EU says capacity to solve debt crisis in doubt (Reuters)

BRUSSELS/ROME (Reuters) – The European Union acknowledged on Wednesday that investors now doubt whether the euro zone can overcome its debt crisis and Italy's Silvio Berlusconi called for more action to ward off market attacks.

European Commission President Jose Manuel Barroso said a surge in Italian and Spanish bond yields to 14-year highs was cause for deep concern although they did not reflect the true state of the third and fourth largest economies in the currency area.

"In fact, the tensions in bond markets reflect a growing concern among investors about the systemic capacity of the euro area to respond to the evolving crisis," Barroso said in a statement.

He urged member states to speed up parliamentary approval of crisis-fighting measures agreed at a July 21 summit meant to stop contagion from Greece, Ireland and Portugal, which have received EU/IMF bailouts, to larger European economies.

But neither he nor European Monetary Affairs Commissioner Olli Rehn offered any immediate steps to stem the crisis, which has flared again with full force less than two weeks after that emergency meeting.

Italy has borne the brunt of a selloff triggered by the unresolved debt crisis and fears of a global economic slowdown.

"Our country has a solid political system ... we have solid economic fundamentals. Our banks are liquid, solvent and they've easily passed the European stress tests," Prime Minister Berlusconi, who has been largely silent, closeted with his lawyers over several ongoing trials, told parliament.

"The markets didn't reflect, and still don't reflect the importance of (European) interventions that have been taken. So it's essential to give certainty to markets," he said.

Italian Economy Minister Giulio Tremonti held two hours of emergency talks with the chairman of euro zone finance ministers, Jean-Claude Juncker, in Luxembourg but neither disclosed anything of substance after the meeting. Tremonti also conversed with Rehn.

A European Commission spokeswoman said there had been no discussion of a bailout for Italy, which would overwhelm the bloc's existing rescue funds.

The market turmoil caused alarm in some parts of Europe but apparent insouciance in the bloc's biggest economy, Germany.

"Italian and Spanish bond yields rose to their new record highs. This is a very alarming and scary thing," Finnish Prime Minister Jyrki Katainen told public broadcaster YLE. "The whole of Europe is in a very dangerous situation."

With many policymakers on holiday, there seemed little prospect of early European policy action, although euro zone governments were in telephone contact about the situation.

German Economics Minister Philipp Roesler said Italy and Spain were not even discussed at Berlin's weekly cabinet meeting which he chaired in place of Chancellor Angela Merkel, who is on vacation and did not call in.

A German government spokesman said Berlin saw no reason for alarm over the selloff of Italian stocks and bonds and was focused on implementing the latest euro zone summit decisions.

In stark contrast, Spanish Prime Minister Jose Luis Rodriguez Zapatero delayed his holiday and held crisis talks with ministers ahead of a crucial bond auction on Thursday.

The euro zone's rescue fund cannot use new powers granted at last month's summit to buy bonds in the secondary market or give states precautionary credit lines until they are approved by national parliaments in late September at the earliest.

The European Central Bank could reactivate its bond-buying program, which temporarily steadied markets last year but has been dormant for more than four months. Weekly data released on Monday show it has so far refrained from doing so despite market rumors to the contrary last week.

Italy and Spain could offer new austerity measures to try to placate the markets, but Rome has just adopted a 48 billion euro savings package and Madrid's lame duck government has just called an early general election for November 20.

BANK SHARES HAMMERED

Shares in banks exposed to euro zone sovereigns, particularly in Italy, have taken a hammering and are having growing difficulty in securing commercial funding.

"Bank funding remains stressed for southern Europe and remains a key source of risk for bank earnings, ability to lend and a drag on economic recovery," Huw van Steenis, analyst at Morgan Stanley in London, said in a note. "The risk of a credit crunch in southern Europe is growing."

Italian bank shares rebounded after data showed the Italian services sector contracted by less than expected in July. Shares in Unicredit, among those pummeled in the latest round of the crisis, rose 2 percent after Italy's biggest bank easily beat second-quarter net profit forecasts.

But the ripples continue to spread.

France's Societe Generale warned investors it may miss its 2012 profit target after taking a 395 million euro pretax charge in the second quarter on its exposure to Greek debt. Its shares plunged by nearly 10 percent.

The Swiss National Bank cut its interest rate target and said it would very significantly increase its supply of liquidity to try to bring down the value of the Swiss franc, which it said has become massively overvalued.

The currency has served as a refuge, along with gold, amid market turbulence driven by anxiety over a slowing U.S. economic recovery and Europe's debt crisis.

Worries about Italy, the euro zone's second biggest debtor, have been exacerbated by political instability in Berlusconi's fractious center-right coalition. Despite the austerity plan, doubts have lingered about a weakened government's ability to enforce the cuts, and about the lack of structural reforms to boost Italy's miserable growth rate.

"For both Spain and Italy, the 7 percent level in yields is the one everyone is focused on," said West LB rate strategist Michael Leister. "Although we're still quite a decent amount away from that, any break of the 6.50 percent level is going to be a catalyst to get to those higher rates."

On Wednesday, Spanish and Italian 10-year yields stood respectively at 6.27 and 6.10 percent. The gap between them has narrowed as Italy has overtaken Spain as the main focus of market concern about debt sustainability.

(Additional reporting by Kirsten Donovan, Swaha Pattanaik and Alex Chambers in London, Gernot Heller in Berlin, Katie Reid in Zurich; writing by Paul Taylor/Mike Peacock; editing by Janet McBride)

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Rival debt plans in doubt, alternatives sought (Reuters)

WASHINGTON (Reuters) – Republicans and Democrats rushed to rework rival deficit reduction plans on Wednesday, but with the fate of both proposals heavily in doubt top lawmakers pursued a behind-the-scenes compromise to avert a crippling U.S. debt default.

With the deadline less than a week away, global stock markets fell sharply on growing fears that the two sides will fail to break the stalemate. That would mean the United States would not be able to borrow more money after August 2 and could run out of cash to pay all of its bills.

Even if a deal is reached to raise the $14.3 trillion U.S. debt ceiling, a budget plan that flinches from hefty cuts in the deficit may result in a downgrade of America's top-notch credit rating, which could sow financial chaos worldwide.

Against this backdrop, congressional leaders scrambled to find common ground, but complications surrounding their competing proposals could mean efforts to forge a compromise will go right down to the wire.

The prospect of a quick resolution suffered another blow when a vote on a deficit reduction plan offered by House of Representatives Speaker John Boehner, the top Republican in Congress, was pushed back to Thursday from Wednesday amid a mutiny by some fiscal conservatives in his own party as well as stiff opposition from Democrats.

A separate plan crafted by Senate Majority Leader Harry Reid, a Democrat, also faced a setback on Wednesday when the non-partisan Congressional Budget Office said the proposal would cut $2.2 trillion from deficits, about $500 billion less than Democrats had claimed.

Boehner rushed to revise his two-step proposal after a CBO analysis found it would cut spending by $350 billion less than the $1.2 trillion over 10 years he had claimed. Obama opposes it because it would extend borrowing authority only until early next year, risking a rerun of the debt impasse during the 2012 election campaign when the president is seeking a second term.

Amid the political brinkmanship, the two parties have been having ongoing conversations about how to break the impasse, Democratic Senator Kent Conrad said.

"One thing I'm quite confident of is we are not going to default. Leaders on both sides recognize now that that would be a disaster," Conrad said.

But weeks of acrimonious dealings may make it hard to narrow the partisan differences. Republicans control the House and President Barack Obama's Democrats control the Senate.

POTENTIAL FOR COMPROMISE

Signaling a potential for compromise, Reid said when asked if the two plans were the only options: "We can change any one of them very easily." But Reid said every Democratic senator would vote against the current Boehner proposal if it is passed by the House and goes to the Senate.

While Democrats and Republicans publicly were pushing their respective proposals, bipartisan talks quietly continued.

Senate Democratic aides said they hoped that once Boehner's plan is killed -- either by the House or Senate -- then support will grow for Reid's one-step remedy, which Obama backs.

As currently written, Reid's approach would save more than the Republican plan and would extend the debt limit beyond the November 2012 elections. "More people will turn their attention to our bill and give it a second look" and "some version" of it would be put to a vote, a Democratic aide said.

Meanwhile, the gridlock dragged global stocks down on Wednesday, particularly in Europe. Major U.S. exchanges slipped by 1 percent or more on nervousness over unfavorable company news and the faltering debt talks in Washington.

Worried investors shifted funds into traditional safe havens gold and the Swiss franc, which both rose to record highs in dollar terms.

Still, there have been no signs of panic in markets because most investors expect a deal to be struck by the deadline.

Adding to that view, Deven Sharma, president of rating agency Standard & Poor's, told a congressional committee the ratings agency does not think the United States will default on its debt. "Our analysts don't believe they would," he said.

(Additional reporting by Deborah Charles and Donna Smith; Writing by Matt Spetalnick; Editing by Will Dunham)

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Strauss-Kahn released without bail, case in doubt (Reuters)

NEW YORK (Reuters) – Former IMF chief Dominique Strauss-Kahn was released without bail on Friday after a dramatic court hearing where the sexual assault case against him appeared to shift in his favor.

Strauss-Kahn, who smiled as he walked out of court, still faces felony charges of attempted rape and sexually assault over the alleged attack on a hotel maid in New York. His lawyers said they will seek to have the charges dismissed but the judge said prosecutors were continuing to investigate.

The turnabout could upend French politics. Strauss-Kahn, 62, was a strong candidate for the 2012 French presidential election until his May 14 arrest.

At a hearing to seek changes to his bail conditions, prosecutors said the credibility of the woman at the center of the case had been thrown into question.

As a result, the court agreed to let Strauss-Kahn be freed and his bail and bond returned. He agreed to return to court as needed, including for a July 18 hearing.

"I understand that the circumstances of this case have changed substantially and I agree the risk that he would not be here has receded quite a bit. I release Mr. Strauss-Kahn at his own recognizance," Justice Michael Obus told the court.

Strauss-Kahn's arrest forced his resignation from the International Monetary Fund and appeared to end his presidential hopes, weeks before he had planned to declare his candidacy.

His supporters in the French Socialist party voiced delight at the apparent reversal and some said they hoped he might re-enter the 2012 presidential race.

'EXTENSIVE INVESTIGATION'

The case has hinged on the accuser, a 32-year-old Guinean immigrant who cleaned the $3,000-a-night suite at the Sofitel hotel in Manhattan where Strauss-Kahn was staying.

Prosecutors said at the hearing their change of view on the maid's credibility followed "an extensive investigation" but they gave no details.

The New York Times quoted two well-placed law enforcement officials as saying prosecutors found issues with the accuser's asylum application and possible links to criminal activities, including drug dealing and money laundering.

They also discovered the woman made a phone call to an incarcerated man within a day of her encounter with Strauss-Kahn in which she discussed the possible benefits of pursuing the charges against him, the paper said.

The conversation was recorded. The man was among a number of people who had made multiple cash deposits, totaling around $100,000, into the woman's bank account over the last two years, The New York Times said.

The woman's brother told Reuters in Guinea that she was the victim of a smear campaign.

Her lawyer said after the hearing that his client's story had never wavered and Strauss-Kahn's assertion that she had consensual sex with him was a lie.

(Additional reporting by Mark Hosenball, Marie Maitre, Catherine Bremer and Geert De Clercq in Paris and Saliou Samb in Guinea; Writing by Paul Taylor and Mark Egan; Editing by Mark Trevelyan and John O'Callaghan)

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