WASHINGTON — Although a semblance of calm has returned to financial markets, Treasury Secretary Henry Paulson warned Tuesday that the turmoil is far from over and there are no quick fixes as the financial sector corrects from a period of excesses.
"This is something which, in my judgment, will take a while to work through," Paulson said during breakfast with a small group of journalists. "There have been improvements in certain markets, but there's still a lot of focus on a number of the complex products."
Credit-market turbulence and the housing slowdown are hurting U.S. economic growth, the treasury secretary acknowledged. But he said he didn't believe that recession lurks around the corner.
"It is very much our view that the economy is strong enough to keep growing despite these two penalties," Paulson said.
Most of Paulson's energy these days is spent on the commercial paper market, a complex and vital component of global finance that's been on the verge of "seizing up," or failing to function for lack of sufficient buyers and sellers.
Commercial paper is short-term debt issued by corporations, generally for 30 days, to generate working capital. Think of it as a type of bond or IOU. Outstanding commercial paper in the United States totals more than $2 trillion. To buy this paper, investors are demanding the highest rate of return in six years, 6.33 percent over 30 days.
More than $120 billion in U.S. and European commercial paper matures in the next week alone, meaning that borrowers could demand to be repaid in full for those loans. It's crucial to the global economy that investors roll over their loans instead — that they continue collecting interest on them rather than cashing them out.
One segment of the commercial paper market, called asset-backed commercial paper, is causing most of the problems. This debt is issued by big banks, which use the revenue to make other investments. This type of commercial paper uses as collateral mortgages, car loans and other loans that are bundled together and sold to investors as bonds.
Commercial paper traditionally has been considered a safe investment, and investors generally roll it over to earn compounding interest. But the bundled loans — sold through complex financial entities called "conduits" and "structured investment vehicles" — are viewed as risky now because they're kept off banks' balance sheets. They aren't subject to regulatory scrutiny the way that conventional stocks and bonds are.
Such a lack of transparency, in these investments and others, is at the heart of Wall Street's turmoil. Investors are fleeing virtually all instruments that lack transparency in how they're valued or who's holding how many of them.
Paulson, a former chairman of the investment bank Goldman, Sachs & Co., said he'd been working the phones daily, trying to ensure that big institutional investors continue rolling over their investments in commercial paper. If they don't, it would be the equivalent of depositors withdrawing money from a bank en masse. Credit markets could seize up, which could hurt broader economic activity.
It's a hard sell, he acknowledged.
"Investors, at a time like this, when they are risk-averse, some of them don't want to read a 300-page document describing a security," Paulson said, confirming a lost sense of trust on Wall Street about the more complex investment vehicles. "When they feel comfortable that they understand the products, the confidence will return. I think we need to expect this period of turbulence to go on for a while."
