Oct. 22 (Bloomberg) -- Opaque financial instruments in the U.S. have created an ``unprecedented'' financial crisis that needs to be repaired by rebuilding the banking system, said former Federal Reserve Chairman Paul Volcker.

``We are really going to have to rebuild this system from the ground up,'' Volcker said during the Columbia University's Women's Economic Round Table today in New York. ``The system is rebuilding itself.''

Volcker was joined by Joseph Stiglitz and Robert Mundell, both Nobel Laureates in economics teaching at Columbia, in discussing the problems plaguing the U.S. and global economies. The Fed has committed to pumping billions into the financial system after credit markets froze following the collapse of Lehman Brothers Holdings Inc.

The creation of complex financial products, ``instead of spreading the risk and creating transparency,'' wound up concentrating risk and ``opaqueness,'' Volcker said.

Stiglitz said the economic downturn in the U.S., while unlikely to be as bad as the Great Depression, ``is going to be a long, deep downturn, probably the worst in a quarter century.''

Volcker, 81, said the current crisis is more complex than any other in U.S. history.

The central bank and Treasury have implemented measures that would have been ``unimaginable'' just months ago, Volcker said. Still, the actions were ``necessary,'' he said, adding, ``I'm not criticizing it.''

Moral Hazard

Volcker said he was most concerned over the question of moral hazard, whereby the government provides too much protection from risk.

``People will come to expect bailouts and take undo risk,'' he said. ``People will assume they'll be protected in the future.''

While more government supervision is likely, ``I don't think regulation is the answer to all problems,'' Volcker said. It's important to come up with rules that won't make the government ``too intrusive,'' he said.

Volcker, who was succeeded by Alan Greenspan and served as Fed chairman from 1979 to 1987, said the U.S. needs a stimulus program ``at this point.''

The size of such a program ``is very much up in the air,'' he said. ``We've got to be able to spend this money constructively.''

The world's largest banks and securities firms have posted $636 billion of writedowns and credit losses since the beginning of last year, according to data tracked by Bloomberg.

``We have an enormous financial challenge'' that will require cooperation between the political parties to resolve, said Volcker, who advises Democratic presidential candidate Barack Obama. ``I don't think anything is going to go very smoothly.''

To contact the reporter on this story: Anthony Massucci in New York at amassucc@bloomberg.net.

Last Updated: October 22, 2008 21:12 EDT