Paulson says market turmoil to last some time

By Mark Felsenthal

WASHINGTON (Reuters) - Treasury Secretary Henry Paulson said on Tuesday the global economy is strong and liquidity will return to normal in financial markets once investors re-price risk, but warned the adjustment will take time.

"Credit is being repriced, reassessed across our capital markets," Paulson told CNBC television.

"As the (Federal Reserve) addresses liquidity this makes it possible, this makes it easier, for the market to focus on risk and pricing risk," he said.

"This will play out over time and liquidity will return to normal when the market has a better understanding, investors have a better understanding, of the risk-return trade-off."

But Paulson warned the adjustment may take a while.

"Markets straighten themselves over time. This is going to take a while to play out," he said.

The Fed stepped in to calm markets on Friday, lowering the discount rate, the rate it charges banks for loans, by a half percentage point to 5.75 percent. Paulson said the Fed was helping settle markets.

"The Fed doing what they do, in easing, and addressing liquidity, makes it easier for the markets to focus on the risk, investors to focus on risk," he said.

Meanwhile, the Fed has held its benchmark overnight federal funds interest rate steady at 5.25 percent.

U.S. stocks fell when markets opened as traders saw Paulson warning of a drawn-out adjustment to credit market worries. Treasury securities were holding steady at higher levels.

The U.S. Treasury chief, a Wall Street veteran before he took over the Treasury portfolio last year, was scheduled to meet U.S. Senate Banking Committee Chairman Chris Dodd and Fed Chairman Ben Bernanke at mid-morning to discuss credit market conditions.

Paulson said strong economies in the United States and around the world will help buffer against shocks from a credit crisis that began with a wave of delinquencies in subprime mortgages, which are extended to high-risk borrowers.

"We have the benefit of having a very strong economy to absorb some of the losses along the way," he said.

However, turmoil in capital markets will likely take a toll on economic growth, Paulson said.

"Economic growth will be less than it ordinarily would have been," he said.