UPDATE 2-Dem bill urges new US powers over financial firms

* Financial Services Oversight Council would be set up

* Treasury would head council to monitor, address risks

* Federal Reserve, FDIC would get new authorities

* Obama says bill urgent, crucial (Updates with Obama letter to Frank)

By Kevin Drawbaugh and Rachelle Younglai

WASHINGTON, Oct 27 (Reuters) - The U.S. government would gain far-reaching new powers to regulate, and even shut down, large financial firms that threaten economic stability under a draft bill released in Congress on Tuesday.

Congressional Democrats and the Obama administration agreed on the legislation, which seeks to protect taxpayers from having to pay for more bailouts, while holding financial firms to much higher capital standards.

"No financial system can work effectively if financial institutions and investors operate with the belief that the government will act to protect them from the consequences of their failures," President Barack Obama wrote in a letter to Barney Frank, chairman of the House of Representatives committee on Financial Services on Tuesday.

Under the bill, the Federal Reserve could limit credit exposures, block acquisitions, restrict pay and bonuses and, in extreme cases, order bankruptcy at financial holding companies it finds severely undercapitalized.

The bill states that the Federal Deposit Insurance Corp -- already able to seize and dismantle failing banks -- could extend Treasury Department credit to solvent banks and non-bank financial firms alike to prevent financial instability.

Any losses from FDIC actions would have to be repaid by "assessments on large financial companies," not taxpayers, a provision reflecting public anger over bailouts of firms such as AIG (AIG.N), Citigroup (C.N) and Bank of America (BAC.N)

These firms and many others got billions of dollars in taxpayer aid through a series of confused emergency actions undertaken last year by the Bush administration in response to the worst financial crisis in generations.

For factbox on legislation, click on [ID:nN27270990].

Obama and Democrats have been working for months on a package of proposals to tighten bank and capital market regulation, with a key goal being to prevent a repeat of the 2008 bailouts and the political uproar that followed.

"It is very important that we reach agreement on comprehensive reform as soon as possible so that we can restore confidence among American taxpayers and the world," Obama wrote in his letter to Frank.

"We can and we we must build a stronger financial system, one that is less prone to periodic crisis, one that provides strong protections for consumers and investors, and one in which no firm is 'too big to fail'," Obama said.