The U.S. economy is showing signs of recovery from a brutal 20-month recession, but the regulatory steps proposed by the Treasury Department to date fall short of what's necessary to prevent another meltdown in the financial sector, the president of the Federal Reserve Bank of Minneapolis said Thursday.

Speaking at an annual business leaders luncheon hosted by the Helena Branch of the Minneapolis Fed, President Gary Stern said that while data is still mixed, there are signs the economy is poised to move from recession to growth.

"There now are in fact signs of stabilization in consumer spending, manufacturing activity, and various measures of residential real estate activity, including the volume of home sales and starts of single-family units," Stern said.

Stern, who is retiring later this year after 24 years as president of the bank, noted that businesses have adjusted their inventories enough to meet the subdued level of demand, which should spur hiring and other business spending, and that credit is now generally more readily available to businesses and households than it was just a few months ago.

He warned, though, that the problems created by the government bailing out banks deemed "too big to fail" haven't been sufficiently addressed.

Stern said that creditors of some of the largest and most complex financial institutions have an expectation that they will be protected in the event that the institutions fail.

"As a consequence, they had at most modest incentive to be concerned about the condition and prospects of these large institutions, leading to underpricing of risk-taking in the marketplace," he said. "With risk underpriced, these institutions took on excessive amounts of it, leading eventually to the precarious position of some of them."

Stern advocates a program of oversight called "systemic focused supervision" that would identify at an early stage when a firms' exposure to each other and to other markets could spill over in a dangerous way; encourage "prompt corrective action" as banks' financial conditions deteriorated; and provide better communication with uninsured creditors, so they'll be aware that losses may be forthcoming.

Stern does not expect inflation to become a problem in the near future. While acknowledging that the Fed's balance sheet has grown from $1 trillion 10 months ago to more than $2 trillion today, the Fed can withdraw liquidity from the economy and shrink its balance sheet as well. The challenge, he said, is knowing when to shift toward reducing the money supply -- but most countries in recent decades have had success with this timing.

"It appears that central banks have largely succeeded in delivering diminishing and, ultimately, low inflation," he said. "I can think of no reason why this cannot continue."

Stern is the longest-serving member of the Federal Open Market Committee, which sets the benchmark interest rates that guide much of the economy. He's currently a nonvoting member of the committee.

The Minneapolis Fed is one of 12 Federal Reserve Banks in the country, and Helena is its lone branch. The region includes Montana, the Dakotas, Minnesota, northern Wisconsin and the Upper Peninsula of Michigan.

John Harrington: 447-4080 or john.harrington@helenair.com