The Obama administration and congressional Democrats got a clear view on Tuesday of the uphill political path they face in pushing for tighter regulation of U.S. banks and financial markets.

With the economy showing some signs of recovery, Treasury Secretary Timothy Geithner told a Senate committee that President Barack Obama next week will unveil his long-awaited plan for sweeping financial regulation reform.

Targeting not only banks and markets for change, but also executive pay, hedge funds and so-called systemic risk to the economy, the Obama plan has been evolving for six months.

Some of its most ambitious proposals have softened amid aggressive lobbying by the financial services industry and intractable political realities in Congress.

A key pullback involves monitoring systemic risk, which Geithner said on Tuesday will not be concentrated at the Federal Reserve, but may fall to a council of regulators.

Minutes after Geithner spoke, Senate Banking Committee Chairman Christopher Dodd said healthcare issues will take priority for now over financial reforms, which he said he may not take up until after Congress' August recess.

He said he remains committed to sending a financial regulation package to the White House by the end of 2009, a goal set by Obama.

In the meantime, Republicans plan soon to unveil a counter-proposal to the Obama plan, with some proposals that are more modest, possibly undercutting support on Capitol Hill for the administration's program.

Regulatory reform will center mostly on turf fights and political infighting, said Jaret Seiberg, financial services policy analyst at research firm Concept Capital.

The odds are less than one-in-five that a massive financial reform bill will be enacted.

If past problems such as the savings-and-loan crisis of 1989-1990 could not trigger comprehensive reform, he said, No crisis is likely to overcome the entrenched interests that favor the status quo. Yet we do believe the odds are north of 75 percent for more limited reform.

Either way, this fight is going to dominate the headlines through the mid-term election.

OTC DERIVATIVES DEBATED

For instance, the administration on May 13 proposed a crackdown on the unregulated over-the-counter (OTC) derivatives market. Exotic financial instruments traded in that market, such as credit default swaps, have been widely implicated in the global credit crisis that brought down firms such as Lehman Brothers and American International Group .

The administration wants to push more trading in OTC derivatives onto exchanges and central clearinghouses, while some Democrats in Congress have proposed moving the entire market onto more transparent and accountable platforms.

But companies with a big stake in the future of OTC derivatives have said regulating them too tightly could drive trading overseas, harming the U.S. economy.

Faced with a panel of industry witnesses at a House of Representatives committee hearing on Tuesday, many lawmakers called for balance and caution in OTC derivatives reform.

One lawmaker said he sensed a soft approach would be taken and he said that would be a mistake.

I get the sense who's winning this fight and I don't think it's the American taxpayer, said U.S. Representative Stephen Lynch, citing the billions of dollars in taxpayer funds committed over the past year to bailing out firms like AIG.

We're not going to regulate this, I get the sense of it right now, Lynch said. We're making a terrible mistake ... in taking a very soft approach.

The OTC derivatives market, just one of many areas being targeted by the administration, involves some of the nation's most influential financial institutions, such as JPMorgan Chase and Goldman Sachs , whose executives pour millions of dollars into U.S. politicians' campaigns.

No industry has insinuated itself more deeply into the halls of Congress and the Washington bureaucracy, a status that will help the industry protect its interests despite broad voter outrage over the financial crisis and the bailouts.

At best, these derivatives are insurance. At worst, they're a bet at the casino, said Democratic Representative Brad Sherman at the House hearing.

If this business goes overseas ... fine, let that casino be offshore. Let some other government have to bail out the next AIG. Let us not be told that the present system is fine so long as the taxpayers write the check.

(Additional reporting by Karey Wutkowski, John Poirier, Glenn Somerville, David Lawder, Patrick Rucker, Alister Bull, Editing by Chizu Nomiyama)

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