Wall Street was braced for a grim week as the U.S. government’s downgraded credit rating and Europe’s worsening debt crisis fueled fears of a repeat of the 2008 financial-system meltdown.
Policymakers of the Group of 7 industrialized nations sought to head off another panic, pledging Sunday to “take all necessary measures to support financial stability and growth.”
The European Central Bank announced Sunday that it would jump into the markets to buy euro-zone government bonds, hoping to stave off selling Monday by frightened investors.
Treasury Secretary Timothy F. Geithner, who had been rumored to be getting ready to leave the Obama administration, assured the White House that he would stay on to help guide economic policy.
But markets were dubious about how much more governments and central banks could do, after nearly three years of attempts to buttress the global economy against another downturn.
Stock markets fell sharply in Asia early Monday, while gold, a classic place to hide in times of turmoil, soared to a record high, nearing $1,700 an ounce.
“There is too much that feels reminiscent of 2008,” said economist Diane Swonk at Mesirow Financial in Chicago.
Investors dumped stocks worldwide last week and poured cash into insured bank accounts, unnerved by increasing signs that the global economic recovery was fading.
In Europe, worries mounted that debt-hobbled Spain and Italy could follow Greece, Ireland and Portugal in seeking bailouts from the rest of the European Union — raising the risk of a new banking crisis on the continent.
The Dow Jones industrial average plunged 512 points, or 4.3%, on Thursday, its biggest one-day drop since the depths of the recession in early 2009. The Dow sank 5.8% for the week, ending at 11,444, its lowest level since December.
Late Friday, credit rating firm Standard & Poor’s stunned Washington by downgrading the U.S. government’s debt rating to AA+ from AAA — the first time in history that America has lost its top-rung rating. S&P cited concerns about the nation’s growing debt load and uncertainty about Congress’ willingness to rein in borrowing.
The downgrade sowed more confusion in the markets by tarnishing the image of Treasury securities, which typically serve as an investment of first resort when money is seeking relative safety. The ratings cut raised the possibility that investors could flee Treasuries, driving up interest rates and posing another threat to the faltering economy.
China, which owns $1.2 trillion in U.S. bonds, called on the U.S. to “cure its addiction to debts” and “learn to live within its means” in a commentary published Saturday by the official New China News Agency.
Yet many analysts said they doubted that money would pour out of Treasury bonds, if only because the world has few other options as a haven.
U.S. bonds “will continue to serve their traditional role as a hedge” against riskier assets, money management giant BlackRock Inc. in New York said in a statement Sunday. There are “few genuine alternatives,” it said.
The firm, with $3.65 trillion in assets, said that although “a time may come when the credit risk-free status of Treasury bonds is diminished ... we do not believe that the S&P downgrade signals that this moment has come now.”
Interest rates on U.S. Treasury bonds were little changed in early Asian trading Monday, easing concerns about possible heavy selling by foreign investors.
In Washington, politicians continued to squabble on Sunday talk shows over who was at fault for the collapse of a “grand bargain” of long-term spending cuts and revenue increases that could have staved off the S&P downgrade.
Meanwhile, European authorities tried to forestall another sell-off in euro-zone governments’ bonds.
The European Central Bank issued a statement saying it would “actively implement” its bond-buying program to deal with “dysfunctional market segments.”
The move had been expected after investors continued to dump Italian and Spanish government bonds last week, driving market yields up and threatening a replay of what has happened to Greece, Ireland and Portugal over the last 15 months.
Rising bond yields could make it too expensive for Italy and Spain to borrow, thereby risking that they, too, would need bailouts from the European Union.
Because Italy’s bond market is the world’s third-largest, after the U.S.’ and Japan’s, the prospect of investors continuing to exit that market has sent chills through the global financial system in recent weeks.
With the European debt crisis entering a dangerous new phase, “the bottom-line question now is whether Europe itself is solvent,” said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Conn.
By rushing to buy euro-zone bonds, the ECB is following the example of the U.S. Federal Reserve, which in June completed its second massive purchase of Treasury bonds. The Fed, which now holds $1.6 trillion in U.S. debt, bought the securities in the hope of pushing down longer-term interest rates and bolstering the economy.
The strategy worked on interest rates, but U.S. economic growth still faded drastically in the first half of this year.
“It’s not at all evident that the Fed accomplished much,” Stanley said.
Fed policymakers will hold their midsummer meeting Tuesday. If markets plunge Monday, Fed Chairman Ben S. Bernanke is expected to try to boost confidence by pledging more help for the economy. But it isn’t clear what else the Fed can do.
Any steps would be “tinkering around the edges,” Stanley said. One possibility is that the Fed could commit to holding its key short-term interest rate near zero for a specific time frame, instead of for an “extended period,” the language policymakers have used since the recession ended.
That may not be enough to stop sliding stock prices if investors continue to lose faith that the global economy can sustain its recovery.
Many analysts say the U.S. still isn’t in danger of falling into recession. On Friday, the government reported that the economy created a net 117,000 jobs in July, a weak figure but better than what most economists had expected.
The fear is that a continuing sell-off in stocks could deepen worries about the economy by causing businesses and consumers to cut back on spending. That raises the risk of a vicious negative feedback loop, as falling markets and a weaker economy feed off each other.
For policymakers, “this is your worst nightmare,” Swonk said.