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updated 5/6/2010 4:56:33 PM ET 2010-05-06T20:56:33

Prodded by President Barack Obama, the Senate on Thursday rejected a Republican consumer protection plan that would have diluted a central element of the administration's financial regulation package.

Democrats and the president argued that the GOP proposal would have "gutted" consumer protections. The vote was 61-38, with two Republicans — Sens. Olympia Snowe of Maine and Charles Grassley of Iowa — joining Democrats to defeat the GOP measure.

Democrats have proposed an independent bureau within the Federal Reserve to write and enforce regulations that would police lending. The Republican proposal would create an agency within the Federal Deposit Insurance Corp. The FDIC would have to approve regulations and enforcement would be left to bank regulators.

Republicans said the Democratic bill overreached and would give a powerful consumer agency too big a voice in banking affairs. The Democratic version of the legislation already contained some concessions to Republicans, and Democrats showed no willingness to cede any more ground

"Alternatives that gut consumer protections and do nothing to empower the American people by cracking down on unfair and predatory practices are unacceptable," Obama said in a statement before the vote.

The Senate turned its attention to another amendment opposed by the Obama administration — a proposed audit of the Federal Reserve that has bipartisan support and that even Senate Majority Leader Harry Reid, D-Nev., has said he is inclined to support.

It would require the Federal Reserve to undergo a thorough audit by Congress' investigative arm, the Government Accountability Office.

The measure, proposed by Vermont Independent Sen. Bernard Sanders, has populist support from across the political spectrum, from tea party activists to liberals and labor organizations. The Federal Reserve and the Treasury oppose the measure, arguing it could interfere with the Fed's independence, a crucial element if the Fed is to carry out unpopular but economically essential policies.

Sanders stressed Thursday that the GAO examination would not intrude on the Fed's job setting monetary policy. Instead, it would focus on the Fed's emergency lending authority to banks and would require that it make public the recipients of that money.

"We cannot let the Fed operate in secrecy any longer," Sanders said.

Deputy Treasury Secretary Neal Wolin on Thursday reiterated the administration's opposition to the audit proposal. But the White House saved its toughest criticism for the Republican consumer provision.

"I will not allow amendments like this one written by Wall Street's lobbyists to pass for reform," he said.

Republicans countered that most of the objections they had heard came from small business owners who feared they would fall under the consumer entity's regulations.

The consumer protection measure is one of the key features of Obama's package to rein in financial institutions. The overall legislation, the most sweeping rewrite of Wall Street rules since the Great Depression, would also set up a system to watch out for risks in the system, create a method to liquidate large failing firms and write new rules for complex securities blamed for helping precipitate the 2008 crisis.

The consumer protections provision, however, has been a point of great partisan friction and has prompted a massive campaign by the U.S. Chamber of Commerce and bank lobbyists to limit its reach.

The bill would turn the U.S. financial system into "a social justice mechanism" by giving a powerful consumer agency a huge voice in banking affairs, said Sen. Bob Corker, R-Tenn.

Sen. Richard Shelby, R-Ala., said the Democrats go too far by allowing state laws to trump federal laws and he rejected claims that his alternative proposal is too weak.

Senate Banking Committee Chairman Chris Dodd, D-Conn., dismissed the Republican plan as "a stimulus package for scam artists."

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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