The Federal Reserve allowed the global credit crisis to happen and must be redrawn as a tough regulator to stop big financial institutions from taking excessive risks, prominent Wall Street economist Henry Kaufman said on Friday.

The world is now in the midst of the worst financial crisis since the Second World War, Kaufman said in a speech titled Who is Primarily Responsible for the Credit Crisis? he gave to a conference in New York.

I am convinced that the misbehavior of some would have been much rarer -- and far less damaging to our economy -- if the Federal Reserve and, to a lesser extent, other supervisory authorities, had measured up to their responsibilities, Kaufman said.

Kaufman became known for correctly forecasting higher inflation and interest rates when he was chief economist with Salomon Brothers in the 1970s and 1980s. During that time, he acquired the moniker Doctor Doom among financial market watchers and is well known as an expert on monetary policy and how financial markets work.

At a minimum, the Fed's sensitivity to financial excesses must be improved, Kaufman said.

SAYS GREENSPAN FAILED TO WARN ABOUT RISKS

Kaufman directly criticized former Federal Reserve Chairman Alan Greenspan for not using his position to dissuade big banks and others from taking big risks.

Alan Greenspan spoke about irrational exuberance only as a theoretical concept, not as a warning to the market to curb excessive behavior, Kaufman said. It is difficult to believe that recourse to moral suasion by a Fed chairman would be ineffective.

Partly because the Fed did not strongly oppose the repeal in 1999 of the Depression-era Glass-Steagall Act, more large financial conglomerates that were too big to fail have formed, Kaufman said, citing a factor that has made the global credit crisis especially acute.

Financial conglomerates have become more and more opaque, especially about their massive off-balance-sheet activities, he said. The Fed failed to rein in the problem.

Banks' exposure via hedge funds and structured investment vehicles, known as SIVs, to assets that turned bad have burdened them with trillions of dollars of write-downs and losses since the credit crisis erupted in mid-2007.

The U.S. central bank is largely to blame for the banking system's ballooning exposure to such risks, Kaufman said.

Much of the recent extreme financial behavior is rooted in faulty monetary policies, he said. Poor policies encourage excessive risk taking.

Now the Fed should act as a regulator to strictly oversee big financial institutions and impose constraints on their assets and profit growth, he said.

However, Kaufman praised the central bank's many emergency measures to combat the global financial crisis by supporting securities markets to get credit flowing again.

For the central bank's resourcefulness and innovativeness in working to revive the credit market ... the Fed deserves to be commended, Kaufman said. Even so, these actions came after the crisis had gained considerable momentum.

(Reporting by John Parry; Editing by Jan Paschal)