UPDATE 2-Credit market turmoil 'far from over'-US Treasury
(Recasts first paragraph; adds comments by committee chairman, SEC chief; background)
WASHINGTON, Sept 5 (Reuters) - A senior U.S. Treasury Department official on Wednesday warned that turmoil in credit and mortgage markets was "far from over" but said the economy has enough underlying vigor to avoid falling into recession.
Robert Steel, the undersecretary for domestic finance, said some financial market participants will be hurt and urged Federal Reserve and other policy-makers to be on guard in case they need to take more action to protect the broader economy.
Steel was one of a series of regulators and Bush administration officials called before the House Financial Services Committee to explain why a crisis originating from risky loans to less creditworthy buyers happened and what was being done to bring it under control.
"I do want to caution policy makers that this process is far from over," Steel said. "It will take more time to play out and certain segments of the capital markets are stressed."
Mortgage defaults are soaring and credit markets have come close to seizing up as lenders grow reluctant to lend amid uncertainty about who holds the biggest portfolios of risky mortgages, which were packaged into securities, given investment-grade ratings by agencies, and sold around the world.
One of the nation's chief banking regulators reassured the committee that they were well poised to weather the current financial market crisis.
"The national banking system remains safe and sound," said John Dugan, Comptroller of the Currency, though be conceded that liquidity in asset-backed commercial paper that is used by businesses for day-to-day financing was tight.
The question of whether regulators had adequately supervised the lending activities of banks, and the agencies that assign ratings to the subprime mortgage-backed securities was a central issue for the committee.
The Securities and Exchange Commission's market regulation director, Erik Sirri, said it was launching a review into ratings of residential mortgage-backed securities and to so-called collateralized debt obligations, which would include an assessment on whether ratings held up after the securities were in the hands of investors.
One frequently heard complaint is that ratings agencies were too willing to assign investment-grade ratings to such securities without adequately disclosing risks that they could go bad if homeowners defaulted on their monthly payments.
Committee Chairman Barney Frank said the situation has led to a loss of confidence that regulators and policy-makers must face up to or face even worse consequences for the economy.
"What we have is a severe lack of investor confidence," said Frank, who also lashed out at the Fed for spurning an invitation to testify at Wednesday's hearing. He suggested the Fed was fearful of tipping its hand about what it may decide on interest rates at an upcoming Sept. 18 policy session, when many analysts think it will cut the federal funds rate.
Steel said policy-makers "must remain vigilant as further stress could create further challenges and continued volatility," but noted the Fed had taken steps to boost liquidity within financial markets.
"Like the Federal Reserve, the Treasury Department shares the perspective that recent market developments pose downside risks to economic growth," Steel said.
"However, the economy was in strong condition going into the recent period of volatility, and while certain sectors like housing are undergoing a transition, overall economic fundamentals remain solid," he said.
"While recent difficulties in the subprime market are having and will continue to have a profound effect for many families, the underlying strength of the economy should allow for continued growth," Steel said.
He said the President's Working Group on Financial Markets -- an inter-agency group headed by Treasury Secretary Henry Paulson -- will examine the role of rating agencies and of the securitization of subprime mortgagees in credit and mortgage markets. (Additional reporting by John Poirier and Patrick Rucker)
