In March 2007, five months before the first tremors of acute financial panic, Harvard bankruptcy law professor Elizabeth Warren gave a lecture at Berkeley titled “The Coming Collapse of the Middle Class.”

Warren is one of a very small circle of experts who, during the boom years, accurately diagnosed the frailty of American finance capitalism. In scholarly articles, blog posts and several widely praised books, she has focused on the ways post-1970s wage stagnation has squeezed the middle class, leading to a drop in savings, a massive spike in consumer debt and more hours of labor spent to purchase core middle-class goods like healthcare and housing. The cumulative effect of these changes, as she argued in her talk at Berkeley, is families taking on far more risk than those of a generation earlier, and an economy skating on very thin ice.

Fast-forward eighteen months to the frenzied, panicked week in September after the fall of Lehman Brothers, when Henry Paulson sent his original three-page TARP proposal to Congress with the notoriously tone-deaf provision that Treasury’s decisions would be “non-reviewable…by any court of law or any administrative agency.” The provision was nearly unanimously panned, and the final Emergency Economic Stabilization Act stipulated several oversight mechanisms, including the creation of a five-member Congressional Oversight Panel. Appointed by leaders in Congress from both parties, the COP was given the task of reporting every thirty days on the program’s effectiveness, transparency and protection of taxpayers.

Somewhat amazingly, Senate majority leader Harry Reid chose Elizabeth Warren to chair the COP. “I asked Harry Reid if he was really sure he wanted me to do this,” Warren told me in a recent phone interview. “And he said, ‘Yes, I expect you’ll bring your consumer perspective.’ I didn’t come into this beholden to anybody, and I’m not looking for a job coming out on the other side. That means I say what I think is right.” (Reid’s office confirmed this account.)

COP’s oversight mandate is, in the words of its spokesman Caleb Weaver, to ask the “fundamental questions” about the Treasury’s strategy of doling out the funds. Although the panel has statutory authority to obtain documents from the government, it has no subpoena power. It has a staff of only eleven and, remarkably, no fixed line-item budget. I asked Weaver what the COP’s budget was. “That’s not clear,” he said. “I know that doesn’t come off well.”

On top of that, the panel got a late start. By the time House minority leader John Boehner got around to appointing Representative Jeb Hensarling on November 19–giving the panel the requisite quorum–it had only eight days to produce its first report.

And yet somehow the COP has managed to raise a considerable ruckus. Meeting at least once a week, the panel (which includes Warren, Hensarling, former Republican Senator John Sununu, AFL-CIO associate counsel Damon Silvers and Richard Neiman, superintendent of banks for the New York State banking department) has churned out four rigorous, detailed reports.

The first asked a series of pointed questions about Treasury’s strategy and the rationale for its approach. Paulson replied, but “he answered our questions by cutting and pasting from earlier speeches,” Warren says. “I think he just assumed he’d mumble around, we’d mumble around and that would be the end of oversight.” Instead, in the second report the COP “put together a grid that listed every question we asked, quoted his answer and called him out every time he didn’t answer our specific question.”

The panel’s latest report created the most headlines. (It was also the first unanimous one, in which Hensarling did not dissent. His office did not return a request for an interview.) Using publicly accessible information, the COP attempted to ascertain the market value of the assets Treasury has purchased. Describing the letter Paulson originally sent to the COP, Warren said, “These ‘investments,’ as he called them, ‘were at or near par.’ That’s a direct quote. That means for every $100 invested, the taxpayers get $100 back in stock and warrants. It was perfectly clear that this was not true, and it was not true not because the market fell afterwards. It was not true on the date of the transaction.”

Indeed, the report found that Treasury has already overpaid by a staggering $78 billion, or almost a third of the money it had spent at the time of the report. “They described a transaction to do one thing,” Warren says, “and it was designed from its inception to do something very different.” She doesn’t say what that “something” is, but it’s clear: subsidize the banks’ losses.

So what now? Charged with oversight, not with crafting policy, Warren is insistent on not offering substantive suggestions for how the new administration should handle the TARP funds. But given that she’s a bankruptcy law professor, I pressed her on the policy options on the table and asked her to describe what a version of bankruptcy for some of the troubled banks might look like.

“Here’s how it would work in a Chapter 11 if this were any other industry: all the equity would be wiped out, then the creditors would get a percentage on the dollar,” she said. “We would totally protect all the deposit accounts, and the rest of the debt would get some combination of stock and pennies on the dollar. The minute that happens, the banks are solvent, and new capital can flow in.”

This is more or less what the FDIC has been doing, largely under the media radar, with numerous small, failed banks at an alarming rate of about two a week for the past few months. Of course, that would mean facing up to massive losses in wealth for equity holders of the banks that go under. Those folks tend to have some muscle in Washington, and their hope is essentially to get the government to take the losses for them. Worrisomely, their interests seem to have been taken to heart by Treasury Secretary Tim Geithner and President Obama’s top economic adviser, Larry Summers, who appear to be doing their damnedest to avoid any resolution of the crisis that involves banks owning up to their losses.

“Someone said to me, You’re describing ripping the Band-Aid off all at once, and we’re saying how ’bout we just keep peeling the corners off a little at a time–ouchy, ouchy, ouchy–and maybe we can adjust as we go along,” Warren tells me. “Sweden ripped the Band-Aid off all at once, and Japan took ten years. But the Band-Aid had to come off.”

“Who are we trying to protect here?” she asks. “Is it a banking system that is in service to American families and the economy, or is it the American families and the economy in service to a banking system? I know what I think the answer should be.”