WASHINGTON (Reuters) - Lawmakers in the U.S. House of Representatives' voted on Wednesday to give government regulators the power to break up financial firms that threaten economic stability, and to expose the Federal Reserve to unprecedented congressional scrutiny.
In a milestone for the Obama administration's push to tighten bank and capital market oversight, the House Financial Services Committee approved a bill to rein in firms seen as "too big to fail" and prevent future taxpayer bailouts like last year's rescues of AIG (AIG.N) and Citigroup (C.N).
Smaller community banks praised the bill, headed next week for consideration on the floor of the House, with Senate debate over financial regulation reform likely going well into 2010.
The House bill would "create a more equitable financial system and hold too-big-to-fail firms accountable for the risks they pose," said Camden Fine, president of the Independent Community Bankers of America, a lobbying group.
Big financial firms attacked it. "This bill will stifle creativity and the free-flow of ideas and capital," said Scott Talbott, a lobbyist for the Financial Services Roundtable, a group representing giants such as Bank of America (BAC.N).
To try to head off "too big to fail" problems early, the House bill proposes a system of increasingly restrictive rules for large, high-risk firms, leading potentially to government-ordered restructurings, divestitures or break-ups.
For firms that get into trouble anyway, even after being hit with stricter rules, the bill would set up a "resolution" process for orderly shutdowns that avoid market panics and avert the need for future taxpayer bailouts.
But the most controversial part of the bill may be an amendment added recently that would subject the Fed's monetary policy for the first time to congressional watchdog audits.
Fed Chairman Ben Bernanke said in a rare newspaper opinion piece last weekend that the measure would undercut the central bank's independence. Officials have warned it could spook investors, raising borrowing costs and harming the economy.
Representative Barney Frank told reporters on Wednesday he does not expect changes during House floor debate to the Fed audit provision. "At this point, my guess is that it will not be changed," said Frank, a Democrat, after closing a meeting of the House Financial Services Committee which he chairs.
Frank had earlier said the Fed audit provision, amended to the bill last month, might be altered on the floor.
Frank's committee voted 31-27, largely along party lines, to approve the sweeping systemic risk bill at the meeting.
It was the seventh major financial regulation bill approved this year by the House panel. Others call for tougher oversight of credit rating agencies, derivatives, executive pay and hedge funds, and stronger consumer and investor protections.
The committee also voted on Wednesday to approve a bill that for the first time would set up a federal government office to monitor the insurance industry, but not regulate it.
The Federal Insurance Office would be part of the Treasury Department. It could recommend heightened regulation of insurers seen as posing systemic risk to the economy, while also representing U.S. interests in international forums.
But it could not preempt state insurance laws, except in limited cases involving international agreements, largely preserving state-by-state regulation of the industry.
The insurance bill and the seven others will be swept together into a package for a vote by the full House. Frank said he hoped that could come as soon as late next week.
Financial regulation reform is a high priority for President Barack Obama and congressional Democrats.
A parallel effort is under way in Europe, where EU ministers on Wednesday reached a deal to set up three pan-EU super-watchdogs to police banks, insurers and financial exchanges, subject to European Parliament approval.
The U.S. reform push has a long way to go and faces stiff opposition from Republicans and an army of bank lobbyists working hard to defend leading financial firms' profits.
The Financial Services Committee's votes came minutes after Treasury Secretary Timothy Geithner urged the Senate Agriculture Committee to take a firm hand in regulating the free-wheeling over-the-counter derivatives market.
Geithner said it was "imperative" that the Commodity Futures Trading Commission and Securities and Exchange Commission get powers to proactively require central clearing of derivatives, even those not now accepted for clearing.
Later, the chief U.S. futures cop said OTC derivatives trading should move onto exchanges, even if Congress decides some swaps do not have to go through clearinghouses.
CFTC Chairman Gary Gensler told a House panel "all standardized OTC derivatives transactions should be moved onto regulated transparent exchanges or trade execution facilities.
Additional reporting by Charles Abbott, Mark Felsenthal,Rachelle Younglai; John O'Donnell, Julien Toyer in Brussels