UPDATE 4-Bailout bill also lets US govt buy bank shares

(changes dateline to PROVIDENCE; new throughout)

By Svea Herbst-Bayliss and Scott Malone

PROVIDENCE, R.I., Oct 6 (Reuters) - The $700 billion bailout law to help Wall Street gives the U.S. government the option of buying preferred stocks from ailing financial companies, the head of the U.S. House Financial Services Committee said on Monday.

"We can buy these preferred shares and if a company becomes more profitable, you (taxpayers) will get a share of that as well," Rep. Frank, a Massachusetts Democrat, said.

He declined to say which companies might be among the pool the Treasury will choose from.

Blaming lax regulation for the worst U.S. financial crisis since the Depression, Frank also vowed to police banks and even hedge funds more actively to avoid future financial meltdowns.

U.S. stocks plunged to their lowest level in about four years at one point on Monday, amid fears the widening credit crisis would drag the global economy into recession.

Frank said the stock market is not a good short term indicator of how the bailout is perceived and how it will work. Given last week's disappointing U.S. jobs data, Frank said a sharp stock market drop is understandable.

Frank has been credited with largely shaping the $700 billion bailout bill that President George W. Bush signed into law on Friday. Wall Street has focused on provisions in the law that let the U.S. Treasury Department buy toxic mortgage-backed securities from financial institutions, but the law also allows the government to take another approach and buy stakes in distressed financial companies, he said.

Next year's agenda in Congress will include capping runaway executive compensation, imposing restrictions on certain complex financial products and regulating certain areas of the market that currently are not restricted, Frank said.

"It was the lack of regulation that led to this crisis ... We have to step in and impose regulations that will not allow this to happen again," Frank said at a lecture at Brown University in Providence.

Earlier in the day, Frank spoke to journalists in his congressional district in Newton, Mass. There he promised to hold hearings on hedge funds, the loosely regulated portfolios that have been blamed for accelerating the financial crisis by having invested heavily in both mortgage-backed securities plus the insurance contracts investment banks tried to write on them.

But Frank said he had no plans to regulate hedge funds as entities but concentrate instead on regulating the activities or markets they have been active in.

"We are going to go to these hedge funds and say you have to meet capital requirements and we are going to make these credit default swaps be traded on an exchange," Frank said at Brown University.

The Securities and Exchange Commission has tried to put the $1.9 trillion hedge fund industry on a tighter leash in the past without much success. He said on Monday that the Federal Reserve would be best suited to monitor markets that hedge funds often trade in.

Frank also said that the cost of the bailout package designed to avert a deep global recession will be far lower than the $700 billion authorized last week. In fact the taxpayer may even have to pay nothing for it, Frank said declining to put real numbers on the deal.