Paulson: Markets calmer but not fully settled

WASHINGTON (Reuters) - Treasury Secretary Henry Paulson said on Friday that markets have calmed down to the point where prices will be driven by economic factors including an improving housing market rather than by fear.

"The markets are considerably calmer now than they were in March," Paulson told regional business leaders. "Looking forward, I expect that financial markets will be driven less by the recent turmoil and more by broader economic conditions and, specifically, by the recovery of the housing market."

He repeated that he thought the period of market turmoil was nearer an end than a beginning but warned that home foreclosures will remain high while a correction that includes falling house prices continues.

"We should not expect to work through this process quickly and we should expect some bumps in the road," Paulson said, though he forecast the economy will be growing more rapidly by the end of the year than it is now.

He said a Treasury-sponsored alliance of home mortgage lenders called Hope Now has made "enormous progress" in helping holders of subprime mortgages, those made to less credit-worthy borrowers, modify their terms to avoid foreclosure.

MORE PAIN AHEAD

Still, he cautioned a housing correction that began in 2006 will take time to resolve because past underwriting standards for loans were so sloppy that inventories of homes are bloated and it will take time for normal activity to resume.

"There were years of excesses," Paulson said. "And this won't be resolved quickly."

Like Federal reserve Chairman Ben Bernanke did a day earlier, Paulson said that lenders who suffered losses as a result of the housing crisis should actively raise capital so that they can continue making credit available.

Major banks have reported upward of $200 billion in writedowns so far on mortgages, though some of that money could be recouped if the value of assets underlying them recovers.

Paulson described the housing downturn as the biggest single risk for the U.S. economy and urged Congress to move ahead with naming a strong regulator for mortgage lending giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N).

CONFIDENCE AN ISSUE

"Together, they touch 80 percent of all current mortgage originations and a regulator on par with other financial regulators will bring confidence to all mortgage market participants," Paulson said.

Citing signs of market progress, Paulson said that liquidity and investor confidence were "gradually improving, not across the board, but in several sectors including corporate bonds, leveraged loans and high yield debt."

In response to questions, Paulson repeated his backing for a strong U.S. dollar as well as his faith in the durability of the U.S. economy.

"Our economy, like any other, has got some ups and downs. But ... our long-term fundamentals compare very favorably with any nation around the world. And I believe those long-term fundamentals are going to be reflected in the value of our currency," he said.

(Additional reporting by Alister Bull and David Lawder; Editing by James Dalgleish)