April 29 (Bloomberg) -- The U.S. economy is “leveling off at a low level” and doesn’t need a second fiscal stimulus package, said former Federal Reserve Chairman Paul Volcker, one of President Barack Obama’s top economic advisers.

Volcker, head of Obama’s Economic Recovery Advisory Board, said the 6.1 percent decline in first-quarter gross domestic product reported by the government today was “expected.” More recent data show the contraction in housing, business spending and inventories has slowed, and stimulus spending is only just beginning to hit the economy, he said.

Still, with the financial system functioning only by “the grace of government intervention,” the economy is “in for a long slog” before a recovery takes hold, Volcker said on Bloomberg Television’s “Conversations with Judy Woodruff” airing May 1 at 6 p.m. Government help will continue, and the administration won’t let any banks fail, he said.

“I’m not here to tell you the economy is going to recover very strongly in the short run,” Volcker said. “There is reason to believe that it should be leveling off, at a low level.”

While Volcker suggested the economy may not need a second stimulus, he said growth isn’t likely to pick up markedly for several years.

‘Take a While’

“I do not think there are grounds for great optimism,” Volcker said. “It is going to take a while, I think, to have a strong recovery.”

That will keep the government involved in the financial system, and the administration will provide the capital needed to keep banks afloat, he said.

“There’s a visible commitment by the government to support these so-called systemically important institutions at this point,” said Volcker, 81, who was Fed chairman from 1979 to 1987. “So they’re not going to go under in the sense of ceasing operations or even interrupting operations. It’s a question of how much support they’re going to need.”

The administration’s plans to help private investors remove distressed assets from banks’ balance sheets will work “to some extent,” Volcker said. “How quickly we deal with the system that is, as I say, still in intensive care, is the question.”

Fed’s Balance Sheet

Volcker, who didn’t comment on monetary policy, expressed concern about the expansion of the Fed’s balance sheet as central bankers attempt to ease credit conditions.

“The Federal Reserve is going beyond the traditional role of central banks here or abroad,” Volcker said. “At some point it’s reasonable to ask should this particular institution, with its independence very well protected, be allocating so much of what is essentially government money.”

Fed policy makers, ending a two-day meeting today, refrained from increasing purchases of Treasuries and mortgage securities. At the previous FOMC meeting in March, policy makers agreed to buy $300 billion of long-term Treasury debt within six months while increasing purchases of mortgage-backed securities to $1.25 trillion this year from $500 billion and doubling purchases of housing-agency debt to $200 billion.

Volcker said Fed Chairman Ben S. Bernanke is “doing a great job” and he declined to speculate on whether Obama will reappoint Bernanke when his term as chairman ends in 2010. “It’s not a situation where any of this problem reflects shortcomings on Mr. Bernanke’s part.”

Fed’s Balance Sheet

Volcker agreed with economists who say the expansion of the Fed’s balance sheet, to more than $2.2 trillion as of last week, might pose an inflation danger at some point.

“The inflation problem, which should be a real threat for the future, is not right on the doorstep,” he said. “But two or three years from now that may be the critical problem, how that’s handled. Because, given what the Federal Reserve has been doing, it’s going to be harder to retrace their steps, so to speak, than it ordinarily would be.”

Volcker said he and National Economic Council Chairman Lawrence Summers have disagreed about how heavily regulated the financial industry should be.

“We’ve had a little talk about this,” Volcker said. “I’m sure he’ll recognize the wisdom of my views sooner or later.”

Separate Functions

Volcker said he wouldn’t favor bringing back the Glass- Steagall Act, repealed in 1999 with the support of then-Treasury Secretary Summers. He would, however, separate commercial-bank functions from what he calls “traders,” venture capital funds, private equity funds and hedge funds.

“I want to separate the service-oriented core of the system from capital market trading, which is of course very risky,” he said. “A lot of money is in markets, particularly in so-called proprietary trading, where people are out there trading things they have no intrinsic interest in. They’re trading to make money. And that I would leave away from the banks.”

Most hedge funds shouldn’t be regulated, he said, although he would subject them to registration. Those whose portfolios become large enough should be forced to report “the major directions of their investment activity,” he said.

“Now if they get really big, then I would regulate them,” he said. “I’d say you have to have a limited, so-called leverage ratio. You have to have so much capital to support your activities. But that would be for, in my view, a relative handful of the really big ones.”

Executive Compensation

Volcker also said it would be difficult for the government to regulate executive compensation. While there could be a “quid pro quo” in exchange for additional federal aid to companies, “this has to be partly a cultural change in the industry and on Wall Street itself,” he said. “It’s not easy to achieve that.”

Volcker’s 15-member Economic Recovery Advisory Board plans to look at potential regulatory reforms for the financial system, aspects of tax reform, how technology can make manufacturing and infrastructure more competitive, and how the administration can deal with financial crises ahead for Social Security.

As for his own future, “my role is as temporary as it can be,” Volcker said. “I’m conscious of the fact I’m not leaving enough time for fishing in my old age.”

To contact the reporter on this story: Michael McKee in New York at mmckee@bloomberg.net.

Last Updated: April 29, 2009 15:55 EDT