Economist Paul Volcker gave a sobering assessment of the global financial situation last night, saying difficult fiscal and economic adjustments are necessary to rebuild the world economy.

Volcker was at Stanford to receive the inaugural Stanford Institute for Economic Policy Research (SIEPR) prize for contributions to economic policy.

The time we have is going short, Volcker said, and the United States needs to adopt a sense of urgency as its government tries to tackle the fundamental problems that led to a recession.

Volcker, 82, a former chairman of the Federal Reserve under Presidents Carter and Reagan and current chairman of the President’s Economic Recovery Advisory Board, has now taken a role as the wise man of the global financial system, and was lauded as such by the institute.

“What do we need in public life right now?” asked George Shultz, Hoover Institution fellow, chairman of the committee that awarded Volcker the prize and the U.S. Secretary of the Treasury under President Nixon. “We need Paul Volcker.”

Shultz and Volcker both served under President Reagan, Shultz as Secretary of State.

When he was chairman of the Fed, Volcker was credited with ending the stagflation of the 1970s. Now, he is advocating a tough regimen of fiscal and economic adjustments to counter years of unrestrained consumption.

“In the United States savings practically disappeared as consumption rose far above past relationships to national production,” Volcker said. “That consumption was satisfied by rapidly growing imports from China and elsewhere in Asia at remarkable cheap prices, helping to keep inflation well subdued.”

Volcker said he knew the remedy to this growing problem would not be concerted policy action, but that it would take a crisis to for real reform to occur.

The financial industry drew sharp criticism from Volcker, who derided its lack of actual economic contribution despite its large profits.

“There was one great growth industry,” Volcker said. “Private debt relative to the GDP nearly tripled in 30 years. Credit default swaps, invented little more than a decade ago, soared at their peak to a $60 trillion market, exceeding by a factor of 10 the amount of the underlying credits potentially hedged against default.”

The ensuing financial crisis, Volcker said, was so deep as to merit the reconsideration of the basic tenets of financial theory, a reconsideration he believes to be absolutely necessary.

But a reconsideration of financial theory is difficult, and building new regulations will be challenging, according to Volcker.

“The fact is the exercise of effective regulatory and supervisory authority is always difficult on a national level, and those difficulties are multiplied when dozens of countries are involved,” he said.

In Washington, Volcker has said the concept of “too big to fail” is one of the fundamental stressors of the financial system. He repeated this point in his remarks on Tuesday, emphasizing the difference between commercial banks, which he said are critical to the economy, and the bloated non-commercial banks he said are stressing the regulatory environment.

The “shadow banking system” that Volcker described was not adequately regulated before the crisis, something he said needs to change.

“To a substantial extent, it was those ‘non-banks’ that were at the epicenter of the crisis,” Volcker said. “Contrary to well-established central bank practices and with active government support, those same institutions received massive assistance to remain viable.”

When the regulatory environment is overhauled, Volcker said, these non banks should be “free to fail.” By letting the banks fail, and denying them opportunities for bailout, the market will discipline them.

The final piece of financial regulatory reform, Volcker said, is to begin answering the serious economic questions that have not yet been satisfactorily addressed.

This includes, in the short run, the United States’ commitment to growing entitlement programs, and in the long run, problems like global warming. All of this must be done in the context of managing a massive national deficit, he said.

For Volcker, the time to act on these issues is now.

“Restoring our fiscal position, dealing with social security and health care obligations in a responsible way, sorting out a reasonable approach toward limiting carbon emissions and producing domestic energy without unacceptable environmental risks all take time,” he said. “We better get started.”