Fed shift on U.S. consumer watchdog cuts two ways

WASHINGTON (Reuters) - The Federal Reserve is toning down its rhetoric on the importance of preserving its role in U.S. consumer protection in a double-edged shift for the White House's proposed financial consumer watchdog.

President Barack Obama wants to create a U.S. Consumer Financial Protection Agency. The proposal is central to his plan to overhaul bank and capital market regulation, with the aim of preventing a recurrence of the 2008 banking crisis.

Well into last year, the Fed was outspoken about its objections to the CFPA, which would strip the central bank, and other regulators, of their consumer protection duties and centralize them in a new agency solely devoted to the job.

Lately, however, the Fed has been quieter on the issue. Recent public remarks by Fed Chairman Ben Bernanke have focused on two other fronts: preserving the Fed's role in bank supervision, and shielding its monetary policy independence.

The Fed's recalibration on consumer protection could mean it sees the issue as a losing battle. That would suggest the CFPA has solid momentum in the Senate. But it could also mean the Fed sees the battle as one it need not fight because the CFPA, opposed by bankers and Republicans, has little future.

"Negotiations between the Senate and the Fed are at a critical stage," said Joseph Engelhard, a policy analyst at investment advisory firm Capital Alpha Partners.

The Fed may be willing to concede the consumer protection fight if it means it can shore up its defenses on bank supervision and monetary policy independence, he said.

"The reality is it will be a struggle for them to retain authority over bank holding companies in the Senate," he said.

Such political calculations were thrown into some disarray last week when Senate Banking Committee Chairman Christopher Dodd announced that he will retire at the end of 2010.

DODD: 'SIGNIFICANT DEBATE'

The Connecticut Democrat -- whose committee is the Senate's main forum for handling financial regulation -- has been a strong advocate of the CFPA and a strident critic of the Fed.

He said on Monday in an interview with CNBC that "issues like consumer affairs, consumer protection, ought to be left, in my view, to a more independent solution."

He said: "One of the ideas we have, of course, is a strong, independent consumer protection function. How that's structured is a subject of significant debate within our committee."

The outlook for the CFPA will become clearer in days ahead as lawmakers return from their long holiday recess.

Some analysts expect Dodd will have to settle for a watered down CFPA to reach bipartisan agreement. Republicans squarely oppose the agency.

Dodd hopes his committee will draft and vote on a final financial regulatory reform bill by the end of January.

The U.S. House of Representatives last month approved reform legislation, including a CFPA proposal, although its scope was narrower than the original White House proposal.

The Fed, led by soft-spoken Chairman Ben Bernanke, is under attack on several fronts following the crisis and the deep recession and massive taxpayer bailout that followed. Many lawmakers blame the Fed for multiple misjudgments.

In addition to the CFPA proposal, legislation being offered by Dodd would create a new bank super-cop that would strip the Fed of its bank supervision responsibilities.

A third attack on the Fed's turf was approved last month by the House. As part of its broad reforms package, the House voted to subject Fed monetary policy -- its core job -- to reviews by a congressional watchdog.

MONETARY POLICY NO. 1

The Fed's No. 1 priority is shielding monetary policy deliberations and decisions, said Mark Olson, a former Fed governor now with consulting firm Corporate Risk Advisors.

Its No. 2 priority is maintaining its role as a direct supervisor of bank holding companies, he said.

"They believe there's a very tight link between monetary policy and financial institutions supervision," said Olson, who served as a Fed governor from 2001 through 2006.

Consumer protection is a priority for the Fed, Olson said, but it has a different level of importance. "It does not play into systemic risk in the same way," he said.

When the CFPA proposal first emerged last year, the Fed pushed back. Bernanke acknowledged in congressional testimony in June that the Fed had been late to invoke its consumer protection powers as the real estate bubble was building.

But he said the central bank had been "very aggressive" in the past couple of years on the issue. He said: "It's very important, if the Fed retains those powers, that we strengthen the priority that those have in our decision-making."

He wrote a letter late in July to lawmakers saying, "We believe that prudential supervision and consumer compliance supervision are complementary and should not be separated."

Since then, the Fed has been quieter on the issue, although last week Kansas City Federal Reserve Bank President Thomas Hoenig said in a post-speech Q&A session that stripping the Fed of its consumer protection role "would be a mistake."

The larger question is how many roles the Fed can be expected to play and which roles it has handled well, said David Min, associate director for financial markets policy at the Center for American Progress, a think tank.

"The Fed didn't necessarily do a great job and that gets down to the question of what is their central mandate and their central focus," Min said.

(Editing by Andrew Hay)