UPDATE 2-US bank group says new products helped fuel crisis

(Recasts lead, adds comments, details)

By Pedro da Costa and Tamawa Kadoya

NEW YORK Aug 6 (Reuters) - Complex financial products like mortgage-backed bonds promoted risky behavior that helped trigger the worst credit crisis in the post-war period, an industry advisory group said on Wednesday.

The new financial products require closer scrutiny from both executives and policy-makers, according to the advisory group, which was headed by Gerald Corrigan, a Goldman Sachs managing director and a former head of the New York Federal Reserve Bank.

Over the past two decades, mortgages and other as sets were repackaged as bonds and sold on the secondary market, a trend that analyst say severed the relationship between lender and borrower.

"The cost of the credit crisis in economic, financial and human terms has already reached staggering proportions and, even after 12 months substantial vulnerabilities remain," according to the report, which emerged in part as a response to the President's Working Group on Financial Markets.

"It is likely that flaws in the design and workings of the systems of incentives within the financial sector have inadvertently produced patterns of behavior and allocations of resources that are not always consistent with the basic goal of financial stability."

Corrigan offered detailed recommendations for reducing the risks that have been made bare by the credit crunch. These included wider adoption of electronic platforms for derivatives trades, and more frequent revisions of financial firms' exposure to risky assets.

Firms should also take steps clarifying the closing out of credit default swaps contracts after a default and set up a central clearinghouse for over-the-counter derivatives, particularly for the CDS sector, the group said.

A separate group of major Wall Street firms told the New York Federal Reserve last week that it will set up a central clearinghouse to process OTC credit derivatives by year-end.

BUBBLE-SPOTTING

The group also indicated central banks should continue to play an active role in mitigating pernicious practices and supervising financial institutions, particularly because of their involvement in the daily operations of financial markets.

Corrigan said the crisis made it more likely that the guidelines detailed in his commission's report would get a fair hearing on Wall Street.

"Five hundred billion dollars in write-downs gets people's attention," he said. "And the meter is still running."

The report noted that policy officials have begun to rethink the prevailing view that asset price bubbles are too difficult to spot in advance, and therefore should remain outside the purview of central banks until they pop.

"Public authorities, particularly central banks, are also reconsidering whether monetary authorities might be able -- at the margin -- to better anticipate asset price bubbles and respond with at least a 'tilt' toward a more restrictive monetary policy," the group said. (Editing by Leslie Adler)