Under questioning from Republicans on the Senate Judiciary Committee, Kagan also defended her decision to limit military recruiting at Harvard while she was dean of the law school.

Kagan, 50, is solicitor general and a former aide in the Clinton administration. Republicans have questioned her lack of experience as a judge and portrayed her as an activist more interested in politics than law.

“My politics would be, must be, have to be, completely separate from my judgment,” Kagan on the second day of her confirmation hearing.

“It is absolutely true that I have served in two Democratic administrations,” she said. “You can tell something from me and my political views from that.”

Senator Jeff Sessions, the panel’s senior Republican, said he viewed Kagan as a “liberal progressive” and pressed her on whether she would follow Obama’s political agenda.

“I honestly don’t know what that means,” Kagan said.

Both parties have jockeyed for political advantage in the hearing ahead of November’s congressional elections. While Republicans questioned if Kagan would be a prisoner of Obama’s political agenda, Democrats criticized what they said was the high court’s tilt to conservative activism under Chief Justice John Roberts.

Kagan has sparked little controversy compared to other Supreme Court nominees and is likely to be confirmed relatively easily. Her nomination has been overshadowed by a heavy crush of political news, including the oil spill in the Gulf of Mexico and last week’s removal of Afghanistan war commander U.S. General Stanley McChrystal.

Kagan defended her decisions at Harvard limiting access to military recruiters under the university’s anti-discrimination rules because of the military’s “don’t ask, don’t tell” policy on gays, which she called unjust.

MILITARY ACCESS

“I’m confident the military had access to our students, and our students had access to the military throughout my entire deanship,” she said, adding she respected and “revered” the military. “We ensured students would know the military was coming to our campus.”

A year before Kagan became dean, Harvard had made an exception to its 1979 non-discrimination policy and allowed the military recruiters to use its Office of Career Services.

Kagan reinstated Harvard’s policy preventing military recruiters from using its career office, but allowed them access through student groups.

Sessions said Kagan’s decision had made the military second-class citizens. “The actions you took created a climate that was not healthy toward the military,” he said.

If Kagan wins Senate confirmation, she will be the first new member of the high court in four decades who has never been a judge.

Democrats have noted about one-third of the Supreme Court’s justices through history were not judges before joining the high court, and said Kagan’s lack of judicial experience would bring needed diversity to a court full of former judges.

Each of the Judiciary Committee’s 19 senators will have 30 minutes during the first round of questioning, which is expected to last all day on Tuesday and into Wednesday.

Republicans are also expected to press Kagan on her views on hot-button social issues like same-sex marriage, abortion and gun rights.

Under questioning from Democratic chairman Patrick Leahy, Kagan said she would recuse herself from any case where she was the counsel of record as solicitor general. She said there were about 10 cases in that category on next year’s court docket.

She also said she would consider recusing herself on any case where she played a substantial role such as formally approving a motion or strategy.

(Editing by Vicki Allen)

Supreme Court nominee Kagan fends off Republican attacks

Senate confirmation appeared assured for General David Petraeus, who became one of the U.S. military’s biggest stars after helping turn around the war in Iraq.

President Barack Obama fired the previous commander in Afghanistan, General Stanley McChrystal, last week after he and his aides were quoted disparaging the president and other top civilian advisers in an article in Rolling Stones magazine. The president named Petraeus to take over the war effort in Afghanistan.

The war in Afghanistan, launched after the September 11, 2001, attacks on the United States, has become unpopular with the U.S. public, but Petraeus used Tuesday’s confirmation hearing to play down any quick turnaround hopes.

He acknowledged limitations in training Afghan forces and in building up local governance in the face of what he called an “industrial strength insurgency.”

“My sense is that the tough fighting will continue; indeed, it may get more intense in the next few months,” Petraeus said in prepared remarks to the Senate Armed Services Committee.

“As we take away the enemy’s safe havens and reduce the enemy’s freedom of action, the insurgents will fight back.”

Petraeus called the security situation “tenuous” and said the Taliban insurgency remained resilient and confident it could outlast the United States and its allies.

In his prepared testimony, Petraeus said he would review how the war was being waged, including rules of engagement that some say put U.S. troops at unnecessary risk in an effort to protect Afghan civilians, a potentially controversial move.

“I am keenly aware of concerns by some of our troopers on the ground about the application of our rules of engagement and the tactical directive. They should know that I will look very hard at this issue,” Petraeus said.

But Petraeus made clear he supported Obama’s underlying war strategy, including the goal of beginning a transition of authority to Afghan security forces and a gradual troop drawdown in July 2011.

Petraeus stressed that any troop drawdown would be based on security conditions on the ground and limited to the 30,000 “surge” forces which Obama agreed to send in December as part of a revised strategy that put a focus on securing population centers, chief among them the Taliban birthplace of Kandahar.

Petraeus acknowledged the “hugely challenging” task of building up Afghan security forces to take over for U.S. and NATO troops.

“Helping to train and equip host nation forces in the midst of an insurgency is akin to building an advanced aircraft while it is in flight, while it is being designed, and while it is being shot at. There is nothing easy about it,” he said.

(Editing by David Alexander and Frances Kerry)

Petraeus plays down Afghan expectations

Obama wants to slap a 0.15 percent tax on the liabilities of the biggest U.S. financial institutions to recoup the costs to taxpayers of the financial bailout.

“We need to impose a fee on the banks that were the biggest beneficiaries of taxpayer assistance at the height of our financial crisis — so we can recover every dime of taxpayer money,” Obama said in his weekly radio and Internet address.

Obama, who is in Canada to attend gatherings with leaders of the world’s biggest economies, also used the address to welcome a deal by congressional negotiators on a historic rewriting of U.S. financial regulations.

Obama hopes to tout the changes as a model for other countries at the Group of 20 summit on Saturday and Sunday.

“I hope we can build on the progress we made at last year’s G20 summits by coordinating our global financial reform efforts to make sure a crisis like the one from which we are still recovering never happens again,” he said.

The financial regulation package would set up a new financial consumer watchdog, create a protocol for dismantling troubled financial firms and mandate higher bank capital standards, with the aim of avoiding a repeat of the 2007-2009 financial meltdown.

The bill, marking the biggest changes to the financial regulatory structure since the 1930s, still needs final approval from both chambers of Congress.

Obama, who hopes to sign the legislation by July 4, urged Congress to push the bill “over the finish line.”

With congressional elections looming in November, Obama hopes the financial reform and the bank tax idea will resonate with U.S. voters furious over Wall Street risk-taking that led to the financial meltdown and the worst recession in decades.

Some lawmakers have indicated they are receptive to the bank tax proposal but others have questioned whether it is fair to impose the tax on banks that have already repaid money from the Troubled Asset Relief Fund to make up for losses by American International Group Inc and General Motors.

Financial companies with more than $50 billion in assets and hedge funds with more than $10 billion in assets will be hit with the new levy upon enactment and lasting until 2020.

(Writing by Caren Bohan, Editing by Mario Di Simine)

Obama calls for bank tax as next step in reform

In a marathon session of more than 21 hours, legislators agreed to a rewrite of Wall Street rules that may crimp the industry’s profits and subject it to tougher oversight and tighter restrictions.

To secure agreement, lawmakers reached deals in the final hours on the most controversial sections which restrict derivatives dealing by banks and curb their proprietary trading to shield taxpayer-backed deposits from more risky activities.

Banks will be allowed to keep most swaps dealing activity in-house, although the riskiest trading would be pushed out. They will also be permitted small investments in hedge funds and private equity funds.

The concessions could lessen the impact on bank profitability. U.S. bank stocks opened about 1.0 percent higher, with Goldman Sachs Group Inc stock up about 2.0 percent in early trade.

The most sweeping rewrite of financial rules since the 1930s aims to avoid a repeat of the 2007-2009 financial crisis, which touched off a global recession and led to taxpayer bailouts of floundering financial giants. Financial institutions would have to pay $19 billion to cover the costs.

The reforms must still win final approval from both chambers of Congress before Obama can sign them into law, giving Wall Street one final chance to deploy its army of lobbyists on Capitol Hill. Quick approval is expected and the reform could go to Obama for his signature by July 4.

Democrats had raced to complete their work before Obama left for a weekend meeting of the Group of 20 economic powers, where he can tout the changes as a blueprint for other countries.

“This crisis proved and events continue to affirm that our national economies are inextricably linked and just as economic turmoil in one place can quickly spread to another, safeguards in each of our nations can help protect all nations,” Obama said at the White House shortly before departing.

Despite last-minute deals, the bill has actually gotten tougher in its yearlong journey through the halls of Congress. Democrats rode a wave of public disgust at an industry that awarded itself rich paydays while much of the country struggled through a deep recession caused by its actions.

“There is no way to view this bill as a positive for the financial sector,” wrote Concept Capital analyst Jaret Seiberg.

The KBW bank stock index fell 10.4 percent in May this as the reform process gained steam, its worst month since October of last year, and the capital markets index fell 10.3 percent, its steepest drop since January 2009 when the crisis reached fever pitch.

Passage of the bill will give Democrats an important legislative victory, alongside healthcare reform, ahead of congressional elections in November. The House could vote as soon as Tuesday, Representative Barney Frank, who chaired the negotiating committee, said.

CURBS ON RISKY TRADING

Lawmakers munched chocolates to stay awake as regulators and administration officials hovered in the wood-paneled room, and as the night wore on, they yielded the microphones to staff to debate the bill’s finer points.

The panel completed its work just after 5:30 a.m. (0930 GMT), more than 21 hours after it sat down to its final negotiating session.

Along the way, the negotiators resolved several sticking points that had threatened to scuttle the bill.

They agreed to water down a proposal by Democratic Senator Blanche Lincoln that would have required banks to spin off their lucrative swaps-dealing desks to a separately capitalized affiliate.

Dozens of House of Representatives Democrats said Lincoln’s proposal would force trading to move overseas, and threatened to vote against the bill if it included the provision.

The compromise allows banks to stay involved in foreign-exchange and interest-rate swaps dealing, which account for the bulk of the $615 trillion over-the-counter derivatives market.

They also could participate in gold and silver swaps and derivatives designed to hedge banks’ own risk.

They would need to spin off dealing operations that handle agricultural, energy and metal swaps, equity swaps, and uncleared credit default swaps.

“Quite frankly, common sense prevailed,” said Lincoln, chairman of the Senate Agriculture Committee, shortly after agreement was reached on the bill. “Our objectives were to get the risky stuff out of banks. We figured out how to do that.

Lawmakers resolved another controversial element of the bill around midnight when they agreed that banks should face restrictions on their risky trading activities.

As with Lincoln’s swaps provision, the financial industry won significant last-minute concessions in that rule, named for White House economic adviser Paul Volcker.

The final version of the Volcker rule would give regulators little wiggle room to waive the trading ban but would also allow banks to invest up to 3 percent of their Tier 1 capital in hedge funds and private equity funds.

The bill would dramatically reshape the financial landscape in the United States.

“Onerous legislation is baked into the price if you look at any large-cap bank names,” said Weston Boone, managing director and position trader for large-cap banks at Stifel Nicolaus in Baltimore. He said smaller banks fared better.

The legislation sets up a new consumer-protection authority and gives regulators new power to seize troubled financial firms before they harm the broader economy.

Though it leaves largely intact the patchwork of federal regulators that failed to stop the last crisis, it sets up an interagency council to monitor system-wide risks to stability.

It forces much of the over-the-counter derivatives market, which worsened the financial crisis and led to a $182 billion bailout of insurer AIG, onto more accountable channels like clearinghouses and exchanges.

Larger banks face will have to raise more capital to help them ride out future crises.

Credit-rating agencies such as Moody’s Corp could see their business models upended by regulators seeking to resolve conflicts of interest, while debit-card issuers like Bank of America will probably have to reduce the transaction fees they charge merchants who use their cards.

(Additional reporting by Roberta Rampton, Rachelle Younglai and Kevin Drawbaugh, Deborah Charles and Tabassum Zakaria in Washington, and Rodrigo Campos in New York; writing by Andy Sullivan and Tim Ahmann; Editing by Alistair Bell and Jackie Frank)

Corrected: Lawmakers agree on historic Wall St reform at dawn

Democrats in charge of the process appear likely to retain tough restrictions on banks’ trading and investment activities that could crimp profits for the foreseeable future.

But with a self-imposed deadline of Thursday evening, last-minute dealmaking could lead to exemptions for mutual funds, manufacturers and other business interests.

The broadest rewrite of Wall Street rules since the 1930s aims to avoid a repeat of the 2007-2009 financial crisis that plunged the economy into a deep recession and led to taxpayer bailouts of troubled banks.

Negotiators aim to resolve differences between versions of passed by the House of Representatives and the Senate in a final session that could last deep into the night.

Success would allow President Barack Obama to hold up the legislation as a model for other economic powers weighing reforms at this weekend’s Group of 20 meeting in Canada.

It also would give Democrats an important legislative victory, alongside healthcare reform earlier this year, as congressional elections loom in November.

Whether they can actually get it done remains to be seen.

Negotiators on the panel must walk a tightrope as they resolve the most controversial aspects of the bill, including proposals to limit banks’ lucrative swaps-dealing operations and their investments in private equity and hedge funds.

Wall Street has been unable to kill both proposals as Democrats ride a wave of public disgust at the industry over the damage from the financial crisis.

Still, the members of the committee are likely to soften their toughest proposals to retain the support of centrist lawmakers whose votes will be needed for the merged bill to clear both chambers of Congress before it is sent to Obama.

NOTES IN EVERY POCKET

“I dredge votes on the floor of the U.S. Senate,” said Christopher Dodd, a Democrat and the lead Senate negotiator. “I come back and I feel like a bulletin board — I’ve got notes stuck in every pocket.”

Moderate Republican Senator Scott Brown was at the center of efforts to weaken the “Volcker rule” — the ban on banks’ trading first proposed by White House economic adviser Paul Volcker, according to aides.

Brown has pushed to allow the large insurers and mutual funds based in his home state of Massachusetts to continue their investments in hedge and private equity funds.

The latest compromise floated on Wednesday would allow banks to invest 2 percent of their core capital in hedge and private equity funds. But it would also strengthen the rule by giving regulators less leeway to interpret it as they see fit.

Senate negotiators have also fought to blunt the impact of new consumer-protection rules on small businesses, a key concern of moderate Republican Senator Olympia Snowe.

Another centrist, Democratic Senator Blanche Lincoln, pushed to force banks to spin off their swaps-dealing operations as she fought a primary election challenge from the left in her home state of Arkansas.

Many analysts had expected Lincoln to quietly drop the provision afterward but she has fought to keep it in and a softened version could become part of the law.

The panel will have to work through more than 100 proposed tweaks to the derivatives crackdown, which aims to tame a $615 trillion market that exacerbated the financial crisis and led to a $182 billion taxpayer bailout of insurance giant AIG.

Wall Street has deployed an army of lobbyists to fight the measure. With the endgame at hand in Congress, their efforts may soon shift to the regulatory agencies that will put the new rules in place.

A lengthy period of uncertainty could loom for businesses as regulators like the Commodity Futures Trading Commission decide how to proceed, said Joel Telpner, a partner with the Jones Day law firm in New York who focuses on derivatives.

“What we’re going to see is another round of intensive lobbying, just as we did as the legislation has been finalized,” Telpner said.

(Additional reporting by Roberta Rampton, Kim Dixon, Kevin Drawbaugh, Rachelle Younglai and Charles Abbott; Editing by Simon Denyer and John O’Callaghan)

Wall Street reform bill goes into final hours

The decision is fraught with risk for Obama, who faces the difficult choice of shaking up command of an unpopular and costly war just six months after ordering 30,000 more troops into the fight against the Taliban.

McChrystal, the U.S. and NATO commander in Afghanistan and architect of Obama’s war strategy, was summoned back to Washington to explain his “enormous mistake” to the president, the White House said.

Obama’s spokesman said “all options were on the table” but the president stressed he wanted to speak to McChrystal first.

“I think it is clear that the article in which he and his team appear showed poor judgment … but I also want to make sure I talk to him directly before I make any final decision,” said Obama, speaking to reporters after a cabinet meeting.

U.S. officials said they expected McChrystal to offer his resignation and allow Obama to decide whether to accept it.

The 55-year-old commander has apologized for the article in Rolling Stone magazine, which quotes his aides calling one top Obama official a “clown” and another a “wounded animal.”

In the article “The Runaway General” — here — McChrystal himself makes belittling remarks about Vice President Joe Biden and the U.S. special envoy to Afghanistan and Pakistan, Richard Holbrooke.

McChrystal’s departure would add to already growing uncertainty about the course of the nine-year-war just one year after his predecessor, General David McKiernan, was pushed out of the same job.

The controversy could also weaken Obama, either making him look soft on insubordination if he lets McChrystal stay or potentially irresponsible if he fires the top general leading an already difficult war effort.

“The White House has to make it pretty tough on (McChrystal) because he was clearly insubordinate. Then they have to decide what to do with him,” said a senior Obama administration official. “It’s a real dilemma.”

White House spokesman Robert Gibbs said Obama became “angry” when he saw the article, due to be published in Rolling Stone on Friday.

Defense Secretary Robert Gates said McChrystal had “made a significant mistake and exercised poor judgment.” Admiral Mike Mullen, who as chairman of the Joint Chiefs of Staff is the top U.S. military officer, expressed his “deep disappointment.”

McChrystal, in an apparent attempt to save his job, reached out to Gates and other officials to say he was sorry.

“It was a mistake reflecting poor judgment and should never have happened,” McChrystal said in a statement.

Lawmakers were split over whether he might have to go, with most leaving the decision to Obama.

“Everyone needs to take a deep breath and give the president and his national security team the space to decide what is in the best interest of our mission,” said Senator John Kerry, a leading Democrat who is close to Obama.

REPLACEMENTS?

Defense officials say they have confidence that a suitable replacement could be found for McChrystal if he is fired.

Possible successors include Lieutenant-General David Rodriguez, who is now McChrystal’s No. 2; Lieutenant-General William Caldwell, who runs the NATO training mission for Afghan forces; and General James Mattis, the commander of U.S. Joint Forces Command.

Afghan President Hamid Karzai fully backed McChrystal and “believes he is the best commander the United States has sent to Afghanistan over the last nine years,” a spokesman said.

The Rolling Stone article, which quoted several McChrystal aides anonymously, portrays a split between the U.S. military and Obama’s advisers at an extremely sensitive moment for the Pentagon, which is fending off criticism of its strategy to turn around the Afghan war.

“It certainly isn’t going to help relations between the White House and this building,” one defense official said.

The article quotes a member of McChrystal’s team making jokes about Biden, who was seen as critical of the general’s efforts to escalate the conflict and who had favored a more limited counter-terrorism approach.

“Biden?” the aide was quoted as saying. “Did you say: Bite me?”

McChrystal himself quipped: “Are you asking about Vice President Biden?”

“Who’s that?” he asked.

He also belittled Holbrooke. One aide said McChrystal had compared the special envoy to a “wounded animal.”

“Oh, not another e-mail from Holbrooke,” McChrystal groaned while checking his BlackBerry during a trip to Paris, according to the magazine. “I don’t even want to open it.”

“CLOWN” STUCK IN 1985

One of McChrystal’s aides called White House National Security Adviser Jim Jones, a retired four-star general, a “clown” who was “stuck in 1985.”

The article also quoted an adviser to McChrystal dismissing an early meeting with Obama as a “10-minute photo op.”

“Obama clearly didn’t know anything about him, who he was. Here’s the guy who’s going to run his (expletive) war, but he didn’t seem very engaged,” the adviser told the magazine. “The boss was pretty disappointed.”

The White House, asked about whether Obama was in fact disengaged, said McChrystal would have Obama’s undivided attention on Wednesday.

“I think anybody that reads that article understands … what an enormous mistake this was, given the fact that mothers and fathers all over this country are sending their children halfway across the world to participate in this,” Gibbs said.

He added that parents of troops needed to know their military was “capable and mature enough.”

“I think that is one of the things that the president will look to discuss tomorrow,” he said.

(Additional reporting by Alister Bull, Will Dunham, Matt Spetalnick, Jeff Mason, Susan Cornwell and Deborah Charles in Washington, David Fox and Jonathon Burch in Kabul; Editing by Patricia Wilson and John O’Callaghan)

Fate of McChrystal in doubt

With final negotiations on the reform bill bogged down amid partisan bickering, Democrats who control the process neared consensus on an element that has drawn furious opposition from the Wall Street banks that could lose billions in profits.

The deal would require banks to isolate their swaps desks in separate affiliates, which would require the banks to raise new capital and deprive them of profits they get from dealing. But it would allow their parent holding companies to retain the value of the operations.

But negotiators remained at odds over another sticking point: how to cover the costs of dismantling troubled financial firms before they threaten the broader economy, as happened during the 2007-2009 financial crisis.

The broadest overhaul of Wall Street rules since the 1930s would establish new consumer protections, crimp big banks’ profits and saddle the industry with tighter regulations in a bid to avoid a repeat of the crisis, which led to the deepest recession in generations.

With congressional elections looming in November, Democrats aim to harness widespread anger at Wall Street and iron out by June 24 the remaining differences between bills already passed by the House of Representatives and the Senate.

That would give President Barack Obama an example for other world leaders to follow at a summit of leaders of the Group of 20 industrialized and developing economies in Toronto, which starts on June 26. Europe is aiming to tackle similar reforms, but the United States is far ahead.

On Thursday, the U.S. Federal Reserve won another battle to maintain its independence as lawmakers on the House-Senate panel dropped a plan to have the head of its New York division appointed by the U.S. president, rather than its board of directors.

However, they decided to prevent bankers on regional Fed bank boards from participating in the selection of their Fed bank chief.

The U.S. central bank, whose authority some lawmakers had wanted to rein in amid wide criticism for lax oversight before the crisis, will actually see its powers increase under the sweeping overhaul of financial regulation.

HIGHER CAPITAL REQUIREMENTS

Separately, lawmakers also agreed to give banks more time to comply with higher capital requirements to help them ride out crises, though they remained at odds over which firms could be grandfathered under the proposal.

They also agreed to exempt small companies, those with market capitalization under $75 million, from a requirement in the Sarbanes-Oxley law that requires them to show they have internal controls in place to ensure the accuracy of their books.

The White House intervened to weaken a provision that aims to give shareholders more say on how companies are governed, though the panel had yet to formally act.

Lawmakers had hoped to resolve a central element of the bill that would give regulators clear authority to seize unstable financial firms before they threaten the economy in an effort to avoid a repeat of the recent crisis, but postponed action after they failed to reach an agreement.

House lawmakers insisted on setting up a $150 billion fund to cover costs for liquidating troubled financial firms, paid for by firms with more than $50 billion in assets.

Senate negotiators rejected that proposal, insisting that costs should be covered by selling off the troubled firm’s assets. Other firms would have to chip in if the asset sales did not cover the bill.

The banking industry does not want to pay any fees up front.

Democrats in both chambers agree that banks, not taxpayers, should foot the bill next time. They brushed aside Republican charges that the new process would encourage reckless behavior.

‘FUNERAL SERVICE’

“Knowing that the funeral service, casket and plot are paid for does not make death any more compelling, at least not for a normal person,” said Democratic Representative Luis Gutierrez.

The new plan would give regulators clear authority to step in and dismantle troubled firms if they deemed them a risk to the system, tools that they lacked in the recent crisis.

At the height of the meltdown, regulators persuaded Congress to authorize $700 billion in funding to bail out Wall Street firms, spurring widespread voter anger.

Regulators did not take a consistent approach to troubled firms during the crisis. They provided $182 billion to bail out insurer American International Group while they let Lehman Brothers declare bankruptcy and steered investment banks Bear Stearns and Merrill Lynch into mergers with other firms.

When it next meets on Tuesday, the committee plans to tackle consumer-protection plans and whether to limit fees on debit-card transactions. The committee plans to address the controversial trading limits later in the week.

Once a final bill is agreed, it must be approved by the full House and Senate before Obama can sign it into law.

(Additional reporting by Rachelle Younglai, Charles Abbott and Kim Dixon; editing by Leslie Adler and Mohammad Zargham)

Swaps plan seen staying in Wall Street reform bill