The Senate is still — yes, still — trying to wrangle together the perfect formula for its version of a tax extenders bill that extends unemployment insurance and several tax credits. The House, when it passed its version of the legislation, jettisoned $24 billion in aid to state’s for Medicaid, but the Senate has been trying to place the funding back, to no avail.

The Medicaid funding has been a sticking point for some of the self-styled “moderates” in the Senate, who seem to think that cutting a bill’s economy-boosting potential is the height of moderation. Sen. Susan Collins (R-ME), for instance, “has twice voted against procedural motions on the tax extenders bill because of their cost.” “That’s been my No. 1 concern,” she said. “I’d like to help [the states], but we can’t afford it,” added Sen. George Voinovich (R-OH).

Senate Minority Whip Jon KyL (R-AZ) said that “he thought at least some cut in the Medicaid aid would be necessary to get the bill to pass.” But as The Atlantic’s Derek Thompson pointed out, the instinct on the part of lawmakers to cut state aid is all wrong on the economics:

The instinct to wean is understandable, but the timing is troublesome. Take New Jersey, where Gov. Chris Christie has proposed to cut $11 billion (that’s 25%!) of the state budget for its fiscal year 2011, which begins in two weeks. The states are looking to the federal government to determine how much money they’ll need to allocate toward Medicaid and education. If [it cuts] our new Medicaid crutch in half, the states’ Medicaid burden grows and in a zero-sum budget, that means something else goes.

Thompson pointed to a Center on Budget and Policy Priorities report stating that “without the extended Medicaid funding, Pennsylvania plans to cut funding for domestic violence prevention in half, eliminate all state funds for addressing substance abuse and homelessness, cut funding for child welfare by one-quarter, and cut payments to private hospitals, nursing homes, and doctors across the state — among other steps.” But Pennsylvania is not the only state that will have to take dramatic steps if Congress doesn’t act.

Arizona would have to cut funding for its state court system, Colorado’s likely cuts “include eliminating state aid for full-day kindergarten for 35,000 children, eliminating preschool aid for 21,000 children, and increasing overcrowding in juvenile detention facilities,” while New Mexico “could eliminate a wide range of Medicaid services, including emergency hospital services, inpatient psychiatric care, personal care assistance for the disabled, prescribed medications, and hospice care.”

Mark Zandi, chief economist of Moody’s Economy.com, estimated that 200,000 jobs could be at stake in this debate over Medicaid funding. “If state governments don’t get additional help from the federal government in the coming fiscal year, then the job losses will be at least that large — in all likelihood, measurably larger than that,” Zandi said.

When she’s not looking to weaken capital requirements for the benefit of her state’s biggest bank, Sen. Blanche Lincoln (D-AR) has been doing good work on financial regulatory reform, as she authored a title on derivatives reform that is stronger than its House counterpart, and would help bring transparency to this currently opaque market.

Lincoln’s title is worthwhile because it forces almost all derivatives trades onto public exchanges (like the stock exchange) and through clearinghouses (which ensure that each party in a trade has collateral should the trade go sour). These steps help both investors and regulators see what is happening, driving down prices and making it easier to police financial shenanigans.

But Lincoln’s bill also includes what’s known as Section 716, which would require banks to place their derivatives trading desks in separately capitalized entities, divorced completely from the banks’ federally insured deposits. House Financial Services Chairman Barney Frank (D-MA), who is also chairing the ongoing financial reform conference committee, had initially expressed opposition to the measure, saying that it “goes too far,” but he is now saying that Lincoln’s goal of getting derivatives away from traditional banking “will happen”:

The essence of what Senator Lincoln wanted to do on pushing derivatives out of the banks will happen, and certainly they will be totally insulated from any insured deposits.

The financial services industry is fighting the spin-off provision tooth and nail, and it’s really no surprise considering that “selling over-the-counter derivatives is among the most lucrative businesses for the largest financial companies.” In fact, U.S. banks held derivatives with a notional value of $212.8 trillion in the fourth quarter of last year. JP Morgan, Citigroup, Bank of America, Goldman Sachs, and Morgan Stanley hold 97 percent of that amount. BusinessWeek estimated that JP Morgan and Citigroup have the most to lose from Lincoln’s provision:

JPMorgan had 98 percent of its $142 billion in current value derivatives holdings inside its bank in the first quarter of this year while Citigroup had 89 percent of $112 billion, the records show…Morgan Stanley and Goldman Sachs Group Inc., each of which entered the commercial banking business in 2008 in the midst of the financial crisis, would be less affected. Morgan Stanley kept just over 1 percent of its $86 billion in derivatives holdings in its bank in the first quarter, and Goldman Sachs Group’s held 32 percent of its $104 billion.

As Kansas City Federal Reserve President Thomas Hoenig and Dallas Federal Reserve President Richard Fisher wrote, that kind of risky trading “should be placed in a separate entity that does not have access to government backstops. These entities should be required to place their own funds at risk.” And it’s looking more and more like such a division could actually become the law of the land.

As part of the financial regulatory reform effort currently being hashed out in conference committee, banks will be required to hold more capital against losses. This is a key reform, as one of the big problems prior to the financial meltdown was that banks and other financial firms (like insurance giant AIG) were way overleveraged and didn’t have adequate capital on hand when the housing bubble burst.

The legislation before the conference committee applies more stringent capital standards to banks with more than $10 billion in assets. However, Sen. Blanche Lincoln (D-AR) wants to boost the threshold to $15 billion, conveniently exempting the biggest bank in her home state — which also just happens to be owned by one of her biggest campaign contributors:

The bank, Arvest Bank Group Inc., of Bentonville, Ark., is predominantly owned by the Walton family, of Wal-Mart Stores Inc. fame, perhaps the most influential family in the state and one of the richest in the U.S. Under Ms. Lincoln’s proposed change, Arvest would be excused from a provision that could require banks to raise more capital, in Arvest’s case about $115 million…Ms. Lincoln “believes the threshold should be high enough to ensure no bank in Arkansas is subject to these new rules on existing capital, which would hinder their ability to generate lending for consumers and businesses at a time when access to credit is already difficult to come by,” said Ms. Lincoln’s spokeswoman, Marni Goldberg.

This is, unfortunately, not the only case of lawmakers pushing to exempt financial firms in their home state from the new financial rules of the road. Sen. Scott Brown (R-MA), for instance, is pushing for an exemption to the Volcker rule — which prohibits banks from trading for their own benefit with federally insured dollars — for Massachusetts based State Street Corp.

These sorts of exemptions are problematic, even putting aside the politics of crafting special deals for powerful entities in a state, because they create pressure for lawmakers to raise the exemptions even higher and set up opportunities for regulatory arbitrage (banks moving activities to unregulated parts of the market.) “Once you open up the door just a crack, Wall Street shoves the door open and runs right through it,” said Frank Partnoy, a professor of law at the University of San Diego and a former trader at Morgan Stanley.

As former Federal Reserve Chair Paul Volcker has said, “the problem with making the exceptions with plausible cases by individual institutions is once you begin, you can never stop. And if you make enough exceptions, you no longer have a rule.” Capital requirements need to be stronger across the board if financial reform is to result in a more stable, safer financial system, and Lincoln’s home state bank doesn’t need special treatment.