“Our economy is structurally sound [and] the long-term fundamentals are strong,” said U.S. Secretary of the Treasury Henry Paulson at the Arrillaga Alumni Center Friday evening. Paulson’s remarks came the same day Wall Street tanked to 2006 levels amid a sluggish February employment report that heightened fears of recession.

Paulson, who delivered the keynote address to the 2008 Stanford Institute for Economic Policy Research (SIEPR) Economic Summit, has recently avoided the claim that the U.S. economy is slipping into a recession, instead touting the Bush administration’s $152 billion stimulus package designed to resuscitate the economy. At the summit, Paulson acknowledged the economic difficulty of the times but spoke with optimism about U.S. policies.

“It is a rough time right now,” Paulson said. “[But] I can’t think of other countries that don’t have more problems than we do, so I like our chances.”

The treasury secretary’s evening address to an audience of California CEOs, businesspeople and University faculty nonetheless focused on policy solutions that the Treasury is applying to different sectors of the U.S. economy.

THE HOUSING MARKET

According to Paulson, a “good year” sees about 650,000 foreclosures on mortgages, while last year faced 1.5 million and this year’s estimates hover near 2 million. Paulson said the Bush administration’s approach to solving the mortgage crisis is two-pronged and resists Congressional proposals calling for deeper involvement from the government.

“Some in Washington are proposing big interventions,” he said. “Most of the proposals I've seen will do more harm than good. I still have no interest in bailing out investors, lenders and speculators.”

The first side of the approach relies on the stimulus package to create more jobs and bolster the economy so that fewer Americans suffer mortgage-threatening income loss. The package allows individuals to receive early tax rebate checks, which Paulson said would most likely be distributed fully by early July.

“We’re working very hard now to get the IRS ready so that they will begin getting the payments out to the American people as early as the first week of May,” he said.

Paulson said the focus of the administration’s efforts are those homeowners who cannot afford their mortgage payments but want to remain in their homes, not “speculators” who are able to make their payments but “choose to walk away” from them.

“As far as I’m concerned, homeowners who can afford their mortgage, whether they have positive or negative equity, have got an obligation to honor that mortgage,” Paulson said, “and a vast majority of them do.”

Although opposed to large intervention from Washington, Paulson said aiding homeowners who cannot pay their mortgages is a “shared responsibility” for both outside servicers and the government.

That governmental role lies not only in the stimulus package but also in the second side of the approach to solve the housing crisis – the Hope Now Alliance, created in October of last year as a cooperative effort between the government, counselors, investors and lenders to aid homeowners who have trouble paying their mortgages.

Servicers encouraged by the Treasury Department and the Department of Housing and Urban Development to form the alliance include, but are not limited to, Bank of America, Citigroup, JPMorgan Chase, Washington Mutual and Wells Fargo.

“The first effort is to get to those homeowners who are delinquent in their payments, having problems, and get them to talk to someone, to reach out,” Paulson said. “Before the program started, only two to three percent [of homeowners] were responding to servicers. Now it’s 20 percent. That’s a big improvement.”

Paulson said the Treasury’s policy is also geared toward subprime mortgage holders with adjustable rate mortgages who will face resets in their rates.

“What the industry agreed to was a way to fast-track the modifications and the refinancing so that we can avoid a market failure,” he said.

According to Paulson, more than a million homeowners, 683,000 of them with subprime mortgages, have received workouts, loan modifications or repayments since July that have allowed them to dodge foreclosure.

Much of the government’s role also lies in maintaining the alliance and ensuring no servicer is a free rider.

“I am going to keep tab on the result, insist that the industry make the results transparent and make sure we don’t have any free riders,” Paulson said, “[so] that every one of the servicers who signed up for this program is going to live up to the commitments that they have made.”

CAPITAL MARKETS

Paulson attributed the crisis in the capital markets to what he called a “sentiment swing” among financial investors and institutions.

“This time last year, we had investors feeling pretty confident, looking for risk, reaching for yield,” he said. “Now sentiment has swung back very, very hard toward risk aversion.”

Paulson said he believes the recent “onslaught of press articles” on economic debt has contributed to this aversion.

To counteract the shift in investor sentiment, Paulson told the audience that the Treasury’s focus is to encourage financial institutions to raise more capital and hence bolster lending power.

“Raising capital is critical here,” Paulson said. “If you’re a financial institution and you need capital or you think you might need capital, you go get it when it’s available. And if you don’t, you’re forced to shrink your balance sheet and cut back on your lending, and this hurts the real economy.”

“If you need capital, go raise capital and raise plenty of it,” Paulson said as advice to financial institutions.

The Treasury Secretary also said he advocated a “balanced” policy response from Washington to help contain the crisis.

“When you go through a period like this, your first priority is to get through this period with as little spillover as possible on the real economy,” he said. “It’s very important to come up with a policy response to reduce the likelihood that we go through a similar period or make similar mistakes in the future.”

Paulson also said the Treasury is working to revamp the U.S. regulatory system “in the relatively near future.”

“Our regulatory system is a good one, but it’s far from perfect,” he said. “It [has] built up over many years and it’s not designed to be the most effective and efficient for today’s world and today’s marketplace.”

ENTITLEMENT PROGRAMS

On programs such as Social Security, Medicare and Medicaid, Paulson said that taking time to reform deficiencies carries risks.

“We need to come up with a solution and I have no doubt we will, because we’re going to have to,” he said. “But the longer we wait, the less flexibility we have, the greater the cost and the burden, which will be borne by the younger generation.”

Paulson drew a difference between the difficulties with which the entitlement programs can be reformed, but said he is working to simplify the issues so that his successor – to be nominated by the next president – will have an easier task.

“Social security is analytically easy but politically difficult, and, of course, Medicare and Medicaid are analytically difficult and politically difficult,” Paulson said to laughter from the audience. “What I tried to do at Treasury is to do everything I could to depoliticize the issue, put out studies, continue to talk about it, to make it easier for those who come after me to deal with this issue.”

FOREIGN TRADE AND INVESTMENT

According to Paulson, the difficulty with reforming trade and investment is that both are highly political issues.

Still, Paulson said he works “hard on these issues every day” and is currently “trying to get some traction with the Colombia Free Trade Agreement.”

“[The agreement] is important not only in terms of economics and in terms of trade, but it’s a very important foreign policy issue, national defense issue, very important to stability in the region and our neighborhood,” Paulson said, “so it’s again something we’re very focused on.”

THE DOLLAR

Recently, the stress of the housing and capital crises has weakened the U.S. dollar, and interest rate cuts by the Federal Reserve have lowered its value against major currencies such as the euro and pound.

Responding to a question from the audience, Paulson stood by his established view that the dollar will regain strength from sound underpinnings of our economy.

“Our economy, like any other, has got its ups and downs,” Paulson said. “We’re facing some challenges right now, but the long-term fundamentals are strong and I’m confident they’ll be reflected in our currency market.”

The audience broke into laughter following the secretary’s standardized response, to which Paulson replied, “It’s funny, but not that funny.”