The US Treasury Secretary gave warning today that there is more pain ahead in the American housing market after he said prices must be allowed to drop before the economy can stabilise.

Henry Paulson’s remarks to the US Chamber of Commerce sent the Dow Jones industrial average plunging by 130 points to 12,402, as investors forecast more months of turmoil ahead. It recovered a little to close down 109.74 at 12422.86.

Mr Paulson said that policymakers were aware it was a housing downturn that fuelled turmoil in the financial markets, and that a slowing housing market posed the biggest risk to the economy.

Mr Paulson acknowledged that the Government would step in to lessen the impact on the economy, but he was emphatic that the house price cycle must run its course.

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“A correction was inevitable, and the sooner we work through it, with a minimum of disorder, the sooner we will see home values stabilise, more buyers return to the housing market and housing will again contribute to economic growth.”

It emerged yesterday that house prices in 20 US cities had declined by 10.7 per cent in the 12 months to January — the worst fall in more than 20 years.

This month US consumer confidence fell to a five-year low.

Mr Paulson also said that regulation governing commercial and investment banks needed to be re-examined and strengthened, after the collapse of Bear Stearns, the Wall Street bank.

He said: “This latest episode has highlighted that the world has changed, as has the role of other non-bank financial institutions and the interconnectedness among all financial institutions.”

Mr Paulson added: “These changes require us all to think more broadly about the regulatory and supervisory framework that is consistent with the promotion and maintenance of financial stability.”

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