WASHINGTON — The economy would be better off with a system in which there are fewer big financial firms that were at the root of the recent crisis, a top Federal Reserve official signaled on Wednesday.

In a speech at the Chamber of Commerce, Federal Reserve Bank of Kansas City President Thomas Hoenig endorsed a proposal that could force large banks to get rid of divisions that make risky bets with their capital.

"I suggest that our economy would be better served by a more diverse financial system," Hoenig said. The growth of big financial companies to a level were they pose a threat to the overall economy has distorted the financial system, the Fed veteran added.

Hoenig, who votes on the Fed's policy-setting committee, said financial holding companies should be banned from proprietary trading and from investing or sponsoring hedge funds. Trading and private equity investment should be housed in "separately capitalized subsidiaries subject to strict leverage and concentration limitations," he said.

That's the essence of the so-called Volcker rule, a proposal made by former Fed Chairman Paul Volcker, now a top adviser for President Barack Obama, that was approved by the Senate Banking Committee Monday as part of a wider financial overhaul. Lawmakers are also considering legislation to let the government wind down failing financial-services companies that are deemed to be systemically risky.

Hoenig said he "couldn't agree more" with statement often heard of policy makers and financial market experts over the past couple years that if a financial firm is too big to fail, then it is too big.

In defense of smaller banks, Hoenig said they had continued to lend despite being badly hurt by the financial crisis and the recession.

Hoenig didn't comment on the broad outlook for interest rates and the U.S. economy, but he did suggest that loans were likely to pick up again as the recovery firms.

"The good news, such as it is, is that the market is slowly correcting and credit growth is or will begin flowing to Main Street, providing job growth and economic recovery," Hoening said. "However, it will not be rapid and I fear it will not be easy."

The Fed last week kept short-term interest rates at a record low near zero to support the economy's recovery. The central bank pledged to keep rates close to zero for an "extended period," which means at least several more months. Hoenig disagreed with maintaining that pledge, fearing it could set the stage for asset price bubbles.

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