White House economic adviser Paul Volcker on Tuesday told Congress to curb risky investing by big banks, warning his soul would haunt lawmakers when the next banking crisis hits if they did not heed him now.

The 82-year-old former Federal Reserve chairman, whose star is rising in the Obama administration, faced tough questions from lawmakers about the White House's latest and far-reaching proposals for a crackdown on the banking industry.

Few details were forthcoming from the venerable central banker, or from U.S. Treasury Deputy Secretary Neal Wolin, who testified with Volcker to the Senate Banking Committee.

President Barack Obama stunned financial markets in late January by calling for new limits on banks' ability to do proprietary trading, or buying and selling of investments for their own accounts unrelated to customers.

Volcker, considered a sage of monetary policy and a crusader for tighter regulation, conceded such a move would not have prevented the debacles at AIG and Lehman Brothers at the heart of the 2008 financial crisis.

But he said that not adopting new trading limits today would lead to another crisis tomorrow.

If proprietary trading is not curbed, Volcker told the committee, I may not live long enough to see the crisis, but my soul is going to come back and haunt you.

Banking Committee Chairman Christopher Dodd, a Democrat, told the two witnesses he supports the new Obama proposals, but complained they were coming very late to a financial regulation debate that has been going on since 2008.

As a result, Dodd said, the proposals seemed to many senators to be transparently political and not substantive, and it's adding to the problems of trying to get a bill done.

He said the administration needs to clue him in early on anymore new proposals and be ready to answer questions. In this case, he said, We're not getting good answers.

He said piling on too many new ideas would be a mistake. I don't want to be in a position where we end up doing nothing because we tried to do too much, Dodd said.

LINE SEEN BLURRED

Since Obama unveiled the Volcker rule, named for its chief proponent, analysts have speculated about exactly what sort of trading would be off-limits if Congress adds it to a sweeping package of reforms still being debated.

Some see a blurred line between proprietary trading and market-making that helps customers. But Volcker disagreed.

Bankers know what proprietary trading is and is not. Don't let them tell you any different ... I don't think it's so hard, Volcker told lawmakers pressing for a clearer idea of where the regulatory lines would be drawn.

Taken on early as an adviser after Obama's election, Volcker initially seemed to have little impact inside the administration. But that has changed since the Democrats lost a Senate seat in a special election in Massachusetts and Obama has shifted to a more aggressive stance on Wall Street.

Under the Obama proposals, banks could not establish or maintain a separate trading desk, capitalized with their own resources and unrelated to customer business, Wolin said.

That could mean barring banks from using such trading desks to speculate on the prices of oil, gas or equity securities, he said, adding that the restrictions should apply to all banks, including U.S. operations of foreign banking firms.

The KBW Banks index <.BKX> of large bank stocks was up about 0.23 percent in broadly bullish trading on Tuesday.

Senator Richard Shelby, the panel's top Republican, said he was quite disturbed by Obama's proposals being air dropped into the financial regulation debate, which is more than a year old. But Shelby said he was willing to consider them.

Senator Bob Corker, also a Republican, questioned the need to crack down on proprietary trading at commercial banks, saying firewalls already exist within bank holding companies to protect deposit-based activities.

TAXPAYER BACKING TARGETED

Despite the firewalls, Wolin said, banks that do proprietary trading enjoy a cheaper cost of capital because of the taxpayer backing of the deposit-funded sides of their business models, which he said is unfair and should end.

In a sign of how the so-called Volcker rule may already be having an impact, people familiar with the matter said on Monday JPMorgan Chase may be rethinking its acquisition talks involving RBS Sempra, a joint venture of Sempra Energy and Royal Bank of Scotland .

The rethinking may be motivated by possible limits on proprietary trading, the sources said.

Volcker -- whose tight-money regime broke the back of inflation when he was Fed chairman in the early 1980s under Presidents Carter and Reagan -- also wants banks to sever ties to hedge funds and private equity ventures.

What I want to get out of the system is taxpayer support for speculative activity, Volcker said.

A second hearing is set for Thursday to hear from executives of JPMorgan and Goldman Sachs .

Banking committee members are trying to negotiate a bipartisan regulatory reform to avoid a repeat of the financial crisis that caused the worst U.S. recession in decades.

Deep divisions remain among committee members over issues such as managing systemic risk, bank supervision and consumer protection. Obama's latest proposals complicated the talks.

The House of Representatives approved a bill in December that called for the biggest regulatory changes since the Great Depression, but the Volcker rule was not included.

Obama also called for a new cap on banks' market share based not only on deposits, which are already capped, but also non-deposit funding.

In related news, Federal Reserve Governor Kevin Warsh said in an opinion article on the Financial Times web site on Tuesday that giving regulators more power would not prevent future crises, and warned of grave risks to the economy if banks come to be regulated like public utilities.

(Additional reporting by Luke Pachymuthu in Dubai and Steve Slater in London; Editing by Dan Grebler)

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