Volcker says mortgage market reform crucial

President Barack Obama (L) greets Chairman of the Economic Recovery Advisory Board Paul Volcker after signing the Dodd-Frank Wall Street Reform and Consumer Protection Act in Washington, July 21, 2010.

NEW YORK (Reuters) - Paul Volcker, special adviser to President Barack Obama, said on Wednesday that reforming the U.S. mortgage market is the biggest single element missing from financial regulatory reform.

The former Federal Reserve chairman said the mortgage industry is dysfunctional and a "creature of the government" that needs reform.

Volcker told a forum sponsored by the International Economic Alliance in New York that he would want to avoid a "hybrid" institution that is "private when things are going well and public when things are going badly."

At the height of the financial crisis in late 2008, the U.S. government seized mortgage giants Fannie Mae and Freddie Mac. Since then, the two entities have taken about $150 billion in direct aid from the government.

The debate over the future of the U.S. mortgage finance system will intensify in January as the Obama administration is set to offer its plans to overhaul Fannie and Freddie.

The deeply political issue will be marked in part by the fight over continued government support for the $10.7 trillion market.

Money market regulation should also be revisited, he said, adding he was "not satisfied" with how credit agencies had been addressed in the financial regulatory reform process.

New rules governing Wall Street, signed into law earlier this summer to toughen the oversight of financial firms, are meant to prevent a repeat of practices that contributed to a devastating global financial crisis in 2007-2009.

Volcker said the U.S. economy's long slog to recovery was due to the fact that the economy had gotten "way out of balance" and could no longer be pumped up through consumption.

In the second quarter of 2010, the U.S. economy grew at an annual pace of 1.6 percent, slowing from a growth rate of 3.7 percent in the first three months of the year.

Volcker said that companies were sitting on a "pile" of cash mainly due to the drop-off in demand that gave them little confidence in making investments to expand their businesses.

TAX POLICY NEEDS REVAMP

Corporate income tax policy "is a mess," he said. Tax policy in general could do more to create incentives for investment in areas of growth for the economy.

"Some kind of energy tax probably makes sense," he said after describing how European gasoline prices are significantly higher than those in the United States and have resulted in more efficiently built transportation systems.

The former Federal Reserve chairman, answering a question about taxes for high earners, said the biggest redistribution of wealth he had seen in his lifetime was from average American families to the rich.

(Reporting by Daniel Bases and Kristina Cooke; Editing by Jan Paschal)