Fed's Warsh says restoring market discipline key

Federal Reserve Governor Kevin Warsh said on Wednesday that regulatory improvements alone would not prevent future financial crises and the government must be willing to let firms fail.

Regulation is too important to be left to regulators alone. We need a system in which insolvent firms fail, Warsh told the New York Association of Business Economics.

In response to an audience question, Warsh said it was essential that the United States coordinate regulatory reform with other members of the Group of 20 rich and emerging countries.

Given the global nature of financial markets, the overall policy prescription has to be global, even as countries make different choices about specific reforms, he said.

Warsh's comments come as Congress mulls an overhaul of financial regulations after the worst banking crisis in decades.

The Fed itself has been severely criticized for what lawmakers and many observers see as the failure to check risky lending practices and to rein in a house price bubble that led to the collapse.

Lawmakers are considering stripping the Fed of the authority to oversee banks and responsibility for protecting consumers, leaving monetary policy as its sole function.

But Warsh said the U.S. central bank should continue to play a critical function in the supervision of financial firms and that the blame for the crisis cannot be laid at the feet of regulators alone.

He said the mortgage finance system, particularly the roles of government-sponsored mortgage finance agencies Fannie Mae and Freddie Mac , should be examined. The federal government took Fannie and Freddie into conservatorship at the height of the crisis.