2009-09-24 17:02:43.334 GMT

By Mike Dorning
    Sept. 24 (Bloomberg) -- Former Federal Reserve Chairman
Paul Volcker criticized the Obama administration’s plan to
subject “systemically important” financial firms to more
stringent regulation by the Fed.
    Volcker told lawmakers today that such a designation would
imply government readiness to support the firms in a crisis,
encouraging even more risky behavior in a phenomenon known as
“moral hazard.”
    “Whether they say it or not, that carries the connotation
in the market that they’re too big to fail,” Volcker, who is
chairman of the White House Economic Recovery Advisory Board,
said in testimony to the House Financial Services Committee.
    Volcker, 82, testified as the House panel begins its
consideration of the administration’s proposed regulatory
overhaul, which is intended to curb some of the practices
blamed for sparking the worst financial crisis since the Great
Depression. He appeared one day after Treasury Secretary
Timothy Geithner came before the committee to make the case for
the Obama plan.
    “The danger is the spread of moral hazard could make the
next crisis much bigger,” said Volcker, who serves as an
outside economic adviser to Obama. Volcker has criticized key
elements of the Obama administration regulatory plan in recent
public statements, and his remarks today largely reprised those
criticisms.

                       Stricter Controls

    Volcker also called for stricter controls on commercial
banks and bank holding companies than the Obama administration
has proposed, saying they should be barred from owning or
sponsoring hedge funds and private equity funds and forbidden
to engage in proprietary trading.
    He also criticized an administration proposal to create a
council of regulatory agencies that would be headed by the
Treasury Department. Instead, he called on lawmakers to give
the central bank more authority to oversee the financial
system.
    “It’s a natural function for the Federal Reserve,”
Volcker said. “There’s no doubt when you get into trouble,
when anybody in the financial market gets into trouble, they
run to the Federal Reserve.”
    Volcker said the Fed should coordinate the activities of
U.S. agencies that regulate financial institutions. He said the
president should nominate a second Fed vice chairman
responsible for financial regulation and supervision in order
to “pinpoint responsibility” for those activities.

                         Too Much Power

    The Obama administration plan has also drawn criticism
from lawmakers including Senate Banking Chairman Christopher
Dodd, Democrat of Connecticut, who have argued that the White
House would give the Fed too much power. Instead, Dodd and
other members of Congress are leaning toward vesting authority
over big banks in the council of regulators that Volcker
opposes.
    Before questioning Volcker, Rep. Mel Watt, a Democrat of
North Carolina, offered a nod to the influence of the former
Fed chairman, who led the central bank from 1979 to 1987. Under
Volcker, the Fed raised its benchmark interest rate as high as
20 percent in 1980 to throttle inflation.
    “There seem to be two financial gurus,” Watt said, after
naming former Fed Chairman Alan Greenspan. “You are the other
one.”

For Related News and Information:
On Paul Volcker: Paul Volcker <HELP>
On finance and government: TNI FIN GOV <GO>
Fed balance-sheet figures: ALLX FARW <GO>
Government relief programs: GGRP <GO>
Fed monetary policy: FOMC <GO>

--Editors: Christopher Wellisz, Carlos Torres