Europe's worsening debt crisis could significantly damage the U.S. economy, Treasury Secretary Timothy Geithner warned on Thursday as he urged Europe to shore up its bailout fund.

Europe is so large and so closely integrated with the U.S. and world economies that a severe crisis in Europe could cause significant damage by undermining confidence and weakening demand, Geithner told the U.S. Senate Banking Committee.

A growing number of economists expect the crisis will tip the euro zone into recession, putting a further drag on an already weak U.S. recovery and endangering President Barack Obama's chances of being reelected next year.

The United States and the International Monetary Fund have been trying to get European leaders to put in place a strategy to stabilize the situation and Geithner has been pushing the European Union to leverage its 440 billion euro bailout fund.

Some analysts have estimated that the fund should be expanded to at least 2 trillion euros to safeguard Italy and Spain if the Greek debt crisis continues to escalate.

The critical imperative is to ensure that the governments and the financial systems under pressure have access to a more powerful financial backstop, Geithner said.

At the hearing, which examined how the U.S. government's risk council is fighting threats to the U.S. financial system, Geithner tried to assuage lawmakers' fears that Europe's debt problems could lead to another Lehman-like crisis. The investment bank's 2008 bankruptcy rippled through the global financial system and triggered a run on money market funds.

Our firms are in a much stronger position, he said. Our institutions hold substantial cushions of capital against the potential risk they may face ahead.

U.S. banks have been shoring up capital levels since the 2008-09 financial crisis. Geithner said global regulators would do whatever they could to make sure that European banks also complied with the higher capital levels required by the Basel Committee of bank supervisors.

Europe's sovereign debt crisis has spilled over into the region's financial system and investors have started to lose faith in banks heavily exposed to Greek assets. Customers have been withdrawing funds from Franco-Belgian bank Dexia and the European Commission president is pushing for a coordinated injection of funds into ailing firms.

RISK COUNCIL

Geithner acknowledged that the Financial Stability Oversight Council has limitations in its ability to predict future risks to the system. The council, which draws together top U.S. financial regulators from various agencies, was established in July 2010 and charged with identifying risks to the financial system.

It has been criticized by the business community for imposing another layer of burdensome rules on companies struggling to recover after the crisis.

Bank lobbyists took a fresh swipe at the council and said it was not clear whether regulators were paying attention to sources of systemic risk, such as the depressed housing market.

Chaired by Geithner, the council is made up of the heads of major financial supervisors, including the Securities and Exchange Commission and the Federal Reserve. It is due on Tuesday to issue another proposal on criteria for picking which systemically important financial firms will be forced to hold more capital and comply with more rules.

(Reporting by Dave Clarke, Rachelle Younglai and Glenn Somerville; Editing by James Dalgleish)

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