Paulson cites progress in calming markets

By Glenn Somerville and David Lawder

WASHINGTON (Reuters) - Treasury Secretary Henry Paulson cited encouraging signs of progress in calming financial markets, which he said made it possible to turn more attention to measures aimed at stimulating a slowing economy.

"I'm not going to make projections in terms of when we'll be through this period because there are a number of markets that aren't functioning as normal," Paulson said in an interview with Reuters News on Thursday.

"But in my judgment, we're making progress in working our way through this and I think the issue is now increasingly about the economy," he added, noting he saw signs that astute investors were coming back into markets to buy leveraged loans and mortgages at discounts.

"That's why a big part of our focus is getting the stimulus checks out, having the financial institutions raise the capital they need to raise and doing everything we can to avoid preventable (housing) foreclosures while not impeding this necessary correction," Paulson said.

"The faster we get this behind us, the faster housing is going to be once again contributing to growth," he added.

Paulson said the Treasury was accelerating its schedule for distribution of tax rebate checks under a $152 billion economic stimulus package, sending out the first payments on Monday instead of in early May.

Payments totaling more than $100 billion should be mostly in consumers' pockets by the end of June, he said.

Financial markets have been in turmoil since last August, when rising delinquencies in subprime mortgages caused credit markets to seize up, triggering losses among holdings of complex and illiquid mortgage-backed securities. Billionaire investor George Soros recently said such losses could top $1 trillion.

Paulson said he wants to guard as much as possible against having market disruptions spill over into the broader economy.

"There's no doubt that it's slowed significantly," he acknowledged. "The last quarter was a tough quarter. This quarter is a tough quarter. We have some head winds from oil prices."

He acknowledged that fuel costs have hurt the American consumer, but downplayed the link between a weaker dollar and higher crude prices, saying the cost increases were due to higher demand from developing countries and tight global supplies that would likely continue for some time.

"The cost in every currency has gone up significantly," he said, repeating his mantra that a strong dollar remains in the United States' interest.

Paulson said he was willing to talk with House Speaker Nancy Pelosi about her ideas for new legislation to aid the U.S. economy in connection with setting up a vote on the Colombia Free Trade agreement. On the housing side, he said he was supportive of parts of a Democratic plan to expand Federal Housing Administration insurance.

RETHINKING RISK

The housing downturn and fallout from financial market turmoil remain the biggest risks to the economy, Paulson said, but on balance, he sounded more optimistic about market conditions after a series of actions by U.S. and international authorities to pump in liquidity to keep credit markets from seizing up.

"You can point to plenty of signs that say the markets aren't functioning as normal, but I see progress," Paulson said. "And I think the progress has been driven by, first of all, time, and markets making progress at reassessing risk."

He said the Federal Reserve's actions in making available more than $400 billion of liquidity as well as opening its discount lending window to investment banks, for the first time since the 1930s, "made a very strong statement on how important stable and orderly financial markets were."

Paulson also cited the Bank of England's announcement this week that it was setting up a special facility to swap risky bank assets for government debt as a significant step in getting financial markets back in order.

"I look at just a whole series of capital raisings around the world and asset sales that I view as a healthy sign," he said, because it means that financial institutions are bolstering their ability to keep lending rather than preparing to shrink their balance sheets.

Regarding the thorny problem of valuing illiquid, opaque mortgage-backed securities held by banks and hedge funds, he said that was best left to the markets to sort out on their own. Treasury tried last year to set up a private-sector fund to buy up distressed assets, but the idea failed to catch on.

"I think that the markets provide benchmarks for valuations. I'm not saying that there aren't some things we (the Treasury) can do, but basically, there are plenty of smart investors out there. And when they think the time is right to come in and buy some things, they will," Paulson said.

(Reporting by Glenn Somerville and David Lawder; Editing by Andrea Ricci)