Two key senators were discussing making the Federal Reserve the home of a proposed U.S. government watchdog office for consumers that has been the main obstacle to bipartisan agreement on financial reform, said sources familiar with Senate discussions on Monday.

Senate Banking Committee Chairman Christopher Dodd, a Democrat, and Republican Senator Bob Corker, a first-term committee member, were talking about the Fed option, said two lobbyists and an aide who asked not to be named.

Other options on the table in recent days have included putting a consumer watchdog in the Federal Deposit Insurance Corp., the Treasury Department, or a new bank regulator that Dodd proposed in November but which has since lost support.

President Barack Obama first proposed in mid-2009 that an independent Consumer Financial Protection Agency be created as part of a sweeping package of financial regulation reforms.

But Republicans and bank lobbyists have resisted that proposal and Dodd has been seeking a compromise that will win enough Republican support to move a financial reform bill out of the banking committee and onto the Senate floor.

Senator Richard Shelby, the committee's top Republican, has proposed making the watchdog a division of the FDIC, with some rule-writing power and a director who is appointed by the president and confirmed by the Senate, documents showed.

Shelby, also has proposed setting up a three-member consumer protection council, but that idea hinged on Dodd's bank-regulator proposal moving forward, and it has not.

The discussions swirling around all three ideas showed that negotiations among Shelby, Dodd and Corker are in full swing, but still have some ground to cover.

After marathon talks over the weekend, lawmakers remained snagged on how much rule-writing power the new watchdog should have, no matter where it is located within the government.

We are at the start of a political dance between Dodd and Shelby. We expect more draft language -- and more headlines -- throughout the week, said financial services policy analyst Jaret Seiberg at investment advisory firm Concept Capital.

Tightening bank and capital market oversight is one of Obama's top domestic policy priorities.

Nearly a year and a half since a severe financial crisis tipped the U.S. economy into its worst recession in decades, financial regulation has changed little in the face of stiff resistance from banks and Wall Street.

But lawmakers in both parties generally concur that reforms are needed and analysts expect legislation this year.

Obama's proposed Consumer Financial Protection Agency is designed to regulate mortgages, credit cards and other financial products. Banking lobbyists quickly targeted killing or weakening it as a top priority in a push against reforms.

(Editing by Gary Hill)