By Richard Cowan

WASHINGTON, March 4 (Reuters) - The chairman of the U.S. Senate Armed Services Committee said on Tuesday he may try to require Iraq to spend more of its oil revenue on reconstruction instead of investing the money in foreign banks.

"What kind of an absurdity is it that we are paying for the reconstruction of Iraq with American taxpayers dollars if Iraqi oil sales, to a significant degree, are going into foreign banks and not being used for their own reconstruction," said Sen. Carl Levin, a Michigan Democrat.

Before the U.S. invasion of Iraq in early 2003, top Bush administration officials suggested some war costs could be financed through Iraqi oil revenues. That never occurred and U.S. taxpayers have instead seen about a half-trillion dollars of their money spent on the war so far.

In the meantime, there are estimates that Iraq has up to $30 billion in assets invested in U.S. financial institutions.

Levin said he would ask Congress' investigative arm, the General Accountability Office, or others in the U.S. government to look into Iraq's use of oil revenues.

He said he would decide after such an investigation whether to use this year's appropriations process to force Baghdad to change its financial practices.

Levin said Congress could condition future war funds on Iraq using its own revenues for reconstruction, reducing the burden on U.S. taxpayers.

According to government estimates, Congress has given the Bush administration $16 billion for reconstruction and relief efforts in Iraq.

"They (Iraq) are selling about $50 billion a year in oil. What are they doing with all the money?", Levin asked.

In December, President George W. Bush announced his intention to veto a defense bill after Baghdad complained about a provision that could freeze Iraqi assets in the United States if Americans sued for actions taken by former Iraqi President Saddam Hussein.

At the time, Iraq also discussed the possibility of pulling its assets, estimated at $20 billion to $30 billion, out of U.S. banks if that defense measure became law.

Levin said that legislative dust-up prompted his look into Iraq's use of oil revenues.

During an Armed Services oversight hearing on Tuesday on U.S. military forces in Iraq, Levin asked William Fallon, the the top U.S. commander for the Middle East, about Iraq paying reconstruction costs.

Fallon said there were some concerns over Iraq's ability to effectively distribute oil revenues.

Levin responded, "I can't accept the answer that they're not capable of administering their own revenues." (Editing by Todd Eastham)

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