Aug. 21 (Bloomberg) -- Senate Banking Committee Chairman Christopher Dodd said U.S. Federal Reserve Chairman Ben S. Bernanke agreed to use ``all of the tools at his disposal'' to restore stability in financial markets roiled by the subprime mortgage crisis.

Dodd, a Connecticut Democrat who's seeking his party's presidential nomination, said banks should take advantage of lower borrowing costs after the Fed's surprise decision last week to cut the interest rate it charges them. The senator addressed reporters after meeting with Bernanke and Treasury Secretary Henry Paulson in Washington today.

The central bank on Aug. 17 cut the so-called discount rate half a percentage point to 5.75 percent to direct more cash to companies starved for short-term financing while avoiding an emergency reduction in its broader lending-rate target. Fed watchers say it may take days before policy makers know whether the action is having the desired calming effect on markets.

``There's a need for some action,'' Dodd said. ``The markets are reflecting that. There are some steps that can be taken to minimize this problem from becoming broader.''

Dodd, whose state of Connecticut is home to many U.S. hedge funds, including Pequot Capital Management Inc. and Tudor Investment Corp., said he didn't specifically ask Bernanke to cut the benchmark federal-funds rate, and Bernanke didn't pledge to do so.

Interest-rate futures show traders are betting the credit crunch will force Bernanke to ease monetary policy for the first time since 2003.

Markets React

``The comment from Dodd and the decision from the Fed are all going in the right direction to bringing some calm back to the financing market,'' said Nicolas Beckmann, co-head of U.S. interest rates trading at BNP Paribas Securities Corp. in New York, one of the 21 primary U.S. government securities dealers that trade with the central bank.

The three-month Treasury bill yield rose 0.35 percentage point to 3.49 percent, climbing for the first day since Aug. 13. It fell 0.66 percentage point yesterday, the most since the stock market crash of October 1987, as money-market funds dumped asset-backed commercial paper for the shortest-maturity government debt.

Dodd said he didn't intend to put political pressure on the Fed, respecting its independence.

``I approve of what they did by lowering the discount rate,'' Dodd said. ``Historically, the fed fund rates have tracked that and followed that. Certainly, that's something that I think could be positive.''

Fed spokeswoman Susan Stawick declined to comment on the meeting.

Treasury Response

While Dodd said he's satisfied with Bernanke's response, he said he was ``concerned the Treasury does not appreciate the importance of this issue.''

Dodd reiterated his criticism of the Bush administration for not allowing Fannie Mae and Freddie Mac, the largest sources of money for U.S. home loans, to invest in mortgages larger than $417,000.

``This would have a positive effect on dampening down interest-rate hikes,'' he said. Paulson told the senator ``they're not likely to move in that direction,'' Dodd said.

Consumer Protection

The senator has been critical of the Fed and other U.S. bank regulators for not taking more aggressive action to rein in lending abuses sooner. Under pressure from Dodd, the Fed has committed to develop new rules to strengthen consumer protections in mortgage lending under a 1994 law.

Dodd said he expects the Fed to release the rules later this year, ``but I'm also simultaneously going to be looking at the possibility of legislating in this area.''

House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, announced this week he will hold a hearing Sept. 5 to consider the implications of credit and mortgage-market volatility for U.S. consumers and the global economy. Officials from the Fed, the Treasury and the mortgage industry are scheduled to testify.

``This is going to focus on what are the lessons we're learning from the current turmoil about the broader market, and whether or not our financial regulatory system is in need of updating,'' Frank told reporters today in Washington.

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net.

Last Updated: August 21, 2007 16:56 EDT