Two top Federal Reserve policy-makers took divergent views on the U.S. economy on Thursday, with the head of the Atlanta Fed seeing a return to growth later this year, while the head of the San Francisco Fed saw the potential for an even deeper contraction.

Both policy-makers -- Dennis Lockhart, president of the Atlanta Fed, and Janet Yellen, president of the San Francisco Fed -- told a conference in New York that it was important to address how to regulate systemically important institutions, those seen as too big to fail.

Lockhart said he expects the recession to end by mid-year with growth slowly picking up in the following months.

Today, the economy is still very weak, but there are some encouraging signs that support cautious optimism, Lockhart told the conference at the Levy Economics Institute in New York.

I do not expect a strong recovery, but I do expect the economic contraction we're now experiencing to give way to slow and tentative growth as early as the third quarter.

The United States has been mired in the most severe recession in a generation since the collapse of the housing bubble in 2007, but some economic data has stabilized, at albeit low levels, and hopes have grown that the downturn is finally bottoming.

Yellen, however, took a more cautious interpretation of the latest economic data, saying signs of improvement should not be taken to mean the U.S. economy is out of the woods.

The negative dynamics between the real and financial sides of the economy have created severe downside risks, Yellen said. While Fed credit policies have created a few welcome signs of stability, financial markets remain highly stressed, making them an impediment to recovery, she warned.

While we've seen some tentative signs of improvement in the economic data very recently, it's still impossible to know how deep the contraction will ultimately be.

Both Yellen and Lockhart are voting members of the Fed's policy-setting committee this year.

Despite his generally optimistic outlook, Lockhart said he remains wary about the impact of weakness in the commercial real estate sector and the harm this could yet do to banks, as well as further nasty shocks from employment and the slide in house prices.

Over 5 million U.S. jobs have been lost since the recession began at the end of 2007, forcing unemployment to 8.5 percent last month, and economists fear employment conditions will get worse before they get better.

SYSTEMIC REGULATION?

Lockhart, a former commercial banker, said the prospect of better times ahead is a good moment to think about the regulatory structure needed to prevent a repeat of the financial crisis, sparked by the collapse in the U.S. subprime mortgage market.

The post-crisis environment will require agile oversight. This regulatory approach should stress actively managing risk as it evolves, Lockhart said.

He also discussed so-called resolution authority to wind down systemically important financial firms, and emphasized this was much easier to talk about than achieve.

However, tackling this issue is crucial to prevent a repeat of the too-big-to-fail problem that has forced the Fed to bail out key institutions.

The financial crisis in this country has resulted in financial industry consolidation. The effect of industry consolidation is greater concentration without, as yet, much reduction of systemic risk, Lockhart said.

Yellen said systemically important institutions, including certain banks, insurance firms, investment firms, and hedge funds, should be subject to consolidated supervision by a single agency.

And she said the carnage of the credit market bust has made her reconsider whether the Fed should take preemptive action against developing asset bubbles, which she said can be economic time bombs.

The Fed's standard line has usually been that monetary policy is too blunt a tool to use to target asset bubbles.

Now that we face the tangible and tragic consequences of the bursting of the house price bubble, I think it is time to take another look, Yellen said.

Another official of the U.S. central bank, Christine Cumming, first vice president of the Federal Reserve Bank of New York, said at a panel at the conference that a systemic regulator would face a difficult task when trying to identify where such risks really lie. That's a non-trivial task... it's very hard to do, she said.

(Additional reporting by Alister Bull, Ros Krasny and Gertrude Chavez; Editing by Leslie Adler)