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Anxiety shakes global markets

Officials trying to allay fears over US credit, European debt crisis

Tourists in New York were driven past Standard & Poor’s, which lowered the US credit rating to AA+. S&P cited the nation’s insufficient commitment to reducing budget deficits. Tourists in New York were driven past Standard & Poor’s, which lowered the US credit rating to AA+. S&P cited the nation’s insufficient commitment to reducing budget deficits. (Karly Domb Sadof/ Associated Press)
By Megan Woolhouse
Globe Staff / August 8, 2011

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Government leaders around the world scrambled yesterday to head off a spreading European debt crisis that, paired with last week’s unprecedented downgrade of the US credit rating, threatened already wavering investor confidence and global financial stability.

Anxiety about the US and international economies intensified over the weekend after rating agency Standard & Poor’s on Friday night lowered the US credit rating to AA+ from AAA, heightening concerns about the nation’s mountainous debt and political inability to control it.

US stock futures fell sharply in Asian trading, an indication of another sell-off when US markets open this morning. Japan’s Nikkei 225 stock average was down 1.3 percent in midday trading, adding to last week’s 5.4 percent slump, the worst since the March 11 earthquake. Australia’s S&P/ASX 200 index slid 1.8 percent, South Korea’s Kospi index dropped 2.9 percent, and Hong Kong’s Hang Seng index tumbled nearly 4 percent.

Alan Greenspan, former Federal Reserve chairman, said yesterday that he did not think global fears would force the US economy into another recession, but predicted stocks would continue their decline, despite statements by an S&P official that the drop in credit rating would have little impact.

“Considering the momentum in which the market went down over the last week, it is very unlikely, if history is any guide, that this isn’t going to take a while to bottom out,’’ Greenspan said on NBC’s “Meet the Press.’’ “So the initial reaction in my judgment is going to be negative.’’

Financial markets around the world were hit by panic selling last week over concerns about a stalling US economy and European debt. The European Central Bank’s governing council signaled yesterday that it would buy Spanish and Italian government bonds, as a way to drive down borrowing rates that otherwise might rise rapidly and drive them into default.

Finance ministers and central bankers from the Group of Seven, an organization of leading industrialized nations, including the United States, held hastily arranged conference calls yesterday and issued a statement pledging to take “all necessary measures to support financial stability and growth’’ in an effort to bolster confidence.

Nigel Gault, IHS Global Insight chief US economist, said yesterday that the European Central Bank’s decision was a positive development, helping to tamp down the possibility of a global financial meltdown. The danger is the result of European government debt held by European banks, which conduct business with banks around the world. If governments default, the impact could cascade through the financial system.

“If European banks are in trouble, then US banks who have dealings with those banks are also threatened,’’ Gault said. “You have the potential for a Lehman Brothers-type ripple effect through the financial markets. It’s the stability of the global banking system that’s at stake with the shock emanating from Europe, whereas last time it emanated from the US.’’

He added that a failure to make debt progress in Europe could force the US economy to tumble back into a recession.

Several economists said Friday’s S&P downgrade is a stark reminder of the longer-term economic challenges facing the United States because of its dangerously high debt levels and Washington’s inability to curtail that debt.

S&P cited the nation’s insufficient commitment to reducing budget deficits and stabilizing the debt burden. S&P kept its outlook at “negative,’’ saying the rating may be cut to AA within two years if further spending reductions under debate in Congress are lower than agreed to.

Kenneth Rogoff, a Harvard economics professor and specialist on financial crises and their aftermaths, said the impact of a downgrade is difficult to gauge at such a volatile and emotional juncture, but debt problems seem likely to make investors in Treasury bonds uneasy in the future, which could lead to costly increases in interest rates.

Once the current crisis passes, “we’ll probably end up having a slightly higher interest rate,’’ Rogoff said. “I don’t think anyone needed to tell us that the debt debate debacle was a disaster, but we’re being told.’’

Rogoff said even a one-tenth of a percentage point increase in interest rates would cost the government an extra $15 billion; a full percentage point increase would cost $150 billion.

“When Treasury bill rates go up, it affects all the interest rates in the economy,’’ Rogoff said, “but at the moment this is still a warning shot.’’

Standard & Poor’s went further than Moody’s Investors Service and Fitch Ratings, which affirmed their AAA credit ratings for the United States. Moody’s and Fitch have said downgrades are possible if lawmakers fail to enact debt reduction measures and the economy weakens.

Still, investors seeking a safe haven from stocks and other riskier investments have bought Treasury bonds in recent weeks, despite warnings by Standard & Poor’s that it might lower the US rating. Before the agency announced its decision, yields on benchmark 10-year notes closed at 2.58 percent Friday, down nearly a quarter-point from a week earlier.

The higher the demand for Treasury bonds, the lower the interest rate. Lawrence Summers, a Harvard economics professor and the former top economic adviser to President Obama, called the S&P downgrade “outrageous’’ on CNN’s “State of the Union,’’ saying families are going to be the long-run losers.

Billionaire Warren Buffett said in an interview Saturday on Bloomberg Television that the rating agency erred when it lowered the US rating and reiterated his view the economy will avoid a second recession in three years. The nation merits a “quadruple A’’ rating, Buffett said.

Standard & Poor’s, based in New York, gives 18 sovereign entities its top ranking, including Australia, Hong Kong, and the United Kingdom.

The US debt downgrade could pose another hurdle for state and local governments, increasing borrowing costs at a time of fiscal strain for them.

Fifteen states could lose their AAA rating, including Maryland, New Mexico, South Carolina, Tennessee, and Virginia, because of the US downgrade.

Massachusetts has an S&P rating of AA, two notches below AAA, because of its high debt burden. Scott Jordan, assistant secretary in the Executive Office for Administration & Finance, said there is no immediate indication Massachusetts could be hurt by the downgrade.

“We are doing a review,’’ he said. “The Commonwealth [will] review all its bond and investment transactions.’’

Material from Bloomberg News was included in this report. Megan Woolhouse can be reached at mwoolhouse@globe.com.