New powers from the financial reform law will help avoid a repeat of 2008's frenzied sale of Wachovia and the wreckage that followed the collapse of Lehman Brothers, U.S. regulators said on Wednesday.

A commission investigating the causes of the financial crisis was told that the legislation, signed into law in July, gives regulators more options, imposing stricter rules on risk-taking and management at large institutions.

The Financial Crisis Inquiry Commission is holding its seventh public hearing, a two-day session focused on what to do about too big to fail, firms that are so central to the financial system that their disorderly failure could trigger a global economic meltdown.

The real question before us is: How did we end up with only two choices - either bail out the banks, or watch our world sink? said commission Chairman Phil Angelides.

The regulatory reform, known as Dodd-Frank after the chairman of the two committees that hammered out the provisions, was aimed at curbing excessive risk-taking by countering the perception that too-big-to-fail firms enjoy an implicit government guarantee.

If a systemically significant organization like Lehman needs to be resolved, Dodd-Frank creates a new resolution procedure that should facilitate a more orderly winddown, Thomas Baxter, general counsel of the Federal Reserve Bank of New York, said in written testimony.

But some critics of the legislation argue regulators will still be highly reluctant to let a big financial firm fail.

Wednesday's commission session is focused on the September 2008 bankruptcy of Lehman Brothers, where regulators say they lacked authority to intervene and could not find a buyer, and the government-brokered sale of Wachovia Bank that began later that month.

Former Lehman Chief Executive Dick Fuld will testify later on Wednesday that regulators did not grant Lehman Brothers the same assistance as its competitors, knocking out the possibility of an orderly unwinding of the firm that could have avoided aggravating the financial crisis.

Thursday's session features Fed Chairman Ben Bernanke and Federal Deposit Insurance Corp Chairman Sheila Bair.

The 10-member, congressionally-appointed commission is due to issue its report on the causes of the financial crisis by December 15.

Lehman's collapse was preceded by the government takeover of housing finance giants Fannie Mae and Freddie Mac.

It was followed days later by extraordinary government aid to American International Group as credit markets froze with fear.

Wachovia, burdened with souring mortgages, also found itself unable to raise capital and was bought by Wells Fargo, which beat out a Citigroup bid that would have required government assistance. The FDIC played a major role in that deal, with Bair reaching out to executives in after-hour phone calls.

September of 2008 will likely be remembered as an epochal period in the history of American finance, Baxter wrote.

He was joined in hailing Dodd-Frank's contribution to curbing risk and improving supervision by Fed Board of Governors' General Counsel Scott Alvarez and John Corston, a complex institutions expert at the FDIC.

The Fed gets greater powers to regulate systemically important financial institutions under the new financial law, while the FDIC is the agency that would liquidate a firm.

FED'S DEFENSE

Baxter defended the New York Fed's actions with respect to Lehman, saying it worked hard with the U.S. Treasury and other regulators to try to save it.

We did not succeed, but the effort made was serious and determined. We came very close, he said in written testimony.

In the end, Lehman was sentenced to bankruptcy when no buyer for the firm emerged from a series of high pressure meetings at the New York Fed on the weekend of September 14-15. No government assistance was offered.

Baxter hailed Dodd-Frank provisions aimed at forcing systemically important firms like Lehman to have more capital and liquidity, adding that this was precisely the type of medicine that Lehman needed.

But Harvey Miller, an attorney for Weil, Gotshal and Manges LLP, which represented Lehman in its final days, painted a different picture, saying that Fed and Treasury officials never explained their decision not to aid Lehman.

Miller said the government missed an opportunity to save billions of dollars in lost value when it opted against a government supported wind-down. This may have cost $40 billion to $50 billion up front, but it would have averted $700 billion in market losses in the first week after Lehman's bankruptcy.

The damages and harm precipitated by the Lehman bankruptcy could have been substantially reduced by innovative actions of the government. Instead, the government miscalculated and the financial system was pushed to the brink of collapse, he said, echoing statements by former Treasury Secretary Henry Paulson.

Fuld, who has testified multiple times in Washington since the firm's collapse, again said the government could have acted sooner to defuse the crisis of confidence that led to the storied investment bank's downfall.

WAMU VS WACHOVIA

September of 2008 was also marked by the September 25 government seizure of Washington Mutual, a massive bank failure involving $307 billion in assets.

But Corston said WaMu's failure, while vastly larger than Wachovia's, was easier for the FDIC to deal with.

He said Wachovia was a far more complex institution and the FDIC had little time to prepare for its downfall.

In the case of WaMu, the FDIC had adequate time to develop strategies and understand the risks associated with those strategies, Corston said.

In the case of Wachovia, the FDIC wasn't informed until the weekend of its collapse and as a result, had very limited information that could be used to understand the market implications especially in a market that was extremely unstable -- or to develop a resolution strategy.

Robert Steel, a former Treasury official who became CEO of Wachovia in July 2008, offered the panel a blow-by-blow account of the bank's collapse in his written testimony.

(Reporting by David Lawder and Dave Clarke; Editing by Karey Wutkowksi and Tim Dobbyn)