a massive and difficult undertaking. Treasury makes about 3 million payments each day.

From their second floor offices in Treasury, Miller and Fiscal Assistant Secretary Richard Gregg, are the lieutenants Geithner is relying on if the administration's first option of negotiating a deal with Republicans falls apart.

"She's dealing with this day in and day out," said a former Treasury official.

The former official said Treasury aides were "speaking with Congress on a daily basis," giving them the latest updates on receipts and when default could occur.

The source said White House Chief of Staff Bill Daley and other officials regularly ask Miller for information.

"Every day they talk about the debt ceiling. The night before, they get the most recent numbers," the source said.

Michael Barr, a former Treasury official who worked closely with Miller, said he spoke with Miller and Gregg a month ago.

"They were exploring if there were any legal and practical alternatives. It was not obvious to them that the president has the legal authority to pick and choose who gets paid," he said.

Barr added: "It is not obvious that even if they had legal authority, that as a practical matter you can do it."

As recently as June 21, Miller told a group of sovereign debt holders in London that there is no Plan B and assured them that the debt limit would be raised before August 2.

Publicly, Treasury has maintained there is no contingency plan. "Our plan is for Congress to pass the debt limit," Geithner said late in May. "Our fall-back plan is for Congress to pass the debt limit, and our fall-back plan to the fall-back plan is for Congress to pass the debt limit."

(Additional reporting by Rachelle Younglai, Tim Reid, and Caren Bohan Editing by Ross Colvin and Jackie Frank)

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