Treasury's Paulson plays down market volatility

WASHINGTON (Reuters) - U.S. Treasury Secretary Henry Paulson said the drop in global stock markets on Thursday was a case of volatility in financial markets that is always present.

"We're always going to have volatility," Paulson told Bloomberg Television. "What we see going on right now is risk being repriced and as we get a broad reassessment of risk we're getting volatility."

Global stock markets fell sharply on Thursday as investors fled risky assets for safe havens while tightening credit markets threatened to make it increasingly difficult to finance corporate deals, and the dollar fell sharply against the yen.

Paulson said the U.S. economy was healthy and global expansion was strong and said that was comforting but suggested it also had led investors to be less cautious.

A flight-to-quality rally in U.S. bonds slammed the yield on the benchmark 10-year note to a two-month low of 4.80 percent. Bond prices and yields move inversely.

U.S. crude oil futures jumped in the morning but reversed course to settle down 1.2 percent at $74.95 a barrel.

By mid-afternoon, the dollar was down 1.4 percent at 118.75 yen. The dollar was also lower against the euro.

European stocks suffered their biggest daily loss in five months, with the pan-European FTSEurofirst 300 index down 2.8 percent. The fall was tied to concerns about corporate financing and persistent U.S. housing sector problems.

In Tokyo, the Nikkei stock index fell 0.88 percent to its lowest close in nearly two months on disappointment over earnings and caution ahead of Sunday's parliamentary election.

"What I've been saying for some time now is whenever we have extended period of good markets, a benign economic situation, there's a tendency for laxness and you can see excesses," Paulson said, adding:

"I do believe this is a wake-up call that says lenders need to be very careful when they price risks, when they structure securities. ... I would like to see more discipline on the part of both lenders and borrowers."

In response to questions, he said the United States was experiencing "a very major correction" in the housing sector that will take a while to work out and it will take even more time to settle problems in subprime markets that cater to less creditworthy borrowers.

"We've repeatedly said that this is going to be very troubling for a number of individual homeowners, there's no doubt about that. But again, I believe this is going to be largely contained, I don't think it poses a serious risk to the overall economy because we have a diverse, healthy economy."

As Treasury Secretary, Paulson chairs the inter-agency President's Working Group on Financial Markets that monitors market conditions. There was no indication it had met on Thursday but Paulson, a Wall Street veteran, turned aside a question whether he feared a "credit crunch" might develop.

"It's my job to be vigilant," he said. "I even hesitate to make this statement now because I've made it since the day I came here and I've made it when the markets looked very good and I've made it during times of volatility but I will say that (on) global financial shocks, it's very hard to predict them, it's very difficult to look ahead and say what will cause a global financial shock."

Wall Street's main gauge of investor anxiety, the Chicago Board Options Exchange's volatility index, or VIX, surged 21 percent to 21.95, its highest since June 13, 2006.

"I am comforted by the fact that we have a strong global economy and very healthy economy in the U.S. but it's my job to be vigilant," Paulson said.

"What we're seeing now is some market volatility. We've had volatility as long as I've watched the markets," he added.

Paulson leaves on the weekend for Beijing to meet top Chinese government officials to press them to speed up economic reforms including letting the yuan currency rise in value.

He said he wanted to counter "a spirit of protectionism around the world" by persuading China it was in everyone' interest to help the global economy become more balanced.

He suggested Congressional anger at China because of what U.S. manufacturers consider an unfair advantage gained from a cheap currency, which is driving bids to develop legislation that could impose tariffs on Chinese imports, was misdirected and unlikely to persuade Beijing to speed up currency reform.

"I believe the right way to deal with it is with the way we're dealing with it: through direct, aggressive engagement."

Paulson is credited with being one of the most knowledgeable U.S. officials on China, having made scores of trips there while he headed investment bank Goldman Sachs.