June 26 (Bloomberg) -- Chairman Ben S. Bernanke’s grilling by legislators over Federal Reserve conduct in Bank of America Corp.’s takeover of Merrill Lynch & Co. may reduce the odds the central bank will win new powers in a regulatory overhaul.

Bernanke failed to resolve some lawmakers’ questions on whether the Fed bullied executives and stepped over other regulators in the name of financial stability in a three-hour congressional hearing yesterday. Republicans asserted the Fed interfered with commercial decisions, and Democrats said it should have wrung more concessions in return for taxpayer aid.

Criticisms by members of both parties are likely to diminish support for the Obama administration’s plan to make the Fed the single agency responsible for the largest and most interconnected financial institutions. The proposal, part of a broad revamp of bank regulation, would give the Fed power to dictate standards on capital, liquidity and risk management.

“It may be more important for us to find another systemic risk regulator,” Representative Paul Kanjorski, a Pennsylvania Democrat and member of the House Oversight Committee where Bernanke appeared, said in a Bloomberg Television interview after the hearing. Congress should “hesitate to put any more authority on the back of the Federal Reserve,” he said.

Representative Darrell Issa, the ranking Republican on the House panel, said the Fed’s actions “ought to be a note of caution to those who want to dramatically increase its power and authority.”

‘Highest Integrity’

Bernanke told the House Oversight Committee that Fed actions helped avert a financial meltdown that would have produced a “Depression-like environment” even more severe than the current recession. It acted with the “highest integrity” in talks on Bank of America’s acquisition of Merrill, he said.

His performance wasn’t enough to convince some lawmakers.

“There’s something rotten in the cotton here -- no ifs, ands or buts about it,” Representative Edolphus Towns, a New York Democrat who chairs the House Oversight Committee, told reporters after the hearing. “There was a forced situation, a shotgun wedding” and “we’re just trying to find out who had the shotgun.”

Still, no congressional leader has drawn a connection to prospects for Bernanke’s renomination, and Robert Gibbs, the White House press secretary, yesterday said President Barack Obama “has confidence” in the Fed chief.

Valerie Jarrett, an Obama senior adviser who previously served on the Chicago Fed’s board of directors, said today on CNBC that Bernanke “did very well” in yesterday’s hearing. She declined to discuss Bernanke’s reappointment.

‘Fine Job’

Obama said in a news conference earlier in the week that the Fed chief has “done a fine job under very difficult circumstances.” He declined to answer a question about whether he would reappoint Bernanke, whose term ends in January.

Issa also said, referring to Bernanke in a Bloomberg Television interview, that on monetary policy “I think he will be judged fairly.” Assessing the emergency actions by Bernanke, former Treasury Secretary Henry Paulson and other top officials, he said, “I’m sure that they will get a C or better.”

The Fed chairman is a Great Depression scholar who has pioneered research on how financial systems can worsen economic downturns. He has told Congress that the Fed’s emergency actions were aimed at saving average citizens on Main Street rather than Wall Street bankers. Bernanke and Paulson successfully lobbied Congress to use $700 billion of taxpayer funds to support the largest U.S. banks.

Lawmakers from both parties, while praising Bernanke’s dedication to ending the financial turmoil, have questioned the central bank’s use of emergency powers and supervisory authority during the crisis.

Emergency Loans

The Fed’s emergency loans helped expand the balance sheet by $1.13 trillion over the past year to $2.03 trillion. The Obama plan would check that authority, requiring the central bank to obtain written permission from the Treasury before making such loans. The Fed announced yesterday that it will let one of its emergency programs expire and trim two others in a first step toward ending its unprecedented interventions.

The hearings also raise questions about whether the Fed can simultaneously supervise big financial institutions while steering the economy toward full employment and low inflation. In the U.K., financial regulation and monetary policy are handled by separate institutions.

At the hearing yesterday, Representative Dennis Kucinich, a Democrat from Ohio, read what he said was an e-mail from Boston Fed President Eric Rosengren to Bernanke suggesting that the Fed chief not rule out removing top executives.

“‘The U.K. replaced senior management’” of the Royal Bank of Scotland Group Plc, Kucinich said, reading what he said was an e-mail written by Rosengren. “‘The bank is maintaining operations without significant disruptions. I would not want to discard this option.’”

Government Bailout

RBS ousted Chief Executive Officer Fred Goodwin in October and turned over control to the government in exchange for a bailout. Goodwin presided over the biggest loss in U.K. corporate history following the acquisition of ABN Amro Holding NV.

Bank of America Chief Executive Officer Kenneth Lewis told the House committee earlier this month that he decided to proceed with the takeover of Merrill after regulators said they might remove management and because his company’s future was “intertwined” with Merrill’s fate.

Bernanke said at the hearing yesterday he didn’t threaten Lewis that he’d be fired if the bank withdrew from the Merrill deal.

The Fed chairman has “probably spent a week or 10 days preparing for this, which is not his job,” said Scott Pardee, a former New York Fed official who now teaches at Middlebury College in Vermont. “Having the chairman of the Federal Reserve in the middle of this diverts from the basic monetary policy job that he has to do.”

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Craig Torres in Washington at ctorres3@bloomberg.net

Last Updated: June 26, 2009 10:05 EDT