Oct. 26 (Bloomberg) -- Federal Reserve Governor Frederic Mishkin said financial-market conditions have improved, while have yet to return to normal, since the central bank lowered interest rates in August and September.

``Market functioning has certainly not yet returned to normal,'' Mishkin said in a speech at a seminar commemorating the 1907 U.S. financial panic, which led to the Fed's creation. Still, Fed actions ``have helped improve conditions in several short-term funding markets and instil confidence in investors that liquidity would be available if needed,'' he said.

Mishkin didn't make any other explicit reference to current financial conditions, interest rates or the economy in his prepared remarks. His speech discussed the Fed's response to past crises and its responsibilities in keeping markets stable.

``The Federal Reserve's role as a provider of liquidity to cope with episodes of financial instability has been, and will continue to be, critical to its success'' in satisfying its mandate for low inflation and full employment, said Mishkin, 56, who joined the Fed board in September 2006 and has studied central banking for three decades.

Investors expect the Fed to cut its benchmark rate by a quarter-point to 4.5 percent when policy makers next meet Oct. 30-31, following last month's half-point reduction that was double what most economists forecast.

In the panic a century ago, from a peak in September 1906 to a trough in November 1907, the value of all listed U.S. shares plunged 37 percent, according to a recent book about the event. At least 25 banks and 17 trust companies collapsed.

`More Effective'

``The more quickly liquidity can be provided when financial instability occurs, the more effective it may be,'' Mishkin said.

He also cautioned against giving banks incentives to take on too much risk, creating ``moral hazard.'' Yet it's ``beneficial'' for the Fed to intervene when financial companies are at risk of failure because of external reasons, a situation where the ``creation of perverse incentives would probably be limited.''

Central bank policy makers have lowered their benchmark rate by half a percentage point and the charge for direct loans to banks by 1 percentage point since access to credit slid in April. The New York Fed has also injected reserves into money markets to help provide liquidity.

Fed and U.S. Treasury officials have said that it will take some time for confidence to return to markets for complex securities. Investors who depended on credit-ratings companies to assess the debt now must struggle to come up with their own prices, Fed Chairman Ben S. Bernanke said Oct. 15.

Mishkin didn't comment on the agreement among Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. to increase liquidity in the market for asset-backed commercial paper. Treasury Secretary Henry Paulson brokered the accord, announced on Oct. 15.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Anthony Massucci in New York at amassucc@bloomberg.net.

Last Updated: October 26, 2007 16:16 EDT