(Bloomberg) The U.S. mortgage market is "absolutely broken" and changing the government's role in housing must be a top priority, said former Federal Reserve Chairman Paul Volcker, an adviser to President Barack Obama.

There is "no ready-made, practical alternative" to the government's role in the mortgage market through Fannie Mae and Freddie Mac, Volcker said in prepared remarks at a banking conference today in Chicago. Creating a new framework for the private mortgage market "is a matter of first priority," he said.

The U.S. financial system has yet to be repaired, he said. "We know parts of it are absolutely broken like the mortgage market," Volcker said at the 13th Annual International Banking Conference held at the Federal Reserve Bank of Chicago.

U.S. regulators are implementing the most sweeping overhaul of financial oversight since the Great Depression. Signed into law by Obama in July, the rules were prompted by a credit crisis that triggered the collapse of Lehman Brothers Holdings Inc. and pushed the U.S. economy into a recession.

The regulatory changes, named after their principal authors, Connecticut Senator Christopher Dodd and Massachusetts Representative Barney Frank, give the government authority to unwind failing financial firms that may threaten the entire system, impose new rules on derivatives markets and create a consumer-protection agency at the Fed to monitor everything from home loans to credit cards.

Backing Change

The law includes limits to investments by commercial banks in private equity or hedge funds, known as the "Volcker Rule" because of Volcker's advocacy for the change. Under a measure that may not take full effect for as long as a dozen years, banks can invest in private-equity and hedge funds, though they will be limited to providing no more than 3% of the fund's capital. Banks also can't invest more than 3% of their Tier 1 capital.

Volcker said the legislation regarding the Volcker Rule, though it did not go as far as he would have liked, is a positive step. "By and large the philosophy is embedded in that legislation and we'll see whether it gets embedded in legislation in other countries," Volcker said.

The use of derivatives has "far exceeded any pressing need for hedging in real markets or financial markets and has become a kind of speculative instrument," the 83-year-old former central banker said.

The conference was attended by policy makers such as Bank of Thailand Governor Tarisa Watanagase and Jose De Gregorio, president of Chile's central bank, and officials from the International Monetary Fund, including Jose Vinals, director of its monetary and capital markets department.

Tame Inflation

Volcker is chairman of the president's Economic Recovery Advisory Board. As chairman of the Fed from 1979 to 1987, he raised interest rates to as high as 20% to tame inflation, triggering a recession.

Earlier this month at a separate conference in Calgary, Volcker said the U.S. and European economies may take years to rebound from the recession, while emerging countries such as China are undergoing "remarkable" growth.

"It's going to take a long time to repair the basic disequilibrium in the economy," Volcker said today.