WASHINGTON–Key senators were close to a deal on legislation to overhaul financial regulations, people familiar with the matter said, bringing the U.S. a step closer to sweeping changes to the way banks interact with consumers and the markets alike.
Top senators from each party were near a breakthrough agreement to create a new consumer-protection division within the Federal Reserve. This has been a contentious point due to heavy criticism of the Fed's past handling of its consumer-protection powers.
Senators Christopher Dodd (D., Conn.) and Bob Corker (R. Tenn.) were conferring with other members of their parties last night in an effort to sell that agreement to them, Senate aides said.
The two senators have also reached a deal that would let the federal government break up large, failing financial companies.
That plan tackles one of the most politically thorny flashpoints of the economic crisis: What powers should the government have to break up firms so it doesn't have to resort to taxpayer-funded bailouts?
Agreements on these details are expected to shape a bill that Sen. Dodd, chairman of the Banking Committee, plans to introduce in the Senate. The House of Representatives passed a bill overhauling financial-market rules in December. Differences between the two packages would have to be reconciled before any final agreement could be signed into law by President Barack Obama.
It is unclear whether White House officials would accept the idea to create a new consumer-regulation unit within the Fed. "The president remains strongly committed to an independent agency whose singular focus is advocacy for consumers," an administration official said.
The deals are the closest the bitterly divided Senate has come to an agreement on new financial rules. Mr. Dodd will likely have to make a hard sell on any plan to give the Fed new powers to police the way mortgages and other products are offered to consumers. He has been one of the Fed's biggest critics and routinely blasted the central bank for failing to enforce the consumer-protection powers it already has.
"Senator Dodd is keeping members informed on how things are progressing as he has throughout this process," his spokeswoman said. "We do not have an agreement yet. He hopes to have a consensus bill in the coming days."
If lawmakers feel they have enough agreement, Mr. Dodd could introduce his bill later this week and potentially hold a vote in his committee later in the month. If other lawmakers balk at agreements between Messrs. Dodd and Corker, it could make it tougher for them to pass legislation this year.
Democrats and Republicans have remained bitterly divided over how best to rework consumer-protection rules.
President Obama has called for the creation of an independent Consumer Financial Protection Agency, which would write and enforce rules for any financial product, from mortgages to credit cards to payday loans.
Many Republicans criticized that idea, saying it would freeze up access to credit and create an unwieldy bureaucracy. Many Republicans said new consumer rules would be best placed within the regulator that oversees nationally chartered banks.
Mr. Dodd, in an effort to get a deal, last week suggested the creation of a new division within the Treasury Department, but Mr. Corker rejected that.
Instead, he proposed creating a new division within the Fed. The division would be led by a White House appointee, have the ability to write and enforce rules, and have a separate budget. It would also give the Fed a more direct mandate to focus on consumer-protection issues.
This could dramatically reshape the focus of the Federal Reserve. For years, it has primarily been focused on monetary policy over bank supervision and often made consumer protection an afterthought.
Republicans might be more supportive of the Fed option because they might see having Fed officials involved could lead to more bank-friendly policies than an independent regulator.
But it could also reignite an anti-Fed sentiment that has rocked the central bank in the past year, at one point threatening the reconfirmation of Fed Chairman Ben Bernanke.
While the consumer-protection piece has been the most divisive for Senate lawmakers, creating powers within the government to take over and break up failing firms is seen as a vital piece to White House and Treasury officials.
They have complained that the government was handcuffed during the 2008 bankruptcy of Lehman Brothers and the near-collapse of American International Group Inc. Existing law lets the Federal Deposit Insurance Corp. take over failing banks, but its powers don't extend to other types of financial companies.
Sen. Mark Warner (D., Va.) and Sen. Corker agreed to details of that arrangement on Feb. 23 after months of meetings, but details of the deal hadn't been announced.
The new arrangement, if adopted into law, would create a type of bankruptcy process for failing financial companies that aren't banks, such as bank-holding companies or bank subsidiaries that don't have insured deposits. Regulators would have the option to force any financial company into a FDIC-controlled dissolution if they believed market chaos required such an extreme step.
Under the proposal, this step could take place only after the agreement of the Federal Reserve's board, a council of regulators, and the Treasury secretary, in consultation with the president.
Messrs. Warner and Corker have said they wanted to create a process that was so painful for investors and management that no one would intentionally steer their company toward such a break-up and the government wouldn't be seen as a fail-safe for reckless behavior.
The new deal would wipe out shareholders and give the FDIC the power to remove management. Creditors would be guaranteed only the liquidation value of their claims in bankruptcy, though they could receive more under some circumstances.
Lawmakers debated for months how to pay for such a system. Treasury officials argued the government should be able to provide a bridge loan to unwind the company. Critics of that arrangement said it equated to a taxpayer-funded bailout
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