Federal Reserve officials criticized congressional financial reform proposals that would strip the central bank of oversight powers, saying they could weaken, not strengthen protections against a future crisis.

St. Louis Federal Reserve Bank President James Bullard said on Tuesday a plan for a multi-member watchdog for the financial system is unlikely to prevent a future crisis because it was not likely to be able to act decisively.

The Fed would be better at navigating this type of decision-making, he told a business group.

Lawmakers are debating financial regulatory reform after a crisis that led to taxpayer-funded bank bailouts and a painful recession. Legislation has passed the House of Representatives but is bogged down in the Senate.

Members of Congress have slammed the Fed for failing to anticipate and prevent the crisis. Reform proposals could take the Fed's regulatory authority away and subject its policy making to congressional review.

The fate of financial reform is uncertain as majority party Democrats regroup after the loss of their three-fifths super-majority, which makes it harder for them to pass legislation. A new proposal from Banking Committee Chairman Chris Dodd is expected soon.

LOUDER RHETORIC

Bullard's criticism echoed remarks leveled at lawmakers by Kansas City Federal Reserve Bank President Thomas Hoenig, who told lawmakers in a letter released on Tuesday that a proposal to create a system-wide watchdog and narrow supervision to one, rather than multiple, agencies would not avert future disasters.

Pinning our hopes on a systemic risk council and a consolidated super-agency would be a mistake, he wrote to Colorado Democrat Michael Bennet and Nebraska Republican Michael Johanns, who are on the Senate committee that is working on reforms.

Their comments were among the most pointed criticism to date by the Fed of financial overhaul plans.

Bullard said a proposal to cut back emergency lending powers, which the Fed used during the crisis for the first time since the Great Depression, limits the Fed's ability to prevent a crisis from escalating in the future.

The Fed system is composed of the Board of Governors in Washington and 12 regional Fed banks around the country.

Regional Fed governors worry that the regulatory reform proposals could weaken their authority over banks and expose them to more political pressure. They also worry that reforms could tip the balance of power in the Fed system toward Washington and Wall Street and away from the rest of the country and regional and community banks.

It is a striking irony to me that the outcome of the public anger directed toward Washington and Wall Street may lead to the further empowerment of both Washington and Wall Street in regulating financial institutions, Hoenig wrote.

DISCOUNT RATE LEVEL

Speaking about monetary policy, Bullard said the Fed may not have to raise its discount rate further to achieve the result it seeks -- minimal use of the emergency loan facility.

The Fed last week boosted the discount rate to 0.75 percent, its first interest rate move since December 2008, but insisted the move was a response to improved financial conditions rather than an attempt to raise borrowing costs.

The fed funds rate, the Fed's main policy tool, remains unchanged near zero.

Bullard said the Fed may not have to widen the gap between the two rates to a full percentage point, as it was before the crisis.

We'll try out this 50 basis points (differential between the discount rate and the fed funds rate), we'll see how it goes, Bullard told reporters after speaking to a business group.

It's not clear that you need the full 100 basis points to make it enough of a penalty rate so that banks don't use the discount window for ordinary lending, he said.

Bullard and Hoenig had sought a rise in the discount rate as early as mid-January, citing improved economic conditions, the Fed said.

The Fed has promised to hold interest rates at an exceptionally low level for an extended period to help the economy pull out of recession.

Bullard said he has come to accept the view of other policy-makers that the extended period pledge means around six months.

He said there would likely be a point of reckoning for policy makers in the fall, when it would need to assess how strong the recovery has been. If the economy continues along an expected path of moderate growth with persistently high unemployment, rate increases would be unlikely until 2011.

If the rebound is stronger than expected, it would have to contemplate rate hikes sooner, he said.

(With additional reporting by Pedro Da Costa in Washington)

(Editing by Carol Bishopric)

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