NY Fed's Sack: Financial reforms must be cohesive

NEW YORK, March 26 (Reuters) - The United States must ensure that the many efforts under way to make its financial system more robust are aimed at achieving common goals, a senior Federal Reserve official said on Friday.

Brian Sack, head of the New York Federal Reserve Bank's markets group, said the worst financial crisis since the Great Depression revealed "significant structural shortcomings" in segments of the U.S. credit markets.

While the Fed was successful in fighting the fire, "it is now necessary to work towards creating a more robust financial system that addresses the structural deficiencies that brought us to the brink in the first place," Sack said, according to remarks prepared for delivery via video-conference to the ACI 2010 World Congress in Sydney, Australia.

The crisis revealed weaknesses in specific financial markets such as structured products, over-the-counter derivatives and tri-party repo, a key bank funding market, Sack said.

U.S. authorities are working on ways to make these markets more resilient, but Sack warned the reform process faces risks.

"There is a risk that, with so many efforts taking place in so many areas, the results will not fit together in a cohesive solution," he said.

Other risks are that reforms will be overly restrictive and undermine market functioning in normal times or that the process will stagnate.

The chairman of the U.S. Senate Banking Committee, Christopher Dodd, said on Friday that Congress "must not fail" to reform financial regulation and defended a bill approved this week by his committee. [ID:nN26149839]

Sack stressed that markets that faltered during the crisis should not be cast aside.

He called securitization "a powerful vehicle that should play an important role in the intermediation of credit in the economy."

While the collapse of securitized credit was "terribly disruptive," this does not mean "if structured properly, (it) should not return in size," he added.

Similarly, the use of derivatives is "integral" to the functioning of financial markets, he said, and the financial system cannot operate efficiently without leverage.

Sack spent much of his speech reviewing how different dollar asset markets fared in the crisis.

He pointed to the strong U.S. dollar rally at the height of the crisis. This rally, he said, was in part due to strong investor demand for dollar-denominated assets seen as safe-havens, such as U.S. Treasuries.

"Markets for certain dollar assets demonstrated considerable resilience to financial stress and were extremely appealing to investors in stress circumstances," he said.

"The Treasury market is supported by a sound and extensive infrastructure for trading, deep financing market, sizable derivative markets and an active dealer community," he said.

His comments on the Treasury market follow a difficult week for U.S. Treasury debt, after a series of poorly-bid debt auctions pummeled the bond market.

U.S. equities and non-financial corporate bonds also demonstrated resilience during the crisis, he said. While investors in these markets suffered losses, the crisis did not reveal any structural flaws, he said.

The recovery in both those markets since early 2009, "has been driven by market forces," Sack said.