The US financial system still needs at least $1 trillion to $1.2 trillion of tangible common equity to restore confidence and improve liquidity in the credit markets, Friedman Billings Ramsey analyst Paul Miller said.

Eight financial companies -- Citigroup Inc, Morgan Stanley, Goldman Sachs Group Inc, Wells Fargo & Co, JPMorgan Chase & Co, American International Group Inc, Bank of America Corp and GE Financial --  are in greatest need of capital, he said.

"Debt or TARP capital is not true capital. Long-term debt financing is not the solution. Only injections of true tangible common equity will solve the current crisis," he said in a note.

Currently, the US financial system has $37 trillion of debt outstanding, he noted. Combined, these eight companies have roughly $12.2 trillionof assets and only $406 billion of tangible common capital, or just 3.4 percent, the analyst said in his note to clients.

Miller said these institutions need somewhere between $1 trillion and $1.2trillion of capital to put their balance sheets back on solid ground and begin to extend credit again, given their dependence on short-term funding and the illiquid nature of their asset bases.

Since the summer of 2007, Wall Street has been hammered by a sharp pullback in debt markets, which began with mortgage woes and escalated into a credit crisis, slowing economic activity around the world.

The bulk of the capital will have to come from the US government, Miller said. The government needs to take the initial steps to begin the process, and private capital and earnings can finish the job.

"The quicker the government acts, the sooner the financial system can work through its current problems and begin to supply credit again to the economy," he said.

The US government must declare a bank-dividend holiday and convert the TARP funding into pure tangible common equity to get the credit markets functioning.

Also, the government should support a centralized CDS clearinghouse that backstops all transactions and eliminates the cross-default problem, the analyst said.

Top US financial regulators said on Friday they were working on developing a centralized clearinghouse for credit default swaps, the exotic instruments that have exacerbated the financial crisis of recent months.

The weakened economy and global credit crisis had pushed the US government into bailing out companies including insurer AIG, investment bank Bear Stearns, and mortgage companies Fannie Mae and Freddie Mac.

Regulators have also shown a willingness this year to intervene when banks appeared to struggle. They pushed Wachovia Corp into finding a buyer and arranged for JPMorgan to buy Washington Mutual Inc's banking assets after worried customers began to yank deposits.

Miller, however, said it could take three to five years for the financial system to fix itself completely, with adequate capital and appropriately priced interest rate and credit risk.  -Reuters