Yesterday, Senate Majority Leader Harry Reid (D-NV) attempted to invoke cloture on Sen. Chris Dodd’s (D-CT) financial regulatory reform bill. However, due to the absence of Sen. Arlen Specter (D-PA), Sen. Scott Brown (R-MA) changing his vote, and Sens. Maria Cantwell (D-WA) and Russ Feingold (D-WI) refusing to end debate without consideration of provisions that would strengthen the bill, cloture was defeated 57-42, setting up another try today. (Sens. Susan Collins (R-ME) and Olympia Snowe (R-ME) voted in favor of cloture.)

One of the issues that Cantwell has with the bill is a loophole in the proposed derivatives regulations, first identified by Zach Carter, which allows derivatives traders to circumvent new regulations without penalty. One of the key parts of derivatives reform is the institutionalizing of central clearinghouses, which ensure that both parties have adequate collateral backing their trade. As Carter explained, “under the current bill, there is no penalty for anybody who fails to centrally clear their trades — even though the bill labels this activity illegal. What’s more, even though this behavior is illegal, the trade itself is still valid.”

Essentially, the law as written gives banks the choice of whether or not to follow the new rules, which is obviously problematic. Cantwell, along with Sen. Blanche Lincoln (D-AR), who authored the derivatives reform portion of the bill, have an amendment clarifying the language to remove this hole. But they can’t bring it up for a vote, fueling Cantwell’s opposition to the bill, because Republicans won’t let it come to the floor:

To underscore the Democrats’ point that Republicans were the ones blocking the bill, Mr. Dodd returned to the Senate floor asked for unanimous consent of the Senate to allow a vote on Ms. Cantwell’s derivatives amendment. Senator Richard C. Shelby of Alabama, the senior Republican on the banking committee, objected.

Ever since regulatory reform seemed inexorably headed for the finish line, Republicans have been objecting to consent to move any amendments that would strengthen the bill. They objected to Sens. Carl Levin (D-MI) and Jeff Merkley’s (D-OR) amendment institutionalizing the Volcker rule, as well as Sen. Byron Dorgan’s (D-ND) amendment banning naked credit default swaps.

Already, Brown has said that he will likely flip back and support cloture today, and Specter has returned to town, which should be enough to ensure a successful cloture vote. But the problem that Cantwell wants addressed is a key one and there’s no reason for Shelby to be standing in the way, unless he thinks the new laws that the Senate is considering should remain unenforceable.

It’s no secret that Sen. Blanche Lincoln (D-AR) — along with her Republican counterpart, Sen. Jon Kyl (R-AZ) — are on a quest to cut the estate tax, slashing taxes for the heirs of multimillionaires. Instead of reinstating the currently expired estate tax at the 2009 level (45 percent, with a $3.5 million exemption), Lincoln and Kyl want to cut the rate to 35 percent and raise the exemption to $5 million.

As I noted earlier this week, Lincoln and Kyl have been searching for offsets to pay for their tax cut, as if there aren’t a host of better things that we could do with $60-$80 billion. And judging by a quote she gave to The Hill, Lincoln either isn’t entirely clear how the estate tax works or is relying on a false characterization of it to build support:

“I don’t think there’s any American out there who believes you should work all of your life to find that when you die, 55 percent of [your estate] has got to go to the government,” the senator said. “Coming up with more balanced exemptions and rates is critical.”

Lincoln is likely right that Americans don’t think 55 percent of any estate should go to the government upon the owner’s death. Fortunately, that is not a policy that anyone is proposing, nor would it be the case if the estate tax was simply allowed to reset to 2001 levels (as it will if Congress fails to act).

Because the estate tax — like the personal income tax — is calculated on marginal income, the particular percentage is only levied on amounts above the exemption. So if the exemption is $3.5 million, the first $3.5 million of the estate is passed on entirely tax free. Tax is only paid on the first dollar in excess of that. So an estate worth $3,500,001 would have a tax bill of .45 cents under 2009 law.

The effective tax rate — the amount paid as a percentage of the entire estate — owed by people who actually had to pay any estate tax at all in 2009 was about 14 percent. There were no grieving widows who have to hand over half of everything they own to the government.

Lincoln also employed the common conservative argument that “small businesses don’t have the profit margins to survive” a higher estate tax. But virtually no small businesses face the estate tax. In fact, 98 percent of estates pay no estate tax at all (because they don’t come even close to exceeding the exemption). Only 0.2 percent of the money that Lincoln and Kyl want to spend on their tax cut will wind up with actual small businesses. The rest will go towards lowering tax bills for the richest of the rich.

A few weeks ago, Sen. Blanche Lincoln (D-AR), who is playing an instrumental role in the financial regulatory reform debate currently going on in the Senate, sought to reassure everyone that one of her other priorities — cutting the estate tax to reduce the tax bill for the heirs of multimillionaires — was still garnering her attention.

And according to Congressional Quarterly, Lincoln and her counterpart on the estate tax, Sen. Jon Kyl (R-AZ), have been hard at work trying to find ways to offset the cost of their huge tax cut for the wealthy, in order to comply with pay-go rules:

Key Senate negotiators are making significant progress toward resolving the tangled legislative mess known as the estate tax. Notably, Finance Committee members Jon Kyl, R-Ariz., and Blanche Lincoln, D-Ark., are finding revenue-raising offsets within the estate tax code to cover the costs of the more generous rate and exemption they want…If they can use estate tax offsets to bridge the estimated $60 billion to $80 billion gap between their proposal and the House-passed bill (HR 4154), Kyl and Lincoln could shield themselves from some class-based arguments about tax fairness.

Kyl announced yesterday that the full proposal is “near completion.”

This strikes me as absolutely crazy. We’re going to find $60-$80 billion in offsets and then spend it to partially cover the cost of a tax cut for the 0.2 percent of households that have to pay any estate tax at all? With unsustainable deficits in the coming years and a series of job creation bills languishing in the Senate (after being passed by the House of Representatives), cutting the estate tax is what Lincoln and Kyl are proposing we spend money on?

Sadly, the Lincoln-Kyl estate tax proposal — which cuts the rate from 45 percent to 35 percent and raises the exemption from $3.5 million to $5 million, compared to 2009 levels — seems to be gaining some steam. Just this week, Senate Budget Committee Chairman Kent Conrad (D-ND) suggested that the Senate make a “grand bargain” by passing a variety of tax measures, including the Lincoln-Kyl estate tax cut, in one huge bill.

It’s quite shocking that there is such a dearth of voices saying that cutting the estate tax now is simply nuts. Last year, taxes in the U.S. were the lowest they’ve been since 1950, while the labor market is still incredibly fragile. Yet, we would waste billions in offsets to cut taxes for those who need it the least, the Paris Hilton’s of the world.

We need to be looking at ways to responsibly raise revenues and find cuts in spending that won’t harm already vulnerable residents, not cut taxes for those at the very top of the income scale. Lt. Gov. Bill Halter (D-AR), who is running in a primary against Lincoln, made this point yesterday. “Folks, we don’t need more tax breaks for people with $10 million in wealth, especially at the expense of debt or deficits on the backs of your children and grandchildren,” he said.

Roll Call noted today that Senate Republicans “are girding for battle on financial regulatory reform and using the recess to develop a legislative and political strategy capable of uniting the minority.” However, they have evidently not decided whether or not complete opposition to the entire effort is the tactic that they will use. The failure of that strategy in the health care fight means some attempt to cut deals might be in the cards.

On that note, the New Republic’s Noam Scheiber reported that the Republican strategy may be to mostly let the Democrats have their way on creating a consumer protection division within the Federal Reserve, in return for weakening other provisions of the bill. As Scheiber put it, “if the bet pans out, the [financial services] industry and its GOP allies would, in effect, be trading a robust consumer agency for a chance to scale back a number of highly consequential but below-the-radar reforms.”

One of these “below-the-radar” areas is derivatives reform, and while the bill that Senate Banking Committee Chairman Chris Dodd (D-CT) moved out of committee is tighter than that passed by the House of Representatives last year, “most continue to regard the derivatives provision in Dodd’s bill as a placeholder, which will almost certainly be nudged aside by a compromise negotiated by Democrat Blanche Lincoln and Republican Saxby Chambliss”:

As one lawyer involved in the derivatives industry told me last week, “If they try to push the Dodd bill as currently written on derivatives—it can’t fly.”…The bottom line, this person concluded, is that voters just aren’t very invested in the details of derivatives reform, and so it’s hard to believe the Democrats will be, too.

The prospect of derivatives reform being watered-down was already very real, since Lincoln made some remarks at the U.S. Chamber of Commerce last month that seemed to indicate her willingness to exempt significant amounts of derivative trading from exchanges and clearinghouses. I don’t think swallowing these exemptions in exchange for a consumer protection entity that already deviates from the administration and House’s fully independent Consumer Financial Protection Agency (CFPA) is a deal worth making.

For one thing, I’m skeptical that compromising will really deliver a large number of Republican votes. Sen. Richard Shelby’s (R-AL) on again-off again attitude toward negotiations with Dodd makes it seem like he’s more interested in buying time than genuinely crafting a bill. Also, as more numbers come out showing that the public is still angry at Wall Street, I think the odds that Dodd can pick up enough Republican votes on the floor to pass a decent bill improve. Down the line, no one’s going to remember if regulatory reform passes with 61 or 81 votes, but they will remember who was in charge if reform fails to rein in the banks and prevent another financial meltdown.

According to the Washington Post, the Senate Agriculture Committee is beginning to work on legislation regulating the vast marketplace in over-the-counter derivatives, which played a large role in the economic crisis, particularly in bringing AIG to the brink of collapse. Committee Chairman Blanche Lincoln (D-AR) said that she expects whatever the committee passes to be incorporated into Senate Banking Committee Chairman Chris Dodd’s (D-CT) larger financial regulatory reform effort.

Lincoln’s step up to the plate has already boosted the spirits of the financial services industry, as “they expect that legislation headed up by Lincoln could be more favorable to the financial industry than the language currently in Dodd’s bill.” And there might be reason for their optimism (and concern for those who want a tightly regulated derivatives market), as last month, Lincoln gave a speech on derivatives reform at the U.S. Chamber of Commerce, in which she said that “I don’t believe in over-reaching or regulation for regulation’s sake. We must be surgical in how we regulate.”

As the Roosevelt Institute’s Mike Konczal explained, the key to judging derivatives regulation is to determine how much trading is required to go onto public exchanges and how much will be mandated to go through clearinghouses. An exchange adds light to the marketplace by making trading information public, instead of the current setup in which derivatives deals can be made between two parties without any reporting. This should both drive down prices and give investigators a much clearer path to follow if shenanigans occur. A clearinghouse, meanwhile, acts as an intermediary between two parties in a derivatives trade, ensuring that each side has adequate capital on hand to make the deal and that each side lives up to its obligations.

During her speech at the Chamber, Lincoln said that “all swaps — both standardized and customized — should be reported,” while “clearing will be mandatory for ‘some standardized and highly liquid‘ swaps.” So the effectiveness of her legislation will largely revolve around what does and does not fall into the “some standardized” category.

As Commodity Futures Trading Commission Chairman Gary Gensler has said, the more trading that occurs in clearinghouses and on exchanges, the better. Gensler likened these to traffic lights that, while necessarily slowing down traffic, are critical to a safe system:

Do yellow and red lights slow down traffic? Do street lamps bring sunshine on otherwise dark and dangerous roads? Absolutely. Could we run a high volume transport network safely without them? Absolutely not. Traffic lights may add costs for all network users, but can anyone imagine a traffic system without safety regulation? Of course not.

To get a sense of how systemically risky the derivatives market can be, consider this statistic: “Since the 1980s, the notional value of the market has ballooned from less than $1 trillion to approximately $300 trillion in the United States – that’s $20 in derivatives for every dollar of goods and services produced in the American economy.” And more than 97 percent of this total is held by five mega-banks. This is a wild amount of money — and risk — so Lincoln’s bill needs to shed sufficient light on it if her legislation is making its way into Dodd’s bill.