NY Fed's Geithner: substantial financial reforms needed

By Burton Frierson

NEW YORK (Reuters) - The U.S. financial crisis shows the need for substantial regulatory reform, and to get the ball rolling the New York Federal Reserve met on Monday with heavyweights from the credit derivatives trade.

New York Federal Reserve President Timothy Geithner, speaking at the Economic Club of New York, also said the Federal Reserve was paying close attention to the U.S. dollar and watching inflation.

On reforms, Geithner said any regulatory overhaul should be accompanied by global initiatives to make the financial architecture stronger across borders and better able to respond to crises that affect financial institutions far and wide.

At the New York Fed, 17 firms representing more than 90 percent of credit derivatives trading, met with their primary U.S. and international supervisors.

Meeting participants, which also included buy-side clients and industry associations, agreed to detail their next steps for addressing priorities to regulators by July 31, the New York Fed said in a statement.

"Making these changes will take time, but we expect to make meaningful progress over the next six months," Geithner said in his speech.

Among the issues agreed upon were increased standardization and automation of derivatives trade processing.

The progress of the efforts will draw especially strong interest in financial markets since credit derivatives played a central role in the recent meltdown.

The meeting agenda also included the creation of a central clearing house for credit default swaps and the incorporation of a protocol for managing defaults into existing and future credit derivatives contracts.

The meeting included major U.S. regulators plus France's Commission Bancaire, the UK's Financial Services Authority and the Swiss Federal Banking Commission.

POOR QUALITY

The meeting was the fourth with major dealers on this topic and attempts to deal with markets and instruments that were considered cutting-edge innovations during the credit boom of the last decade.

However, they proved unable to function well under the weight of mass liquidations when things soured and the easy funding that sustained this "parallel financial system" the system dried up.

Geithner said the current crisis exposed very significant problems in financial systems of the U.S. and other major economies and that innovation got too far in front of the knowledge of risk.

"The most fundamental reform that is necessary is for all institutions that play a central role in money and funding markets -- including the major globally active banks and investment banks -- to operate under a unified framework that provides a stronger form of consolidated supervision, with appropriate requirements for capital and liquidity," Geithner said.

Geithner said regulatory reforms should mitigate and reduce need for future interventions, but that it was not realistic to attempt preemptively to diffuse pockets of risk and leverage.

"I do believe, however, that we can make the system better able to handle failure by making the shock absorbers stronger," Geithner said.

INFLATION, DOLLAR

Geithner also said containing global inflation would probably require tighter monetary policy on average around the world, but the mix will vary across countries.

He also said he has yet to see evidence of a significant acceleration of underlying inflation in goods, services or wages or a "substantial erosion in long-term inflation expectations."

"But we are going to be very attentive to those risks," Geithner added.

Geithner's comments on the dollar came a week after similar remarks from Fed Chairman Ben Bernanke, who drew links between a weaker dollar and higher import prices and consumer price inflation.

"No government, no central bank can be indifferent to changes in the value of its currency," Geithner said.

He said the dollar was important not just because of its effect on growth and inflation in the U.S. and elsewhere but also because of "the very important role" it plays in the international financial system.

Geithner added: "As a result, as you would expect, we pay very close attention to what happens in (foreign) exchange markets."

(Additional Reporting by Ros Krasny)