June 12 (Bloomberg) -- The Federal Reserve is likely to emerge as the most powerful regulatory agency in the Obama administration’s plan for overhauling financial market oversight, people familiar with the proposal said.

Treasury Secretary Timothy Geithner told Chairman Ben S. Bernanke in a June 9 meeting the administration will call for the Fed to be the regulator of firms deemed too big to fail, one of the people said. While a council of regulators would share oversight of financial risks, Treasury officials describe it as weak, lacking power to make final decisions on intervening with the firms, the people said.

The proposal is just the first step in what may become the biggest revamp of U.S. financial rules in seven decades, and will be subject to intense debate in Congress, analysts said. Its focus on the Fed clashes with rising skepticism among some lawmakers as to whether the central bank has appropriately used its emergency lending powers during the crisis.

“No matter what Treasury proposes next week, Congress is going to play a very heavy hand in this,” said Camden Fine, president of the Independent Community Bankers of America, a Washington trade group. “It’s a fluid situation and it will remain fluid.”

Bernanke came under fire at a House Oversight Committee hearing yesterday for his role last year in what some legislators said was pressuring Bank of America Corp. to complete its takeover of Merrill Lynch & Co.

New Fed Lobbyist

The central bank has hired a former aide to President Bill Clinton’s three Treasury secretaries, Linda Robertson, to help bolster its public image and plot legislative strategy as Congress debates the regulatory changes. Robertson served as a lobbyist for Enron Corp.

In President Barack Obama’s plan, scheduled to be released June 17, the Fed is also expected to retain supervisory authority over bank holding companies and the state-chartered banks it currently regulates, the people familiar with the matter said.

Asked yesterday whether the Fed or a council should be the regulator for systemically important banks, House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said: “We’re still talking about that.”

Under the administration plan, the central bank would lose its responsibilities for some issues relating to credit cards, mortgages and financial education to a newly created consumer protection agency, the people said.

SEC’s Role

The Fed’s gain in the Obama plan is unlikely to erode the role of the Securities and Exchange Commission in regulating money managers, brokerage firms and stock exchanges.

SEC Chairman Mary Schapiro left the June 9 meeting with Geithner, the former president of the Federal Reserve Bank of New York, and Bernanke increasingly confident her agency wouldn’t lose its current responsibilities, people familiar with the matter said.

The administration had earlier discussed stripping the SEC of its authority over mutual funds, people familiar with the matter said last month.

The proposal to give the Fed enhanced duties has also drawn criticism from former regulators, who say the central bank failed to curtail business practices that triggered billions of dollars of losses at financial institutions after the U.S. mortgage market collapsed in 2007.

‘Should Be Fired’

“If the Fed hasn’t been worried about systemic risk all these years, then people really should be fired,” former SEC Chairman Richard Breeden told lawmakers in March. “Rather than simply calling for more authority for people who didn’t use the authority they already had, we need to reexamine why our regulators missed so many of the risks staring them in the face.”

Citigroup Inc., whose primary regulator is the Fed, has received $45 billion in government cash injections after loans made to less-creditworthy homebuyers defaulted and the bank had to bail out investment funds set up to hold higher-risk mortgage securities off its balance sheet. The Fed conducted routine inspections and examinations of the New York-based bank.

In the Merrill controversy, Bank of America Chief Executive Officer Kenneth Lewis told New York state investigators earlier this year that Bernanke and Former Treasury Secretary Henry Paulson pressured him to complete the purchase even as Merrill’s spiraling losses posed risks to Bank of America and its shareholders.

At the House hearing yesterday, some lawmakers alleged the Fed overstepped its authority. In one Dec. 20 e-mail released by the committee, Richmond Fed President Jeffrey Lacker wrote that Bernanke planned to “make it even more clear” that if Bank of America tried to back out of the deal “and they need assistance, management is gone.”

In an April letter to Representative Dennis Kucinich, chairman of the oversight panel’s domestic policy subcommittee, Bernanke said the Fed “acted with the highest integrity” during its discussions with Bank of America on Merrill Lynch and didn’t seek to withhold any information from the public.

To contact the reporter on this story: Robert Schmidt in Washington at rschmidt5@bloomberg.net; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

Last Updated: June 12, 2009 00:01 EDT