Resetting risk gauge to take time: Treasury's Steel

By Kevin Drawbaugh

WASHINGTON (Reuters) - Years of misjudgment on the risks of complex new financial instruments and how they are interconnected lie at the heart of the global credit crunch, a senior Treasury official said on Thursday.

When times were flush on Wall Street, "people miscalculated in multiple places the estimate of the riskiness of the structured finance business," said Treasury Undersecretary for Domestic Finance Robert Steel at the Reuters Housing Summit.

"You can pull that thread into rating agencies. You can pull that thread and go onto the banks' balance sheets. You can pull that thread into lots of places, but it's the same thread," said Steel, a former Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) executive.

In remarks that underscored the Bush administration's faith in the power of markets to self-correct, Steel said Treasury is confident in its present policy responses to severe problems in housing finance and is always assessing other possible steps.

At the same time, he emphasized the complexity of the bad bets that are now unraveling across capital markets.

"People say risk is being repriced. OK, that's that. Turn the page. But it's not good enough. There's market risk. There is liquidity risk. There's volatility risk. There's counter-party risk and there's refinancing risk," he said.

When economic growth was surging amid strong investor returns, profits and home prices, risk was not only under-appreciated, it was vigorously pursued, he said.

At Treasury, he said, government must now try to map the next problems from the market's under-estimation of risk and the linkages among new instruments backed by mortgages, credit cards, student loans, auto loans and other assets.

"What should we do, if we should do anything? If we shouldn't do anything, what are the likely ways in which it will unfold so that we can prepare?" he said.

"What we've tried to say from the beginning of last summer is that the repricing of risk will take time. It will work through."

(For summit blog: summitnotebook.reuters.com/)

(For more on the Reuters Housing Summit, see ID:nN11312603

(Reporting by Kevin Drawbaugh,editing by Leslie Gevirtz)