House GOP leader says deficit deal likely (AP)

WASHINGTON – The No. 2 Republican in the House says he's still confident that a bipartisan deficit "supercommittee" will be able to reach agreement even though there's little more than a week to go before its deadline.

Majority Leader Eric Cantor said he knows the panel is under great pressure but he believes its members can succeed by Nov. 23.

The panel is charged with coming up with at least $1.2 trillion worth of deficit cuts over the coming decade but has been deadlocked over taxes and cuts to benefit programs. Failure would trigger automatic spending cuts to the Pentagon budget and a wide range of domestic programs.

The Virginia Republican declined to otherwise comment on the committee's work, including last week's GOP proposal for revenue hikes.

THIS IS A BREAKING NEWS UPDATE. Check back soon for further information. AP's earlier story is below.

Despite prodding from President Barack Obama, members of Congress' supercommittee concede no deal is in sight to meet their goal of $1.2 trillion or more in deficit savings over the next decade.

Instead, with only 10 days remaining until a Nov. 23 deadline, the panel is divided along partisan lines and Rep. James Clyburn, D-S.C., said Sunday the six committee members of his own party "have not coalesced around a plan."

Despite the difficulties, Clyburn and Republicans on the deficit panel all said they haven't given up hope of a deal by the deadline.

"But if this was easy, the president of the United States and the speaker of the House would have gotten it done themselves," said Rep Jeb Hensarling of Texas, the Republican chairman of the committee.

Obama mentioned his own unsuccessful negotiations with Speaker John Boehner in passing at a news conference in Hawaii on Sunday where he urged the members of the committee to show more flexibility. "It feels as if people continue to try to stick with their rigid positions rather than solve the problem," he said.

"There's no magic formula. There are no magic beans that you can toss on the ground and suddenly a bunch of money grows on trees," Obama added. "We got to just go ahead and do the responsible thing."

Despite some concessions, the two sides remain divided over the same basic issues that thwarted earlier deficit reduction efforts — finding a mutually agreeable blend of tax increases and cuts in the largest government benefit programs.

Democrats on the supercommittee say they are willing to make significant reductions in programs such as Social Security, Medicare and Medicaid only after Republicans agree to higher tax revenue, including a larger bite out of the income of the wealthy.

Republicans say that the soaring deficits result from too much spending, and not from a shortage of revenue to the Treasury, and tax increases would crimp efforts to create jobs.

In an offer they said marked a significant concession, GOP members on the panel offered last week to raise taxes by $250 billion over a decade as part of an overhaul of the tax code that simultaneously would cut the top rate from 35 percent to 28 percent.

Democrats swiftly rejected that as a tax cut for the wealthy in disguise, and separately jettisoned an earlier proposal that would have slowed the growth in cost of living increases under Social Security.

There has been little, if any, indication of progress in the talks since then.

But Hensarling seemed to suggest in an interview Sunday that the two parties could find a way around the fast-approaching Thanksgiving deadline by coming to a general understanding with respect to raising new revenue, without actually having to agree on a process or specific remedy.

"There could be a two-step process that would hopefully give us pro-growth tax reform, which by the way, every other bipartisan effort that has said that some revenues have to be raised in this method," he told CNN in an interview. "That is again broaden the base, historically this is how we both produce jobs and more revenues for the government."

For the most part, however, officials in both parties seem to be positioning themselves publicly for political advantage in case the talks falter.

Hensarling said the panel has a goal of cutting deficits by $1.2 trillion, but added it also has a duty.

"The duty is to put forth legislation that actually addresses long-term structural debt. Now the president himself has said that the drivers of our debt are Medicare, Medicaid and health care. Nothing else comes close," he said, adding that Republicans have done that.

But Obama described the situation differently at a news conference after wrapping up an economic summit with leaders of Pacific-region nations.

"If we've got to raise money, it makes sense for us to start by asking the wealthiest among us to pay a little bit more before we start asking seniors, for example, to pay a lot more for their Medicare," he said.

Nor do the two sides agree about a fallback plan already in place to make sure deficits are reduced even if the panel fails to reach an agreement.

Obama said twice over the weekend Congress shouldn't count on being able to change the automatic spending cuts that would take effect beginning on Jan. 1, 2013.

About $450 billion in cuts would come from defense and the same amount from domestic accounts, with savings on interest payments making up the balance of a $1.2 trillion total.

Republicans, joined by Defense Secretary Leon Panetta, say the Pentagon couldn't sustain reductions of that magnitude, and Sen. Pat Toomey, R-Pa., said there would be a "lively debate" in Congress on changing which programs the cuts would affect.

Clyburn and Toomey appeared on Fox. Hensarling was interviewed on CNN.

_____

AP reporter Erica Werner in Hawaii contributed to this story.

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INSIDE WASHINGTON: 'Zombie' program cuts deficit (AP)

By RICARDO ALONSO-ZALDIVAR, Associated Press Ricardo Alonso-zaldivar, Associated Press – Sat?Oct?8, 9:02?am?ET

WASHINGTON – They're calling it the zombie in the budget.

It's a long-term care plan the Obama administration has put on hold, fearing it could go bust if actually implemented. Yet while the program exists on paper, monthly premiums the government may never collect count as reducing federal deficits.

Real or not, that's $80 billion over the next 10 years.

The Community Living Assistance Services and Supports program, CLASS for short, may just keep lurching along indefinitely. It would join other peculiar creatures of the federal budget such as "trust funds" that are actually more like IOUs and Medicare cuts that can be counted twice.

"It's a gimmick that produces phantom savings," said Robert Bixby, executive director of the Concord Coalition, a nonpartisan group that advocates deficit control..

"That money should have never been counted as deficit reduction because it was supposed to be set aside to pay for benefits," Bixby added. "The fact that they're not actually doing anything with the program sort of compounds the gimmick."

The program was created under President Barack Obama's health care overhaul, and arguably provided much of the 10-year, $143 billion in savings claimed under the law. But now some Capitol Hill aides have dubbed CLASS a "budget zombie."

The administration recently asked Congress to hold off on money for implementing CLASS as it tries to find a way to make it solvent for the long run. The chief financial expert for CLASS left the government, saying the program's staff was abruptly reassigned.

CLASS was a priority of the late Democratic Sen. Edward M. Kennedy of Massachusetts, who envisioned a voluntary, long-term care insurance plan sponsored by the government, without the overhead costs of private insurers, or the rigorous pre-screening they require.

CLASS beneficiaries would pay an affordable monthly premium while they were healthy and working. In exchange, they could collect a modest daily cash benefit if they became disabled. Congress included CLASS in the health care law, specifying it must be self-sustaining.

Kennedy's idea was to give families some financial breathing room. The burden of long-term care is growing. Most families cannot afford to hire a home health aide for a frail elder, let alone pay nursing home bills. Long-term care is usually provided by family members, often a spouse who may also have health problems.

But a central design flaw dogged CLASS from the beginning. Unless large numbers of healthy people willingly sign up during their working years, soaring premiums driven by the needs of disabled beneficiaries would destabilize it, eventually requiring a taxpayer bailout. The main reason the program produced budget savings in its first 10 years was a rule that enrollees pay in for at least five years before collecting benefits.

The chairman of the House subcommittee that oversees money for Health and Human Services says the administration is playing a shell game.

"They've shelved it, but they're keeping it around," said Rep. Denny Rehberg, R-Mont. "The only logical reason I can see is that they need the money — even though there is no money there — to make Obamacare work."

Absolutely not, says the administration.

"We are looking at the CLASS program from every angle," Kathy Greenlee, assistant HHS secretary for aging, blogged recently. "We are doing our due diligence." The administration will soon release a report with recommendations about how to proceed, she added.

Although Greenlee did not give any hints, one option is to go back to Congress for additional legal authority to revise the program.

Meanwhile, supporters of CLASS are getting concerned. Many groups that pushed for the health care law also backed CLASS. They wrote Obama recently, saying he doesn't need any additional authority from Congress to go forward.

"The people who care about this program are just getting angry," said Connie Garner, a former Kennedy aide who is directing a coalition of CLASS supporters.

Don't expect CLASS to go away easily. If the congressional supercommittee tackling the debt decides to recommend repeal, the panel would have to come up with about $80 billion in other cuts — possibly real and painful — to offset the hypothetical savings from CLASS.

"They'll probably ignore it," said Bixby, the deficit hawk. "I think they're not sure what they're dealing with."

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Obama deficit plan: Is there ever a good time for a tax increase? (The Christian Science Monitor)

New York – Would President Obama's tax-the-rich proposal, part of a plan to raise some revenue for deficit reduction, actually harm the economy?

Critics say it would, but economists suggest a major part of the equation involves the state of the economy itself. By 2013, the earliest Mr. Obama's tax reform policies would go into effect, no one knows if the economy will be humming along, muddling through, or in a recession.

To that, economists suggest it's anyone's guess. Yes, the economic outlook is that uncertain, leaving any analysis of the economic impact of a potential $1.5 trillion in tax hikes equally uncertain. Congress, Greece, and the housing market could all play significant roles – but what those roles might be are yet to be determined, experts say.

RECOMMENDED: Unemployment, Inc.: Six reasons why America can't create jobs

The optimists believe the US housing market, suffering since 2008, will revive, giving the economy a significant boost.

Those who are less optimistic, think the economy will be moving ahead at a snail’s pace – not much different than today.

And the pessimists think the financial problems in Europe could send the US economy back into recession – assuming it’s not there already.

“Next year is probably more uncertain than 2013,” says economist Joel Naroff of Naroff Economic Advisors in Holland, Pa. “If we get through 2012 OK, then 2013 will be good. But if not, then 2013 will be a disaster.”

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What Congress doesSome economists say that Congress could play a significant role in what happens next. It has already agreed to cut spending, but that will actually reduce economic activity, says Mark Zandi of Moody’s Analytics.com.

He estimates the impact of the fiscal austerity will cost the economy 1.7 percentage points of economic activity unless Congress does something such as renewing the reduction in payroll taxes (think Social Security and Medicare taxes). In 2013, the belt-tightening will cost the economy 1.5 percentage points.

It’s also not clear if Congress will agree to any of Obama’s job-creation plans – a combination of some tax reductions, some spending on new schools, and direct grants to the states. If Congress does nothing, it could mean the economy just “muddles along for the next two years,” says economist Richard DeKaser of the Parthenon Group, a Boston-based strategy consulting firm.

What Greece doesThe economy next year could also be adversely affected by events in Europe, says Mr. Zandi. If the Greek government were to default on its loans, he expects Europe will have a mild and short recession. However, if the debt woes were to spread to other countries, he predicts that would drag the US into a recession as well.

If the bankers reach some accommodation on Greece, then the US economy may start to get a lift from the housing market, predicts Mr. Naroff. “A year from now you will have worked off the inventory in the housing market,” he says.

Zandi, also a housing optimist, expects the housing market to increase from a current rate of building 600,000 new homes a year to 1.7 million homes a year. “That is a lot of growth,” he says, “and it begins in 2013 in earnest.”

What the economy doesThe shape of the economy may well have a lot of bearing on what Congress does – if anything. If the economy is suffering, lawmakers are less likely to make any significant changes in tax policy. No one wants to run for reelection right after raising constituents’ taxes. However, if the economy has its swagger back, they might be more inclined to act.

a€?The worst time to raise taxes is during a recession,a€

That’s because tax hikes tend to take money out of the economy at a time when consumers are already in a funk. Ms. Villarreal, who supports some form of tax reform, such as a consumption tax, argues that even tax increases on the wealthy could have an adverse impact on the economy.

“If they have less to invest in job creation that trickles down to the rest of the economy,” she says. “What they do to the top earners will effect the rest of us.”

However, Naroff argues that tax changes on the well-to-do probably won’t change their spending habits. “The Obama proposals are not aimed at people who are likely to dramatically or even at all change their spending behavior,” he says.

Changing the tax codeOne of the biggest battles of the year is likely to be whether to extend the so-called “Bush tax cuts” for high-income earners. Those tax cuts expire at the end of 2012 and Obama has vowed to veto any legislation that extends them again.

“I am assuming the Bush tax cuts expire but are replaced with something else,” says Mr. DeKaser. “Maybe there is a change in the tax brackets, a gradual introduction of a more stringent tax policy.”

If the economy is not a recession, tax changes might be good, argues Zandi. He particularly endorses some form of broadening the tax base, which is usually means shutting down loopholes and making the tax code less complex.

“If tax reform means the flattening of the tax base and it stays that way for a lengthy period of time, the economy could easily digest that and perhaps even benefit from it,” he says. “If you are talking about scaling back many of the deductions and tax credits in the tax code and it becomes less complex, that could be therapeutic.”

No matter what happens in terms of tax reform, Zandi expects it will be phased in. “We could not do it all cold turkey,” he warns. “Households and businesses have made decisions based on those loopholes.”

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Obama to offer his own deficit reduction package (AP)

WASHINGTON – Even as President Barack Obama prepares his opening bid on long-term deficit reduction, the White House wants to keep the focus on jobs and is determined to avoid getting sucked into another budget fight with lawmakers.

Administration officials see the task of attending to deficits as necessary but not necessarily urgent, compared with the need to revive the economy and increase employment.

The White House also sees this as the time to draw sharp contrasts with congressional Republicans, whose public approval ratings are lower than Obama's.

As a result, when Obama announces at least $2 trillion in deficit reduction measures Monday, he is not expected to offer all the compromises he reached with House Speaker John Boehner, R-Ohio, in July before those talks broke off.

"I would view this as the president's vision for how we achieve deficit reduction, which makes it inherently different than the sorts of legislative negotiations we were undertaking with the speaker over the summer," said the White House communications director, Dan Pfeiffer.

The plan represents an economic bookend to the $447 billion in tax cuts and new public works spending that Obama has proposed to as a short-term measure to stimulate the economy and create jobs. He's submitting it to a special joint committee of Congress given the task of recommending how to reduce deficits by $1.2 trillion to $1.5 trillion over 10 years.

The White House signaled its approach Saturday by highlighting a proposal in the president's plan that would set a minimum tax rate for taxpayers earning more than $1 million.

The measure — Obama is going to call it the "Buffett Rule" for billionaire investor Warren Buffett — is designed to prevent millionaires from using tax-avoidance schemes to pay lower rates than middle-income taxpayers. Buffett has complained that he and other wealthy people have been "coddled long enough" and shouldn't be paying a smaller share of their income in federal taxes than middle-class taxpayers.

However, the proposal is a certain dead-letter with Republicans, who have pledged to oppose any increase in taxes.

"It adds further instability to our system more uncertainty and it punishes job creation and those people who create jobs," said GOP Rep. Paul Ryan of Wisconsin, the House Budget Committee chairman. "Class warfare may make for really good politics but it makes for rotten economics," he told "Fox News Sunday."

Senate Republican leader Mitch McConnell, noting that a similar effort to raise taxes on the wealthy failed a few years ago, continued to push for revising the tax code and looking to increasing revenue through economic activity rather than taxes. He was dismissive of Obama's so-called Buffett Rule.

"With regard to his tax rate, if he's feeling guilty about it, I think he should send in a check," McConnell said of Buffett while appearing on "Meet the Press" on NBC. "But we don't want to stagnate this economy by raising taxes."

The White House also has said that Obama will not offer any proposals to reduce long-term spending in Social Security, even though Obama had suggested to Boehner reducing annual cost-of-living adjustments for Social Security recipients. The idea drew loud objections from Democrats.

Now Democrats are waiting to see what Obama proposes to do with Medicare, the government health care program for older people.

In his talks with Boehner, Obama was willing to go along with gradually increasing the eligibility age for Medicare beneficiaries from 65 to 67. That idea has run into opposition from Democrats, and the White House was deciding whether or not to leave it in the president's new deficit plan.

"Potentially raising the retirement age for Medicare is something that deserves a lot of consideration," said Christina Romer, the former head of Obama's Council of Economic Advisers. She said such an increase in the eligibility age is more conceivable with Obama's health care law because guaranteed private health insurance would be available to middle-class early retirees starting in 2014.

Still, an analysis by the nonpartisan Kaiser Family Foundation found that two-thirds of 65- and 66-year-olds would pay more for their new coverage than they would have under Medicare.

Raising the eligibility age is "bad policy and bad politics," said Nancy Altman, one of the leaders of Strengthen Social Security Campaign, a coalition of advocacy organizations.

"What the president proposes on Monday, especially if the Republicans were to embrace it, would be harder for Democrats in Congress to separate themselves from it," she said.

Overall, the president's proposal could help reduce long-term deficits by about $4 trillion.

Under a compromise in early August that averted a threatened government default, Congress agreed to cut nearly $1 trillion from some programs. The president's proposal would reduce deficits by an extra $2 trillion. On top of that, drawing down military forces in Afghanistan and Iraq is estimated to reduce projected deficits by $1 trillion over 10 years.

Republicans have ridiculed the war savings as gimmicky, but House Republicans included them in their budget proposal this year and Boehner had agreed to count them in his talks with Obama.

In addition to the new minimum tax rate for millionaires, Obama's proposal will include revenue increases that Obama has identified to pay for his $447 billion jobs plan. Those include limiting deductions for wealthier taxpayers, closing corporate loopholes and eliminating tax subsidies to oil and gas companies. Boehner last week ruled out many of the tax increases Obama has proposed.

William Galston, a former economic adviser to President Bill Clinton, said it would have been better if Obama had presented his jobs plan and his deficit reduction proposal sooner and as one package.

"The president has generated a problem for himself by giving the appearance of not being forthcoming enough with regard to his own fiscal plan," Galston said. "He feels the need, as he should, to lean forward a bit more. It's a shame this didn't happen a whole lot earlier."

Senior administration officials say that in pushing for his jobs plan, Obama will highlight the need for long-term deficit reduction and the need to achieve it through spending cuts and tax revenue. In so doing, they will try to create sharp differences with Republicans that could serve him in the 2012 presidential campaign.

To that end, some Democrats say it would be foolish for Obama to offer a deficit reduction plan that embraces some of the deals he was prepared to strike with Boehner.

"I don't think he is bound by the compromise they were working on," said Rob Shapiro, a former undersecretary of commerce in the Clinton administration Shapiro. "It has always been the president's position that in a compromise, he was prepared to support entitlement reform if the Republicans were prepared to support revenue increases."

Still, the White House considers passing the jobs bill far more pressing and Obama has been looking for every opportunity to bring it to the public's attention.

In his Saturday radio and Internet address, Obama said he would lay down a plan that would show how to pay down the nation's debt and pay for his employment legislation.

"But right now," he said, "we've got to get Congress to pass this jobs bill."

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Analysis: Pension funds in new crisis as deficit hole grows (Reuters)

LONDON (Reuters) – Pension funds in developed economies are facing a new crisis as falling equities and tumbling bond yields widen their deficits, threatening the incomes and retirement dates of future retirees.

At the heart of their problems is a steady move by pension plans in the United States, euro zone, Japan and the UK to cut exposure to risk after the financial crisis.

But this "de-risking" may end up depressing their long-term returns from stock market investment and challenge the conventional wisdom that shares generate higher returns than bonds.

With weaker holdings and increased liabilities, companies will find it more difficult to fund existing pension schemes. They may cut new business investments as they use more cash to pay pensions.

For future pensioners, it means they will potentially face a lower retirement income and a longer working life -- or both.

This year has been a nightmare for many in the industry -- which controls $35 trillion, or a third of global financial assets -- and funding deficits are posting double-digit rises.

"We had a credit crisis and government bond crisis, and the third one we have is the pension crisis. This is the one where everything is going wrong and there's no obvious way out," said Kevin Wesbroom, UK head of global risk services at consultancy Aon Hewitt.

The sharp retreat in stocks through the summer has hurt them again by weakening their asset positions and threatening to erode stock market recoveries seen since the equity collapse surrounding the 2007-2009 credit crisis.

Even lower bond yields are proving to be a new headache.

"The real killer is liabilities are going up because in the flight to quality everyone gets out of equities and runs for cover in safe assets like government bonds, and yields are falling," said Wesbroom.

Many defined benefit(DB) pension plans -- where benefits are pre-determined -- pay a fixed stream of income to retirees.

The low-yielding environment makes it harder for the funds to meet these bond-like liabilities, forcing them to accumulate even more fixed income instruments to try to meet their obligations, creating a vicious circle.

FALLING YIELDS

Recent data on pension deficits highlight the plight of many pension funds.

In the United States, funding deficits of the 100 largest DB plans rose $68 billion to $254 billion in July, according to the Milliman Pension Fund Index. July marked the 10th largest deficit rise in the index's 11 year history.

Even if these companies were to achieve an optimistic annual return of as much as 8 percent and keep the current benchmark yield of 5.12 percent, their funding status is not estimated to improve beyond 93 percent by end-2013 from the current 83 percent.

Aon Hewitt estimates deficits of DB pension plans for FTSE 350 companies as of end-August rose 20 billion pounds from July to a 2011 high of 58 billion pounds. Their funding ratio stands at 89.8 percent, down from 94.1 percent three years ago.

The drop in the funding ratio is driven by a rally in the fixed income market. In Europe, the double-A rated corporate bond yield -- one of the benchmark rates used by regulators -- fell 300 basis points in the last three years to 3.55 percent, according to Barclays Capital.

The widely used rule of thumb is that a 50 basis points fall in the discount rate roughly results in a 10 percent increase in liabilities.

"Things look substantially worse now than they were during the credit crisis," said Pat Race, senior partner at investment consultancy Mercer.

In reaction to the past few years of an equity decline and volatility, many pension funds are indeed planning to buy more bonds, a move highlighted by Mercer's survey of over 1,000 European DB pension funds in May.

"Trustees do want to de-risk but financial directors have irrational desire to have equities. They are too wedded to equity markets," Race said.

"You still have massive uncertainties with a potential for another dip into recession. I don't see any reversion to days when equities are dominant part of DB plans."

JP Morgan's data shows pension funds and insurance companies in the United States, euro zone, Japan and UK bought $173 billion of bonds in the first quarter, boosting their bond buying for the third quarter in a row.

At the same time, they cut equity buying for a fifth quarter in a row, selling $22 billion of stocks in Q1.

In Europe, pension funds slashed their weightings for equities to an average of 31.6 percent in 2011 from 43.8 percent in 2006, while fixed income holdings rose to 54 percent from 47.8 percent in the same period, according to Mercer.

EQUITY PREMIUM PUZZLE

Growing pension funds deficits on corporate balance sheets may make it more difficult for companies to access credit and discourage firms which are already hoarding cash from spending cash to expand business.

For wider financial markets, the giant industry's gradual move away from stocks could hit equity risk premium -- excess return of equities over risk-free securities which compensates investors for taking on the relatively higher risk.

This may reinvigorate an academic debate where some economic analysis suggests the equity risk premium should be small, in most cases less than half a percentage point, as opposed to the widely-used range of 4-6 percent.

Indeed, 10-year U.S. Treasuries gave higher total returns in the past 10 years on a rolling basis than world stocks. http://link.reuters.com/nyv53s

"The puzzle... is that for the past 20 years, there has been no net equity risk premium. With the recent sell-off in risk and the rally in bonds, I think there might have been a net premium on bonds," Stephen Jen, managing partner at SLJ Macro Partners, said in a note to clients.

"This has turned financial theory on its head, and managers of pension funds and sovereign wealth funds need to think about this very carefully."

(Editing by Anna Willard)

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Obama eyes more deficit talks (Reuters)

WASHINGTON (Reuters) – President Barack Obama will decide on Saturday whether to summon lawmakers for a new round of debt and deficit talks, weighing the chances of progress as both sides stick to their positions on spending and taxes.

Congress must raise the $14.3 trillion limit on U.S. borrowing by August 2 or the government will run out of money to pay its bills, causing turmoil in global financial markets and potentially forcing the United States into another recession.

The top two Republicans in the House of Representatives, John Boehner and Eric Cantor, met on Friday with Treasury Secretary Timothy Geithner and Bill Daley, the White House chief of staff.

But prospects for a deal anytime soon appear unlikely, as the House and Senate were expected to spend much of next week debating measures that have little chance of becoming law.

Republicans want a deficit-cutting deal in order to raise the debt limit, but they disagree with Democrats on how to do it. The White House wants some tax increases on wealthier Americans to be part of a package; Republicans reject that.

"The truth is, you can't solve our deficit without cutting spending," Obama said in his weekly radio and Internet address on Saturday.

"But you also can't solve it without asking the wealthiest Americans to pay their fair share -- or without taking on loopholes that give special interests and big corporations tax breaks that middle-class Americans don't get."

The House is expected next Tuesday to pass a bill that would raise the debt ceiling by the $2.4 trillion Obama has requested as long as Congress adopted a balanced budget amendment -- an unlikely prospect.

Republican Senator Orrin Hatch has lined up every Senate Republican behind a balanced-budget measure. It is expected to fail in the Democratic-controlled chamber next week.

"Only by restoring constitutional restraints on the ability of Congress to spend, can we constrain the growth of the federal government," he said in the weekly Republican address.

"The solution to a spending crisis is not tax increases. Yet, Washington has consistently demonstrated that it cannot control its urge to spend."

As the two sides bicker, the consequences of inaction are looming. Ratings agencies Moody's and Standard & Poor's have signaled they may cut the gold-plated U.S. credit rating if the borrowing limit is not raised and deficit-reduction measures are not laid out.

BACK TO THE TABLE?

The White House and congressional leaders have tried to reassure markets that the United States would not default on its debt.

A backup plan put forward by Senate Republican Leader Mitch McConnell may be the solution all sides embrace if a big deal cannot be reached.

McConnell's plan would essentially allow Democrats to raise the debt ceiling without Republican help, and Senate Democratic Leader Harry Reid has cautiously embraced it. The plan could include about $1.5 trillion in spending cuts and set up a panel to find further savings. The Senate could vote on it late next week, but it remains unpopular with House Republicans.

"The idea itself is stupid," Republican Representative Jason Chaffetz told Fox News. "The people that have been there, the so-called adults in the room, have been there too long. And that's why we're in this problem."

On Thursday evening Obama gave lawmakers a Saturday deadline to come up with a plan to go forward. He could call for further talks on Saturday or Sunday if needed.

The president warned on Friday that inaction could lead to higher borrowing costs for ordinary Americans -- "effectively a tax increase on everybody," he said.

"Whether you're using your credit or you're trying to get a loan for a car or a student loan, businesses that are trying to make payroll, all of them could end up being impacted as a consequence of a default," Obama said.

(Additional reporting by Laura MacInnis, Steve Holland and Mari Saito; Editing by Paul Simao and Eric Beech)

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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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Oil imports drove May trade deficit to $50.2B (AP)

WASHINGTON – The U.S. trade deficit surged in May to the highest level in more than two and a half years, driven wider by a big increase in oil imports and a decline in exports.

The Commerce Department said Tuesday that the deficit increased 15.1 percent to $50.2 billion in May. That's the largest imbalance since October 2008.

Exports declined 0.5 percent to $174.9 billion. Imports rose 2.6 percent to $225.1 billion. Oil prices have fallen since May, so the effect of higher prices should ease some in the coming months.

The deficit is running at an annual rate of $563.2 billion. That's 12.6 percent higher than the 2010 imbalance. A higher trade deficit subtracts from overall economic growth because it means consumers are purchasing more foreign-made goods and fewer products made by U.S. workers.

Analysts said the wider deficit in May means that the economy probably grew at an even slower pace in the April-June quarter than they had previously forecast. Paul Dales, chief U.S. economist at Capital Economics, said he was now looking for economic growth of around 2 percent in the second quarter. That's roughly the same pace as the first three months of the year.

The deficit with China jumped to $25 billion, the largest monthly gap since November. The deficit with Japan fell 26.4 percent to $2.6 billion. Japanese imports shrank further because of supply-chain disruptions caused by the March earthquake and tsunami.

Economists say Japan is starting to rebound from the crisis and a parts shortage that followed those disasters is beginning to dissipate. As a result, Japan's factories should increase shipments to the United States over the next few months.

"As the supply chain disruptions continue to unwind, we expect imports from Japan over the next few months to recover and for the overall trade deficit to modestly widen later this year before leveling off in 2012," said Troy Davig, an economist with Barclays Capital.

Jennifer Lee, senior economist at BMO Capital Markets, noted that while total imports from Japan declined, imports of Japanese auto parts rose. She said that indicates that Japanese auto plants were starting to resume more normal operations and supply U.S. factories with critical component parts.

American companies depend on component parts supplied from Japan. The supply-chain disruptions have slowed production at U.S. factories, particularly among those companies that make autos and electronics.

Manufacturing has been one of the strongest areas of the U.S. economy in the two years since the recession officially ended. Sales in foreign markets have been helped by increased demand and a weaker dollar, which makes U.S. goods cheaper overseas and imported goods more expensive.

Last year, the U.S. deficit with China hit $273 billion. It's the largest deficit the United States has ever had with any country. The huge trade gap between the two countries has prompted many companies and members of Congress to criticize China for manipulating its current to gain a trade advantage. U.S. manufacturers contend that China is keeping its currency undervalued against the dollar by as much as 40 percent.

The Obama administration has been pressuring China to allow its currency to rise at a faster rate against the dollar. But in May, the administration declined to cite China as a currency manipulator. Such a designation could eventually lead to U.S. economic sanctions against China.

The Chinese government says it has been allowing its currency to rise in value against the dollar for more than a year. But Beijing says it must do so gradually to avoid adverse consequences to the Chinese economy.

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Obama says ending tax breaks required to cut deficit (Reuters)

WASHINGTON (Reuters) – President Barack Obama pressed his case on Saturday for achieving deficit reduction, in part by ending tax breaks and singling out hedge fund managers, oil companies and billionaires to take the hit.

Obama is locked in a dispute with Republicans over how to bring down the deficit as part of a deal to raise the debt ceiling and prevent Washington from default.

Democrats insist that some tax increases be included in a deficit-cutting package.

Republicans say that would be bad for the economy.

"Now, it would be nice if we could keep every tax break, but we can't afford them," Obama said in his weekly radio and Internet address.

"Because if we choose to keep those tax breaks for millionaires and billionaires, or for hedge fund managers and corporate jet owners, or for oil and gas companies pulling in huge profits without our help - then we'll have to make even deeper cuts somewhere else."

Obama listed a range of areas, some of which are considered top Democratic political priorities, that would face the chopping block if such tax breaks were allowed to continue.

"We've got to say to a student, 'You don't get a college scholarship.' We have to say to a medical researcher, 'You can't do that cancer research.' We might have to tell seniors, 'You have to pay more for Medicare,'" he said.

"That isn't right, and it isn't smart. We've got to cut the deficit, but we can do that while making investments in education, research and technology that actually create jobs."

Senator Dan Coats, delivering the weekly Republican address, said reducing spending was the key.

"The president and Democrats in Congress must recognize that their game plan is not working," he said. "It's time to acknowledge that more government and higher taxes is not the answer to our problem. It's time for bold action and a new plan to address our current crisis."

TIT FOR TAT

Treasury Secretary Timothy Geithner has warned of huge risks if Congress fails to raise the $14.3 trillion debt ceiling by August 2, potentially triggering a default that could send shivers through an already-fragile banking system.

Obama said both sides agreed spending cuts were necessary and said he and Vice President Joe Biden had made progress in getting lawmakers to agree on areas to cut.

"Over the last few weeks, the vice president and I have gotten both parties to identify more than $1 trillion in spending cuts," Obama said.

"But after a decade in which Washington ran up the country's credit card, we've got to find more savings to get out of the red. That means looking at every program and tax break in the budget - every single one - to find places to cut waste and save money."

Fears of a default, which could disrupt everything from debt payments to retirement benefits, rose after Republicans walked out of budget negotiations led Biden last week.

Coats said Obama had to step up to get a deal done.

"Now is the time for decisive leadership from this president," he said. "It's time to cast aside the false safety of political denial and re-election hopes and put the future of our country above all else."

(Editing by Jackie Frank)

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