Nov. 3 (Bloomberg) -- During one of his first meetings about overhauling U.S. financial regulations in February, President Barack Obama had a question for his economic advisers, who included Treasury Secretary Timothy Geithner and National Economic Council Director Lawrence Summers.

“What about the families?” Obama asked, according to people familiar with the discussions. He then asked them whether they’d read the work of Elizabeth Warren, a Harvard Law School professor and longtime advocate of a national consumer financial protection agency. Michael Barr, a University of Michigan professor who was a Summers aide at the time, jumped in to say he knew Warren’s work.

“Well, what do you think about it?” asked the president, according to the accounts of the conversation.

“I think it’s a great idea,” Barr, 44, replied. The two debated the merits of such an agency during several meetings over the following three days. Then Obama offered Barr, whose own work included research on the borrowing patterns of low- income households, the job of assistant Treasury secretary for financial institutions. He was confirmed by the Senate in May.

Thus an idea that the U.S. banking industry has learned to hate moved a giant step closer to reality. The creation of a consumer protection agency is part of the Obama administration’s plans to enact the most wide-ranging financial regulations since the Great Depression.

Following the 1999 decision to overturn the Glass-Steagall Act that separated commercial banks from securities firms, bank lobbyists have been able to shoot down virtually any proposed rule they perceived as unfavorable to their industry, lobbyists and politicians say.

Campaign Contributions

Banks and securities firms spent $193 million to fund political campaigns for the 2008 elections and raise even more money through events that their trade groups organize. They have successfully fought the administration’s efforts to limit executive pay and are battling against draft legislation governing the $592 trillion market for derivatives.

When it comes to consumer banking, the industry’s lobbyists are no longer all-powerful. Banks lost their bid to squelch new credit card rules that Obama signed into law in May. They lobbied for months before a bill that would have forced them to renegotiate mortgages failed in the Senate.

Now the banks and their trade associations are lobbying furiously to kill Obama’s plan to create the new financial protection agency, which was approved by the House Financial Services Committee in late October and is likely to face a full House vote by the end of 2009.

Influence Lost

The different trade groups that represent the industry are also divided over how they want the bill rewritten. They will now shift their struggle to the Senate, which has yet to unveil its version of proposals overhauling financial regulations.

“Banks have lost their influence on consumer issues,” says Brian Gardner, an analyst monitoring Washington’s impact on financial services for the brokerage firm Keefe Bruyette & Woods Inc. Gardner says banks will retain their clout when it comes to more complex financial issues such as derivatives. “Folks on Capitol Hill still need to talk to the banks for the expertise on highly technical areas,” Gardner says.

Members of Congress who have traditionally been supportive of the banks’ positions are breaking ranks as popular opinion shifts strongly against the institutions. Some 80 percent of the public blames banks and other financial firms for the economic crisis, according to an ABC News-Washington Post poll in March.

“Many members of Congress who have been pro-banking and who have done the banks’ bidding are walking more cautiously since the financial meltdown,” says Representative Maxine Waters, a California Democrat.

Frank’s Priority

Representative Barney Frank, chairman of the Financial Services Committee, says he’s making it his priority to create the new agency to protect consumers.

“The existing structure for consumer protection in the financial area, particularly in the area of bank products, has failed miserably,” the Massachusetts Democrat told a news conference in July.

Frank has gotten $2.1 million in campaign contributions from financial firms over the past three elections, according to the Center for Responsive Politics, a Washington-based research group.

The biggest U.S. banks have a lot at stake. They rely on the relatively stable revenue from consumer lending to balance out the volatility of their investment banking operations. Bank of America Corp., the largest U.S. bank in terms of assets, and No. 3 Citigroup Inc. got almost half of their revenue from consumer lending, including credit cards, in the first nine months of 2009.

Dimon in Washington

Harvard’s Warren says the consumer agency she proposes will affect the larger banks disproportionately: “It may cost the community banks some nickels, but the real impact will be on the big banks’ profit model.”

JPMorgan Chase & Co., the second-biggest U.S. bank, got 48 percent of its revenue from consumer lending in the first nine months of 2009. The bank, which was one of the least scathed by the crisis, has stepped up its lobbying. Chief Executive Officer Jamie Dimon now visits the capital twice a month, meeting with administration officials and congressional leaders, up from twice a year in 2006.

JPMorgan also added two lobbyists to its Washington staff, which includes former Commerce Secretary William Daley. Jill Blickstein, who was previously chief of staff at the Office of Management and Budget in the Obama administration, was one of the new hires.

‘Weakened Position’

Citigroup and Bank of America are both partially owned by the government following the bailouts of 2008, and have cut their lobbying budgets as a result. The two banks spent a combined $6.6 million to lobby in the first nine months of 2009, down 12 percent from a year earlier, according to congressional disclosures they have filed.

“No question that the banks and the rest of the industry are in a weakened position,” says Bruce Thompson, who lobbied Capitol Hill for 22 years on Merrill Lynch & Co.’s behalf. “They used to be able to say, ‘This will hurt us,’ and Congress wouldn’t do it. Now, they laugh at you.”

Waters says she has introduced or sponsored dozens of legislative proposals to rein in banking practices. For example, she proposed a 2003 bill that aimed to prevent predatory lending by increasing the amount of information that banks would have to disclose when offering mortgages. All were blocked by bank lobbying, she says.

“They manage protecting their interests quite well,” she says.

‘Losing Some Battles’

Consumer advocates agree. “We couldn’t get a vote on bills banks opposed,” says Ed Mierzwinski, the consumer program director at the U.S. PIRG, a federation of state public-advocacy groups that lobby for consumer rights. “Now, they’re losing some battles, winning others.”

One fight the banks lost in 2009 was against the creation of a credit card consumer’s bill of rights. The failure came even though financial industry lobbyists, led by the American Bankers Association and the largest individual banks, outnumbered consumer lobbyists by 10 to 1, according to congressional staffers involved in the talks.

Credit Card Bill

The credit card bill, which was first introduced in 2008 by Representative Carolyn Maloney, a Democrat from New York, passed the House and then died in the Senate amid opposition by banks and credit card companies. Christopher Dodd, the Democrat from Connecticut who is chairman of the Senate banking committee, wasn’t forceful enough, some congressional aides say. Dodd has received more than $8.4 million in election contributions from financial firms since 2005, according to the Center for Responsive Politics.

Dodd had introduced several proposals to curb credit card practices in past years and fought the banks’ lobbyists each time, says his spokeswoman, Kirstin Brost. “It took the economic crisis and the 2008 elections for there to be enough support for the bill to be passed this year,” she says.

The financial crisis, and Obama’s election, improved the bill’s prospects. Maloney reintroduced the measure in January, revising it to incorporate elements from Obama’s campaign platform, such as restricting how and when credit card issuers can increase interest rates and late-payment penalties.

Banks Fought Bill

The ABA, along with Bank of America, Citigroup and JPMorgan, argued that the bill would hurt the availability of credit and jack up interest rates on cards. This time around, Dodd followed with a similar proposal cracking down on credit cards himself.

The banking committee chairman was humiliated in March when it was disclosed that a bill he sponsored curtailing pay for executives of firms bailed out by the government made an exception for insurance company American International Group Inc. The company’s derivatives arm is based in Connecticut, Dodd’s home state, and the senator is the largest recipient of campaign contributions from AIG. Dodd said the exemption had slipped in during negotiations without his knowledge.

In the spring of 2009, Maloney’s bill sailed through Congress, getting 357 votes in the House and 90 in the Senate.

Cram-Down Fight

Banks also had to fight hard before they succeeded in blocking the so-called cram-down provision proposed by six senators led by Dick Durbin of Illinois and Chuck Schumer of New York this past spring. The proposal, which would have given judges the right to restructure mortgages during a personal bankruptcy trial, was being considered by some of its sponsors as early as 2007.

After the government bailed out several of the largest U.S. financial institutions in the fall of 2008, interest in the measure grew. Citigroup, which got the biggest U.S. bailout -- $346 billion -- decided to back the cram-down provision, reversing its previous stance. In January 2009, Durbin and Schumer held a news conference together with Dodd to announce the bank’s support for the provision.

It was the new political circumstances with Obama in power that made the bank change course, former and current Citigroup lobbyists say. Citigroup’s consumer-friendly position gave the bank some positive publicity, too, these people say.

Lobbying Block

The House passed a version of the cram-down bill in March. In the Senate, Durbin and Schumer needed at least a handful of Republicans to muster 60 votes to avoid a filibuster. Without the banks’ support, that majority wouldn’t materialize. So the two senators started negotiating with the ABA, JPMorgan and two trade groups that represent credit unions. The Independent Community Bankers of America, which represents small banks, later joined the talks along with Wells Fargo & Co. and Bank of America.

After a few meetings, the ABA pulled out and lobbied quietly against the cram-down bill, while the ICBA publicly opposed it. The Financial Services Roundtable, which consists of the CEOs of the top 100 U.S. financial firms, coordinated the different groups’ efforts and meetings with members of Congress from both parties, says Scott Talbott, the Roundtable’s chief lobbyist. The provision died in the Senate in April.

The lobbyists’ success may be short-lived: In September, Durbin and his allies introduced a new version of the cram-down bill.

Next Battle

The next big test for the banks is whether they can influence plans to create the new regulatory agency to protect consumer rights.

“The administration’s proposal would hurt banks that never made a subprime loan, and yet you’re going to pile a whole new set of regulations and a new regulator on them,” says ABA President Edward Yingling.

The ABA has organized its members to write 140,000 letters to congressmen, provided Op-Ed templates for community bank executives who want to write editorials in local newspapers and set up hundreds of meetings between its members and their congresspeople.

In September, some 80 bankers from 28 states mingled at an ABA reception at the Madison hotel in downtown Washington, gearing up for meetings with congressmen representing their districts. Floyd Stoner, the ABA’s chief lobbyist, circulated among the crowd, stopping to chat with bankers and dispensing lobbying tips.

The pressure from the community banks has had some impact: In October, Frank’s committee revised the original proposal so that small banks can stick with their existing regulators, which will enforce the consumer agency’s rules.

Consumer Groups Unite

The banks face opposition from consumer groups, which have banded together in a 200-strong coalition to push for the agency. Obama, who himself started in politics as a community organizer, has been sympathetic to their concerns.

“In a financial system that has never been more complicated, it has never been more important to have a watchdog function like the one we have proposed,” Obama said in October.

The Treasury’s Barr has even appointed a former consumer advocate at the Center for Responsible Lending, Eric Stein, as his deputy in charge of consumer protection.

While Barr asked the banks for their opinion of the consumer agency during meetings in March and April, their objections weren’t heeded, according to people familiar with the discussions. He also asked consumer groups and community organizations to weigh in, an unprecedented move when the government considers financial regulation, according to lobbyists.

Leveling the Playing Field

“The status quo has fundamentally failed consumers and helped to bring us to the brink of financial disaster,” Barr says. “We need to level the playing field.”

While banks’ lobbying efforts may have been weakened, their deep pockets still give them willing listeners on Capitol Hill and in the White House, says Joseph Stiglitz, winner of the 2001 Nobel Memorial Prize in Economics.

“It comes down to the influence of money on our political process,” the Columbia University economics professor says.

Even if Barr levels the playing field and the new agency is created, banks bearing cash still may win the game.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

Last Updated: November 3, 2009 11:17 EST