Business Blog Posts

With the twin debt crises raging and stock markets plunging, the Group of Seven leaders said after a telephone consultation that they intend to stay in close contact and were "ready to take action to ensure stability and liquidity in financial markets."

The G7 -- the United States, Britain, Canada, France, Germany, Italy and Japan -- said that included joint action if needed in foreign exchange markets because "disorderly movements ... have adverse effects for economic and financial stability."

The statement was designed to calm financial markets and followed a signal from the European Central Bank that it would buy up Italian and Spanish bonds. Market analysts said it should provide some reassurance as trading resumes on Monday.

"The G7 has effectively drawn a line in the sand on contagion," said Christian Cooper head of U.S. dollar derivatives rating at Jefferies & Co in New York.

The G7 meeting followed Friday's downgrading of U.S. debt quality by rating agency Standard & Poor's and a week in which a European debt crisis threatened to engulf larger nations as Italy's borrowing costs shot higher.

The ECB's decision to start buying Italian and Spanish debt was viewed as a critical move to quell a bond rout that has rocked financial markets.

The promises to bring more policy action to bear on nervous markets, through coordinated measures, came in the face of new signs of continuing stress as stock, oil and commodity futures all dropped sharply in early Asian trading.

CHINA NOT APPEASED

China lashed out again at weak-kneed politicians in the United States and Europe for lacking the courage to tackle debt issues seriously -- a concern to Beijing because of its huge holdings of U.S.-denominated and other foreign debt.

"It must be understood that if the U.S., Europe and other advanced economies fail to shoulder their responsibilities and continue their incessant messing around over selfish interests, this will seriously impede stable development of the global economy," said a commentary in People's Daily newspaper, the mouthpiece of China's ruling Communist party.

Market unease was heightened by Standard & Poor's decision to cut the U.S. debt rating to AA-plus from "risk free" AAA -- a move that Treasury Secretary Timothy Geithner bitterly condemned.

In an interview on NBC and CNBC television, Geithner said the rating agency "has shown really terrible judgment" and claimed its downgrade meant nothing and wouldn't affect investors' faith in U.S. debt.

In Frankfurt, ECB President Jean-Claude Trichet said in a statement after discussions with his Governing Council that the central bank welcomed new steps taken by Italy and Spain on fiscal and structural reforms, and hence it would "actively implement" its bond-buying program. A monetary source said this meant it is ready to start buying up the debt of these two countries.

"The Euro system will intervene very significantly on markets and respond in a significant and cohesive way," the source said.

Trichet wanted the policy-setting Governing Council to take a final decision on buying Italian paper after Prime Minister Silvio Berlusconi announced new measures to speed up deficit reduction and hasten economic reforms, an ECB source said.

FRANCE, GERMANY ON SAME PAGE

On Sunday afternoon, German Chancellor Angela Merkel and French President Nichola Sarkozy weighed in with a joint statement praising both Italy and Spain for their pledges to impose budget austerity.

They stressed that "complete and speedy implementation of the announced measures is key to restor(ing) market confidence."

The back-and-forth between Standard & Poor's and the Obama administration over whether the downgrade of Washington's rating was justified continued on U.S. Sunday-morning talk shows where a senior official from the ratings agency said its concerns about political impasse in Washington were valid.

John Chambers, an S&P managing director, said on ABC's "This Week" that years may be needed to regain AAA status and even them "it would take, I think, more ability to reach consensus in Washington than what we're observing now."

Geithner, who had indicated he might leave the administration once an increase in the debt ceiling was agreed, said he was not doing so and would stay on.

That relieved President Barack Obama of the difficult prospect of finding a replacement who could win Senate confirmation in Washington's bitterly partisan atmosphere.

The ECB reactivated its sovereign bond-buying program on Thursday but purchased only small quantities of Irish and Portuguese bonds, seeking tougher austerity measures from Italy. That did nothing to stem market attacks on Italian assets.

Berlusconi's plans entail moving up a balancing of the budget by one year to 2013, enshrining a balanced budget rule in the constitution and pushing through welfare and labor market reforms after talks with trade unions and employers.

(Additional reporting by Laura McInnis, David Lawder and Mark Felsenthal in Washington, Sarah Marsh in Berlin, Astrid Wendlandt in Paris, Kim Yeonhee and Yoo Choonsik in Seoul, Praveen Menon and Shaheen Pasha in Dubai, and Reuters bureaux worldwide; Writing by Mark Heinrich and Glenn Somerville; Editing by Christopher Wilson))

The European Central Bank decision would be aimed at calming markets grown increasingly doubtful about Europe's ability to deal with its debt issues, a strikingly parallel concern to that which led ratings agency Standard & Poor's to knock U.S. debt down from "risk free" AAA status to AA-plus.

Meanwhile, finance chiefs from Group of Seven industrial nations were to confer by telephone late on Sunday-- and possibly issue a statement afterward -- to try to soothe anxious investors after a week in which $2.5 trillion of market value was wiped out.

Any statement would be timed to precede the opening of trading in Tokyo, the first major market to open on Monday, at 9 a.m. local time.

ECB President Jean-Claude Trichet said in a statement after discussions with his Governing Council on Sunday that the central bank welcomes new steps taken by Italy and Spain on fiscal and structural reforms, and hence it would "actively implement" its bond-buying program. A monetary source said this means it is ready to start buying up the debt of these two countries.

"The Euro system will intervene very significantly on markets and respond in a significant and cohesive way," the source said.

Political leaders are under searing pressure to reassure investors that Western governments have both the will and ability to reduce their huge and growing public debt loads.

ECB President Jean-Claude Trichet wanted the policy-setting Governing Council to take a final decision on buying Italian paper after Prime Minister Silvio Berlusconi announced new measures on Friday to speed up deficit reduction and hasten economic reforms, one ECB source said.

LOOKING FOR A BOUNCE

Buying Italian bonds would likely prompt a sizable relief rally on global markets.

On Sunday afternoon, German Chancellor Angela Merkel and French President Nichola Sarkozy weighed in with a joint statement praising both Italy and Spain for their pledges to impose budget austerity.

They stressed that "complete and speedy implementation of the announced measures is key to restor(ing) market confidence."

The back-and-forth between Standard & Poor's and the Obama administration over whether the downgrade of Washington's rating was justified continued on U.S. Sunday-morning talk shows where a senior official from the ratings agency said its concerns about political impasse in Washington were valid.

John Chambers, an S&P managing director, said on ABC's "This Week" that years may be needed to regain AAA status and even them "it would take, I think, more ability to reach consensus in Washington than what we're observing now."

White House economic adviser Gene Sperling blasted the S&P ruling on Saturday night, saying it "smacked of an institution starting with a conclusion and shaping any arguments to fit it."

U.S. Treasury Secretary Timothy Geithner, who had indicated he might leave the administration once an increase in the debt ceiling was agreed, announced on Sunday that he was not doing so and would stay on.

That relieves President Barack Obama of the difficult prospect of finding a replacement who could win Senate confirmation in Washington's bitterly partisan atmosphere.

Treasury says that S&P's debt calculations were off by $2 trillion but the agency said that did not change the fact that the United States' longer-term debt prospects were worsening.

Twin debt crises in the United States and Europe had policy makers scrambling to keep financial markets from panic.

The ECB reactivated its sovereign bond-buying program on Thursday but purchased only small quantities of Irish and Portuguese bonds, seeking tougher austerity measures from Italy. That did nothing to stem market attacks on Italian assets.

Berlusconi's plans entail moving up a balancing of the budget by one year to 2013, enshrining a balanced budget rule in the constitution and pushing through welfare and labor market reforms after talks with trade unions and employers.

He gave little detail about how that would be achieved and the measures will take some time to enact.

G-20, G-7 CRISIS CONTACTS

South Korea said finance deputies from the Group of 20 big economies addressed the European crisis and U.S. sovereign rating downgrade in an emergency conference call on Sunday morning Asian time.

French President Nicolas Sarkozy, who chairs the G7 and G20 forums this year, conferred with Britain's Prime Minister David Cameron on Saturday.

"Both agreed the importance of working together, monitoring the situation closely and keeping in contact over the coming days," a spokesman for Cameron said.

Over time, S&P's move could ripple through markets by pushing up borrowing costs and making it more difficult to secure a lasting recovery.

S&P chief David Beers told "Fox News Sunday" that the Treasury Department's criticism of the credit rating agency's analysis was a "complete misrepresentation." Even with the debt limit agreement passed by the U.S. Congress, he said, "the underlying debt burden of the U.S. is rising and will continue to rise over the next decade."

Asked about prospects for a further lowering of the U.S. rating, Beers said the agency's negative outlook meant that "risks are on the downside."

ALARM IN GERMAN, FRENCH MEDIA

Newspapers in Germany, the euro zone's reluctant bankroller, were both incredulous and gloomy on Sunday about the financial upheaval.

Welt am Sonntag dedicated an entire section to global economic uncertainties, entitled "Der Crash" and wrote: "No one could have foreseen this dramatic crash and now the situation can only be endured with gallows humor."

French newspapers carried grim headlines with Le Journal du Dimanche trumpeting "The world on the edge of collapse" with a sub-headline saying: "The week starting should be crucial. Markets from now on are living in fear of a crash."

Washington's Asian allies rallied round the battered superpower, with Japan and South Korea both saying their trust in U.S. Treasuries remained unshaken and urging investors not to panic.

"I expressed our country's position on the (G20 conference) call that there will be no sudden change in our reserve management policy," South Korean Deputy Finance Minister Choi Jong-ku told Reuters by telephone, referring to Seoul's heavy ownership of U.S. bonds.

"There's no alternative that provides such stability and liquidity," added Choi.

SPLITS IN ECB

In some quarters including in the German government, there are doubts that Italy can be rescued by the European emergency fund, even if the fund were tripled in size, according to newsmagazine Der Spiegel.

Italy's financial needs are so huge that it would overwhelm resources, according to government experts, Der Spiegel said in its online edition. Italy's public debt is about 1.8 trillion euros, or 120 percent of its national output.

Germany has consistently said troubled euro-zone governments should focus on spending cuts and internal reforms, not bailouts. The European Financial Stability Fund currently has 440 billion euros ($632.5 billion) and would need to be expanded to cater for the likes of Italy and Spain.

China, the largest foreign holder of U.S. debt, took the world's economic superpower to task for allowing its fiscal house to get into such disarray.

On Sunday, a commentary in the People's Daily, the main newspaper of the ruling Communist Party, said Asian exporters, who depend on demand from the United States, could be among the biggest victims of the mounting U.S. economic woes.

"The lowering of the United States' long-term sovereign credit rating has sounded a warning bell for the international currency system dominated by the U.S. dollar," said economist Sun Lijian, writing in the paper.

(Additional reporting by Laura McInnis in Washington, Sarah Marsh in Berlin, Astrid Wendlandt in Paris, Kim Yeonhee and Yoo Choonsik in Seoul, Praveen Menon and Shaheen Pasha in Dubai, and Reuters bureaux worldwide; Writing by Mark Heinrich and Glenn Somerville; Editing by Eric Walsh)

The immediate effects of the Standard & Poor's downgrade of the country's AAA credit rating late on Friday are likely to be modest, largely because it was expected and already at least partly discounted, experts said.

Many downplayed the likelihood of the sort of financial contagion experienced when Lehman Brothers went under in September 2008. Few had expected it to have to file for bankruptcy, and few were prepared for the fallout. Money market funds froze, some major commercial banks collapsed, and many major dealers and finance houses teetered on the edge of failure.

But even if that type of scenario is unlikely this time, bankers, lawyers and investors wonder if there could be longer-term consequences of S&P's downgrade, given that U.S. sovereign credit is bedrock to the world financial system.

The analysis is complicated because so many of the potential stress points for the financial system are relatively opaque areas like over-the-counter derivatives markets.

Adding to the difficulties is the concern that the downgrade is only one of the many issues roiling global markets. The European debt crisis is spreading, with Italy and Spain coming under the gun after Greece, and data in recent weeks point to a weaker U.S. economy than many investors had thought and have led to fears of another recession.

"I actually think it is going to end up having more of an impact than some of the news stories are suggesting," said Thomas Stoddard, a senior managing director at Blackstone Group who focuses on financial services investment banking.

"Not having the U.S. as triple-A is just going to pop up in more places and have more frictional costs than people might suspect," Stoddard added.

A number of entities that are key players in the U.S. financial system -- including mortgage finance companies Fannie Mae and Freddie Mac, and securities clearinghouses like the Options Clearing Corp Depository Trust Co -- are likely to be downgraded by Standard & Poor's on Monday.

For Fannie Mae and Freddie Mac, losing their triple-A rating could lift borrowing costs, potentially making mortgages more expensive for consumers and adding to stress in the already unstable U.S. housing market.

Last month, S&P said it may also cut ratings for companies like the Depository Trust Co, which facilitates payment transfers among major banks, and several Federal Home Loan Banks and Farm Credit System Banks.

On Friday evening, when S&P cut the United States' sovereign rating by one notch to "AA-plus," it said it would offer more detail about the ratings for these companies on Monday.

DERIVATIVES MARKETS

Another source of potential stress is derivatives markets, where investors and banks often collateralize their positions using U.S. Treasuries.

If banks start demanding more Treasuries to collateralize the same exposure, investors could be forced to sell assets to come up with extra collateral, causing broader market declines. As long as Treasury yields are at all time lows, that risk seems relatively low, said a hedge fund trader who spoke on condition of anonymity.

Some derivatives transactions may have ratings triggers built into them that unwind the deals if the U.S. is downgraded, the trader said, but he said it is difficult to know how many such transactions are out there.

But there are some factors working in markets' favor, analysts noted.

For one thing, major U.S. banks are better capitalized as credit losses have slowed. The U.S. banking system had $1.51 trillion of equity capital at the end of the first quarter, compared with $1.29 trillion in the fourth quarter of 2008. That roughly 17 percent of extra capital is supporting about 3 percent fewer assets than it used to.

If stresses become strong in areas like the repo market, a massive market that banks use to fund securities short-term, dealers are fairly sure the Federal Reserve can jump in to offer support, as it did during the credit crunch, the trader said.

Any impact in the derivatives market will be less than what the pessimists fear, said Michael Holland, founder of asset manager Holland & Co. "I don't expect major disruptions in markets just from the downgrade."

BORROWING COSTS

Borrowing costs for companies with top ratings like Microsoft Corp and Exxon Mobil Corp could drop, because triple-A rated debt may be even more attractive to some investors now, analysts said. Some companies have at times had more available cash on their balance sheets than the U.S. government in recent weeks.

In general, corporate borrowing costs may not rise following the U.S. downgrade. Last week, when many in the market were expecting the U.S. to be downgraded, six U.S. companies issued 30-year bonds, which is unusually long-dated for the corporate market.

Even highly-rated corporate bonds have seen their risk premiums rise in recent sessions, signaling that portfolio managers are still concerned about credit risk. As turmoil in Europe ratchets higher, those risk premiums may rise more. But investors' willingness to buy long-term corporate debt signals some confidence in the sector.

"To a certain extent, corporate debt may look even more attractive, especially cash-rich balance sheet companies with lots of liquidity," said Chip MacDonald, a financial services partner at law firm Jones Day.

STATE FINANCES

States that rely heavily on federal government spending -- such as Virginia and Maryland, which are home to many federal employees and defense contractors -- could suffer if Congress and President Barack Obama slice the federal budget more deeply.

A downgrade of Fannie Mae and Freddie Mac would affect billions of dollars of debt issued by public housing authorities secured by federally guaranteed mortgages.

Hospital credits could be weakened if the federal government slashes programs such as Medicaid -- the health plan for the elderly, poor and disabled that accounts for as much as 30 percent of state spending. Stocks in the health care sector sold off last week, amid fears of declining government support for spending in the sector.

"The degree of dependence on the federal government now becomes a state credit issue," said Philip Fischer a managing principal at eBooleant Consulting, in a recent report.

S&P is also expected to immediately downgrade pre-refunded bonds. When municipal bonds are refunded, investors are typically repaid from Treasuries held in escrow.

Debt issued by AAA-rated universities and colleges with global reputations might rise in price, said Evan Rourke, a portfolio manager, with Eaton Vance, citing Harvard and Princeton as examples.

Indeed, the immediate impact of the downgrade might be muted by the tax-free market's traditional strengths.

"I don't see a tremendous flight out of municipals. You might see credit spreads widening for lower-rated issues but we also think a lot will hold their ratings," Rourke said.

(Reporting by Paritosh Bansal and Dan Wilchins, additional reporting by Joan Gralla and Ben Berkowitz; Editing by Marguerita Choy)

He has been true to his word, keeping interest rates near zero since late 2008 and more than tripling the size of the Fed's balance sheet to $2.85 trillion. But cutbacks in government spending may end up having a similarly chilling effect on the economy, and there is little Bernanke can do to counter that.

Back in 1937, the U.S. economy had been growing rapidly for three years, thanks in large part to government programs aimed at ending the deep recession that began in 1929.

Then the central bank clamped down hard on lending, and federal government spending dropped 10 percent. The economy contracted again in 1938. The jobless rate soared.

"Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again," Bernanke said back in 2002 at a conference honoring legendary economist Milton Friedman's 90th birthday.

Bernanke convenes the Fed's next policy-setting meeting on Tuesday, facing growing concern that the United States may be slipping into another recession while Europe staggers toward a deeper debt crisis. Standard & Poor's decision on Friday to lower the U.S. credit rating adds yet another element of uncertainty.

His options are limited.

Nigel Gault, chief U.S. economist at IHS Global Insight, said the Fed could promise to keep interest rates near zero or its balance sheet swollen for even longer than investors anticipate. Or it could buy even more U.S. government debt.

"It is hard to see any of these options as 'game changers,'" Gault said. "The Fed would be doing them not because it could be sure they would make a huge difference, but because it would feel the need to do something."

Gault put the odds of another recession at 40 percent.

However, Friday's U.S. employment figures soothed recession fears, showing the economy created 117,000 jobs in July. That was up from a revised 46,000 in June and prior months payrolls were revised up slightly. The unemployment rate slipped to 9.1 percent but mostly because workers dropped out of the labor force.

"While I do not think this sounds the all-clear signal, it does quell some of the conversation that the U.S. is falling back into a recession," said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York.

"Having said that, there are still plenty of headwinds, like Europe. I am also very encouraged to see the upward revisions to the previous months. This report pulls us back from the ledge a little bit."

HITTING A POTHOLE

Full employment is one of the Fed's prescribed goals, and it is clearly falling short. Government spending cuts are making matters worse. Friday's employment report showed a net loss of 37,000 government jobs last month.

State and local governments with balanced budget rules had little choice but to cut jobs in order to make ends meet. The federal government has no such restriction, but its spending outside of defense fell at a 7.3 percent annual rate in the second quarter, crimping economic growth.

Michael Feroli, an economist with JPMorgan in New York, said he had held out some hope that Congress would approve some form of additional fiscal support in the coming months, but the debt ceiling fight showed lawmakers dead set against that.

"It now looks likely that growth could hit a pothole early next year," Feroli said.

He cut his growth forecast for the first half of 2012 to 2.0 percent from 2.5 percent. At that sluggish pace, the jobless rate won't fall much below 9.0 percent, keeping the Fed on hold until at least the middle of 2013, Feroli said.

Without fiscal help, the Fed will be under greater pressure to find some other way to lift growth. Another round of government bond purchases would no doubt elicit wails of protest from emerging markets, which contend that the Fed's easy money spills into their economies, driving up inflation.

China, whose $1.16 trillion in Treasury holdings are second only to the Fed's, has not been shy about expressing its concern over the state of U.S. public finances and the dollar's slide.

Yang Jiechi, China's foreign minister, said on Friday that Washington should enact "responsible monetary policies" to ensure global economic stability, a thinly veiled reference to the Fed's bond-buying programs.

China releases its monthly economic data this week. The figures are expected to show double-digit gains in industrial output and retail sales, suggesting the country's economic growth remains robust.

Strong growth in China has helped to lift the rest of Asia, outside of Japan, which is still hurting from the March earthquake and tsunami. But all bets are off if conditions worsen significantly in the United States.

"Our view is that the region can 'decouple' from modest slowdowns, and we think the ongoing slowdown qualifies as modest," said TJ Bond, emerging Asia economist at Bank of America-Merrill Lynch in Hong Kong.

"We would start to worry if the U.S. tipped over into recession."

(Editing by Dan Grebler)

Following its worst week in almost three years, the S&P 500 has fallen into correction territory and year-end forecasts are already being lowered. Safe havens like gold and the Swiss franc rallied.

Economic growth has slowed and budget-cutting legislation recently passed in the U.S. Congress could further dampen economic activity.

That leaves the path uncertain. So what are investors to expect in the weeks ahead?

"In a word, volatility," Citigroup strategist Jamie Searle said.

The CBOE Volatility Index .VIX, the market's gauge of anxiety, had its largest daily percentage spike since early 2007 on Thursday.

Another source of worry was thrown into the mix late Friday, when Standard & Poor's stripped the United States of its top-notch triple-A credit rating. In its report, S&P sounded pessimistic that U.S. lawmakers could reach the consensus needed to rein in deficits that were responsible for this ratings cut.

"The long-term implications are daunting," said Jack Ablin, chief investment officer of Harris Private Bank in Chicago.

"Short-term, Treasurys remain a premier safe-haven refuge."

Until June, equity investors could count on the Federal Reserve to keep pumping money into the system, boosting equity and commodity prices. The $600 billion the Fed used to buy assets in a second round of quantitative easing -- known as QE2 -- flooded markets with cash and helped lower interest rates. That's over now.

Following a political showdown in Congress that took the United States to the brink of a default and a bitter battle to rein in spending, few expect more fiscal stimulus. And additional action from the Fed is unlikely after its meeting this coming Tuesday.

"There is certainly not going to be any fiscal stimulus coming, given the debt situation we are in," said Paul Mendelssohn, chief investment strategist of Windham Financial Services in Charlotte, Vermont.

"You've got so much discord and so much dysfunctionality in Washington that (Fed Chairman Ben) Bernanke has to think twice before he does anything."

Fears of another recession have crept back, fed by flagging economic growth and a perceived inability of politicians on both sides of the Atlantic to deal with escalating government debt.

In Europe, a credit crisis that initially hit Ireland, Greece and Portugal escalated and now threatens to engulf Italy, the euro zone's third-largest economy. Bond yields soared this week to highs not seen in more than a decade, worrying investors about Rome's ability to finance -- and balance -- its budget.

During the afternoon of New York's Friday session, Italy pledged to speed up austerity measures and social reforms in return for European Central Bank help with funding.

PANIC BEGETS PANIC

Having fallen in nine of the last 10 sessions, the S&P 500 closed this week down 7.2 percent -- its biggest percentage drop since the third week of November 2008.

Selling was broad as average daily volume for the week soared to 11.6 billion shares traded on the New York Stock Exchange, NYSE Amex and Nasdaq. That represents about a 55 percent jump from what was until last week the yearly average of nearly 7.5 billion.

Frantic moves in markets like the ones seen this week go beyond curbing investor confidence. Nervous consumers hold off on spending. Corporations don't sell their products and services so their earnings don't rise. Stock prices fall, creating a vicious circle.

"We're facing years of markets that will be at times scary and chaotic and that won't be providing the kinds of returns people want to expect from investments," said Rob Arnott, chairman of Research Affiliates in Newport Beach, California, who oversees $80 billion in assets.

"Most people think double digits in the past was not difficult so, 'I'm going to be conservative and expect 7 to 8 percent.' But that's not what the markets are priced to give you -- it's more like 3 to 5 percent," Arnott said.

Following downgrades to U.S. gross domestic product estimates and weak global figures on factory and services sector activity, hopes for a boom in the second half of the year have evaporated.

"I just don't think 3 percent GDP growth in the second half is anywhere close to realistic at this point,' said Keith Davis, bank analyst and principal at money manager Farr, Miller & Washington in Washington, DC.

"The third quarter is starting off pretty slow, and people are bringing down their numbers."

On Friday, Credit Suisse equity strategists cut their year-end estimate for the S&P 500 by 7 percent to 1,350 from 1450, with 1,400 as the target for year-end 2012.

Contrarian views are, nonetheless, ready to dismiss the panic and take it as a good time to jump back in.

"The biggest fear in our mind is: 'Is it a self-fulfilling prophecy? Is the market volatility causing people to really pull back?'" said Thomas Villalta, portfolio manager for Jones Villalta Asset Management in Austin, Texas.

"I think you'll see things kind of calm down over the weekend, and I suspect next week will be a better week for the market as people calm down and reassess the situation."

(Wall St Week Ahead appears every Friday. Questions or comments on this column can be e-mailed to: rodrigo.campos(at)thomsonreuters.com)

(Reporting by Rodrigo Campos; Additional reporting by David Gaffen, Jonathan Spicer, Chuck Mikolajczak and Caroline Valetkevitch; Editing by Kenneth Barry and Jan Paschal)

After a week that saw $2.5 trillion wiped off global stock markets, political leaders are under mounting pressure to reassure investors that Western governments have both the will and ability to reduce their huge and growing public debt loads.

South Korea said finance deputies from the Group of 20 major economies discussed the European debt crisis and U.S. sovereign rating downgrade on Sunday morning in Asian time zones.

A Japanese government source said finance leaders from the Group of Seven big developed economies would also discuss the crisis and may issue a statement afterwards, although the timing of such a call was unclear.

The European Central Bank was scheduled to hold a rare Sunday afternoon conference call. Investors are anxiously looking for the central bank to start buying Italian and Spanish debt on Monday to stabilize prices, a move that has split the ECB governing council.

French President Nicolas Sarkozy, who chairs the G7/G20 group of leading economies, conferred with Britain's Prime Minister David Cameron on Saturday.

"They discussed the euro area and the U.S. debt downgrade. Both agreed the importance of working together, monitoring the situation closely and keeping in contact over the coming days," a spokesman for Cameron said.

In Washington, a White House economic advisor castigated ratings agency Standard and Poor's for downgrading the United States' credit rating to AA-plus from AAA, a move that over time could ripple through markets by pushing up borrowing costs and making it more difficult to secure a lasting recovery.

Washington's Asian allies rallied round the battered superpower, with Japan and South Korea both saying their trust in U.S. Treasuries remained unshaken.

"I expressed our country's position on the (G20 conference) call that there will be no sudden change in our reserve management policy," South Korean Deputy Finance Minister Choi Jong-ku told Reuters by telephone, referring to Seoul's heavy ownership of U.S. bonds out of more than $300 billion in foreign reserves.

"There's no alternative that provides such stability and liquidity," added Choi, who declined to elaborate further on the G20 discussion.

There was no confirmation of the timing of a G7 call for finance ministers and central bankers, but a second Japanese government source said it "would be normal" for it to take place before Asian markets opened. Tokyo's stock market, the biggest in Asia, starts trading at 9 a.m. (0000 GMT) on Monday.

EURO ZONE CRISIS

The most immediate concern for financial markets was the debt crisis in the euro zone, where yields on Italian and Spanish debt have soared to 14-year highs on political wrangling and doubts over the vigor of budget cuts.

Investors saw the ECB's failure to include Italy and Spain in a relaunch of its bond purchases late last week as a sign of the depth of political divisions over the role of the euro zone currency.

German officials want to see stiffer austerity programs in place before the ECB would shoulder more Italian and Spanish debt.

The danger is that further pressure on Italian and Spanish bonds could undermine an already damaged European banking system and lock Italy, the world's eighth largest economy, out of the market.

Indeed, doubts are growing in the German government that Italy could be rescued by the European emergency fund, even if the fund were tripled in size, according to the German news magazine Der Spiegel.

The financial needs of the country are so huge that it would overwhelm resources, according to government experts, Der Spiegel said in its online edition. Italy's public debt is about 1.8 trillion euros, or 120 percent of its national output.

Italy's Prime Minister Silvio Berlusconi, his government weakened by infighting, ruled out early elections to stem market panic. "This has never been an option," Berlusconi said.

Instead he has pledged to bring forward austerity measures and balance the budget by 2013, a year ahead of schedule -- steps the ECB will consider to gauge whether to buy its bonds.

Germany has consistently said troubled euro-zone governments should focus on spending cuts and internal reforms, not bailouts. The European Financial Stability Fund currently has 440 billion euros and was designed to help small to medium-sized countries, although the spreading of the debt crisis to Italy and Spain has led to calls for its expansion.

ACRIMONY OVER S&P

Defending its downgrade of the U.S. credit rating, S&P cited the acrimonious debate in Washington on raising the debt ceiling and near political paralysis over the best way to reduce the country's $14.3 trillion debt, which on the current trajectory could climb above 100 percent of national output this decade.

The U.S. Treasury said the rating agency's debt calculations were wrong by some $2 trillion. [ID:nN1E774236]

S&P has confirmed it changed its economic assumptions after discussion with the Treasury Department but said that did not affect its decision to downgrade, a decision slammed by President Barack Obama's National Economic Council head Gene Sperling.

"It smacked of an institution starting with a conclusion and shaping any argument to fit," Sperling said in a statement.[ID:nN1E77508R]

Obama called on lawmakers once again on Saturday to set aside partisan politics and work together and to put the nation's fiscal house in order and stimulate the stagnant economy. [ID:nN1E77503Z]

S&P's one-notch downgrade of the U.S. sovereign credit, while not totally unexpected, adds another level of uncertainty.

Loss of gold-plated status for the world's benchmark interest rate risks pushing up borrowing costs on everything from car loans, mortgages and corporate debt to government bonds worldwide.

"However justified, S&P couldn't have picked a worse time to downgrade the U.S.," said Rabobank in a note to clients.

Mark Mobius, executive chairman of Templeton Emerging Markets group, predicted further volatility in markets, and said emerging market currencies and stocks could become safe havens.

"During the sub-prime crisis safety was in U.S. dollars and U.S. Treasuries. Now that anchor to the global community is deteriorating," said Mobius, whose unit oversees $50 billion in emerging market assets, in an email to Reuters.

DEBT ADDICTION

China, the largest foreign holder of U.S. debt, took the world's economic superpower to task for allowing its fiscal house to get into such disarray.

"The U.S. government has to come to terms with the painful fact that the good old days when it could just borrow its way out of messes of its own making are finally gone," China's official Xinhua news agency said in a commentary that scorned America for its "debt addiction."

On Sunday, a commentary in the People's Daily, the main newspaper of the ruling Communist Party, said Asian exporters, who depend on demand from the United States, could be among the biggest victims of the mounting U.S. economic woes.

"The lowering of the United States' long-term sovereign credit rating has sounded a warning bell for the international currency system dominated by the U.S. dollar," said economist Sun Lijian, writing in the paper.

China and Japan have called for coordinated action to avert a new worldwide financial crisis.

(Additional reporting by Paul Taylor in Paris, Laura McInnis in Washington and Reuters bureaux worldwide; Writing by Stella Dawson and Alex Richardson; Editing by Dean Yates)