WASHINGTON (Reuters) - Upcoming Treasury Department proposals to make the Federal Reserve the chief regulator of U.S. financial markets and give it sweeping new powers won praise on Saturday from the central bank and the head of the Securities and Exchange Commission.

The U.S. Federal Reserve Building is pictured in Washington, March 18, 2008. REUTERS/Jason Reed

Treasury Secretary Henry Paulson is expected to unveil a blueprint on Monday for fixing gaps in the U.S. financial market regulatory structure that have been exposed by the ongoing subprime mortgage crisis.

Lax regulation has been widely blamed for permitting a flood of inadequately documented loans to be made during the boom years of a U.S. housing market that has since soured and now threatens to drag the economy into a deep recession.

“The Treasury’s report presents a timely and thoughtful analysis and is an important first step in the complex task of modernizing our financial and regulatory architecture. We look forward to working with the Congress and others to help develop a policy framework that will enhance financial and economic stability,” a Federal Reserve spokeswoman said.

An executive summary of the Treasury proposals says a “market stability regulator” is needed and the Fed best fits that role, suggesting the central bank could use its control over interest rates as well as its ability to provide market liquidity to fulfill its functions.

STEP BACK AND MODERNIZE

When the current regulatory structure was put into place 75 years ago, “our capital markets were in New York and very few people were invested and the number of products was limited,” said David Hirschmann, president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness.

The financial world has changed dramatically since then, and over the years there has been a tendency to respond to market crises by adding new layers of regulation, he said.

“It’s become clear, I think to all, that the solution at this point is not to simply layer on more layers of regulation on a creaky outdated system, but really to step back and modernize the entire structure,” Hirschmann said.

Among its recommendations, Treasury suggests merging the Securities and Exchange Commission, the U.S. markets watchdog, with the Commodity Futures Trading Commission that oversees the activities of the futures market.

The subprime mortgage crisis provides “further evidence, if more were needed, that financial services regulation in the United States needs to be better integrated among fewer agencies, with clearer lines of responsibility,” SEC Chairman Christopher Cox said in a statement.

“Just as systemic risk cannot be neatly parceled along outdated regulatory lines, the overarching objective of investor protection can’t be fully achieved if it fails to encompass derivatives, insurance, and new instruments that straddle today’s regulatory divides,” Cox said.

THE SAME FALLBACK

Democratic presidential candidate Barack Obama called the plans inadequate.

“There are some good things about consolidating the multiple regulatory agencies,” but now that the Fed has opened its discount window to investment banks it should hold them to the same reserve requirements as commercial banks, he said at a campaign stop in Johnston, Pennsylvania.

“If I’m a commercial bank right now I’m still not clear why it is that investment banks are still able to do things I can’t do, aren’t subject to the same capital requirements and liquidity requirements that I am and yet they’ve got the same fallback with the Fed,” Obama said.

CFTC Commissioner Bart Chilton warned it could be disastrous to hastily consolidate the CFTC and the SEC into one agency because of the different approaches they take to regulatory oversight.

The CFTC has “an entirely different regulatory approach and the data confirms that it works,” he said.

“The SEC has a very proscriptive old-style approach to government. Putting those two in the same room doesn’t solve any problems. In fact, I think it would create a calamity” unless Congress takes its time and does a thorough overhaul of statutes authorizing the two agencies, Chilton said.