Amid the frenzy in Congress over health-care reform, the Obama Administration and key lawmakers have moved to jumpstart action on another major initiative: Reforming regulation of financial markets. 

But since their release in June -- and since overshadowed by the health-care battle -- many of the President’s financial regulation proposals have come under heavy fire -- not only from the financial-services industry and conservative critics, but also from fellow Democrats, other regulators and even former Federal Reserve Chairman Paul Volcker, one of the President’s top economic advisors.

That combination has sent the President and reform supporters scrambling to reclaim the political and public relations advantage in the debate while forcing the Administration to signal some early compromises. The outcome will frame the financial system’s ability to handle future shocks -- and how much government help it will get the next time, if any. 

“Those of us who have opposed this all along are making progress,” said Peter Wallison, a former general counsel at the Treasury Department in the Reagan Administration and now a fellow at the American Enterprise Institute. He argues that existing government policies created the current crisis and that the Administration’s proposals would only encourage new ones.

“Congress can’t go back to the American people and say ‘business as usual,’" countered Elizabeth Warren, the Harvard University professor who chairs the Congressional Oversight Panel of the Troubled Asset Relief Program, the $700 billion financial bailout Congress approved in October. 

Hearing It Out

On Wednesday, the House Financial Services Committee kicks off a run of 11 hearings over three weeks on regulation reform. At the first hearing, Treasury Secretary Timothy Geithner will make his boss’s case for his proposals, which can be viewed here.

Financial industry sources say that in the Senate, banking committee chairman Sen. Christopher Dodd (D-Conn.) is negotiating with the panel’s top Republican, Sen. Richard Shelby  (R-Ala.), on a bipartisan “framework” for moving forward on new regulations for Wall Street and the banking system. 

The President has been teeing up the next push for reform. On Wall Street last week, he gave a major speech on the financial crisis and argued for his reform plan. His weekly address on Saturday focused on both topics as well. And he has been talking up the topics in recent media interviews.

“Not surprisingly, lobbyists for big Wall Street banks are hard at work trying to stop reforms that would hold them accountable and they want to keep things just the way they are,” the President said Saturday. “But we cannot let politics as usual triumph so business as usual can reign. We cannot let the narrow interests of a few come before the interests of all of us. We cannot forget how close we came to the brink, and perpetuate the broken system and breakdown of responsibility that made it possible.”

Dodd and the chairman of the House Financial Services Committee, Rep. Barney Frank (D-Mass.), hope to complete financial-regulation legislation by the end of the year. Both panels have already held hearings on it. On Monday, Treasury announced Geithner would meet with Dodd and Frank on Tuesday “to discuss the Administration’s proposals for financial regulatory reform.”

Extending the Timeline

But financial industry sources say that with Congress battling over health care as well as trying to finish action on the President’s 2010 budget, the deadline for financial reform could slip into next year.

“It’s a very complex bill and health care is ahead of it line,” Warren said.

But one financial-industry lobbyist who didn’t want to be identified because he has business pending before the committees, believes the initial urgency for reform has waned with time and a recovering stock market.

“It’s tied to the value of 401[k]’s,” he said. “Unlike health care, which is a kitchen-table issue, this one’s not… I just don’t think the average American cares.”

Still, representatives for the financial-services industry and consumer-advocacy groups have been waging a quiet but furious fight over the legislation.

The top target for both: the Administration’s proposal for a new Consumer Financial Protection Agency, which would regulate the sales, marketing -- and in some cases, even the structuring -- of credit cards, mortgages, home equity loans and other financial products.

Among other things, the agency would require firms to offer them in “plain vanilla” versions, with common, basic terms and conditions, and sell them using easy-to-understand marketing materials. 

Consumer groups say the CFPA would help protect consumers from sales of confusing, complicated or unsuitable financial products such as some types of exotic subprime mortgages.

But many banks, particularly community banks, say complying with rules from a new agency would raise their regulatory costs and burdens; limit products and services; and make it harder for them to compete against large rivals. 

 “We are eager to work with you to fill the gaps in consumer protection,” six community banks executives wrote Geithner in an August letter. “We believe that that CFPA would do little to fill those gaps. We are very worried, however, that the proposal would instead hurt the ability of community banks to provide the high level of service that is our hallmark and the key to our success.” 

Some consumer advocates -- and even some industry lobbyists -- believe approving the CFPA is a political no-brainer for incumbent politicians heading in to Congressional midterm elections next year.  

More Power for the Council?

But as previously reported, one compromise some bankers are pushing is vesting new consumer financial protection powers in a council of financial regulators.

The Administration’s plan already includes creating a Financial Services Oversight Council to monitor big, integrated, “systemically significant” financial firms whose failure could threaten financial stability. Members of the oversight council would include the Treasury secretary, the chairman of the Federal Reserve, the chairman of the Securities and Exchange Commission and other regulators.

“You’re creating this council anyway,” said Wayne Abernathy, executive vice president for the American Bankers Association. “Why not have the council put together the [consumer] programs?”

He added that the ABA would also support Congress directly increasing consumer protection powers at the existing agencies as an alternative to the CFPA.

Abernathy said there is “a lot of talk” about the ABA’s proposals in Congress. Because of their widespread presence in states and Congressional districts, community bankers are among Washington’s most powerful business lobbies.

Travis Plunkett, legislative director for the Consumer Federation of America, criticized bankers for using “old, tired, failed arguments” to block the CFPA. But he also acknowledged bankers are “getting some traction” with lawmakers in their criticisms of the proposal.

The Administration’s proposed structure for a financial oversight council is itself on shaky ground.

Under the President’s plan, the Fed would be the government’s big power player. The council would “advise” the Fed in identifying large, interconnected financial holding companies like Citigroup (C), Bank of America (BAC) and American International Group (AIG) that could wreck the entire financial system if they failed.  At the same time, the Fed would have primary authority to supervise such firms, including their capital levels, liquidity and risk management practices.

Frustrations With the Fed

Fed officials have not overtly, publicly lobbied for the job.  But they have said that, given the rescue programs and actions the central bank launched during the financial crisis under its existing emergency powers, the Fed became the “de facto” supervisor of such firms and has the staff and experience for the role.  (While the Administration agrees, it also proposed giving the Treasury Department veto power over Fed emergency-lending activities in a future crisis.) 

But some lawmakers, including Dodd and Shelby on the Senate Banking Committee, are reluctant to approve additional powers for the Fed. They say it contributed to the financial crisis through sometimes lax regulation and by keeping interest rates too low for much of the early part of the decade, which they say helped fuel the housing bubble.

And in what some analysts regard as a standard Washington turf war, some of the Fed’s fellow regulators have opposed giving it new, consolidated powers.

Other critics also worry that the proposed oversight structure would create an ongoing “too big to fail” regulatory regime that, rather than limiting excessive risk-taking by firms, would facilitate it.

Paul Volcker, chairman of the President’s Economic Recovery Advisory Board and is himself a former Fed chairman, is in this camp.

“I do not share one part of the general philosophy which seemed to emerge from this, particularly the proposal that the Federal Reserve supervise directly all ‘systemically important’ institutions,” he said in an interview in July with a former Fed colleague. “I don’t know what ‘systemically important’ institutions are, incidentally, but I’m sure that if you picked them out, people will assume they’re going to be saved, that they’re too big to fail. At the same time, there’d be some that you don’t pick out in advance that you’d want to save under particular circumstances. So I think that is a mistake.”

You can read the entire Volcker interview here.

On Saturday, Dodd made his move against the Fed-centric White House plan, proposing instead to merge the Fed with the Office of Thrift Supervision, the Federal Deposit Insurance Corporation and the Comptroller of the Currency into one “superagency.” Dodd has said he is hoping to prevent “shopping” for the most lenient regulator by financial institutions, something critics say helped bring about the financial crisis.

(The Administration had considered and rejected this idea, determining that it would be too politically difficult to pull off. In its reform plan, it only went as far as proposing a merger of the OCC and the OTS, after the OTS was widely criticized for the failures last year of Washington Mutual and IndyMac on its watch.)   

In a statement on the Dodd announcement, a Treasury spokesperson said, "President Obama and Senator Dodd share a commitment to passing a bill that will usher in a stronger regulatory structure that closes loopholes, focuses on systemic risk and creates a more robust regulatory agency on behalf of consumers. We recognize there will be many ideas put forward and we look forward to continuing to work with the leadership of the Senate Banking Committee and the House Financial Services Committee to get a bill done that accomplishes those goals this year."

A spokesperson for Frank did not respond to requests for comment.

“The idea of making the Fed the systemic risk regulator is dead,” Wallison said bluntly.

The Administration has also proposed new powers for regulators to take over, close and sell off the assets of failed institutions as an alternative to the bankruptcy process. The White House and financial supervisors feel bankruptcy can be a riskier, more disruptive process, as was the case of the bankruptcy of Lehman Brothers last year, which basically shut down the credit markets and sent the financial industry into a tailspin. 

Under the Administration’s plan, the Treasury could move to “resolve” a failing firm with joint approval of the Fed and FDIC, in the case of a firm with more bank assets; or with the approval of the SEC, in the case of a firm with more assets of a securities broker-dealer.  Depending on the assets, the FDIC or SEC would take over the firm and wind it down.

In addition, the Administration has proposed new oversight of derivative products such as so-called credit default swaps, which sank AIG last year, forcing the government to take control of it, and rocked many other financial companies. The SEC and the Commodities Futures Trading Commission have already agreed on a general plan for sharing the responsibility of derivatives regulation.

Also, the Administration has pledged to outline its plans for mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) in its 2011 budget, which it is scheduled to send to Congress in February. The government took them over last year, too, as the housing crisis worsened.  

While the White House, lawmakers and regulators continue to hash out details of how to structure new rules for banks and Wall Street, Administration officials are confident they will win Congressional approval of new consumer-protection powers, stronger systemic risk oversight and failed firm resolution authority.

Elizabeth Warren agrees.  “There is pressure” on politicians in Washington to support “substantial” reform going into midterm Congressional elections next year, she said.

“It’s political opportunity… every challenger will bring this up” in every race in which an incumbent did not support reform, she predicted.