Bank Friendly New Democrats Draft Letter In Favor Of Loophole Ridden Derivatives Reform

Yesterday, the conference committee reconciling the House and Senate versions of financial reform really got underway, with the first amendments being offered (and then counter offered). One item that has not yet been placed onto the docket though is derivatives reform, particularly the provision authored by Sen. Blanche Lincoln (D-AR) that would require banks to places their derivatives trading desks into separately capitalized entities.

Lincoln’s spin-off provision, known as Section 716, has been slowly receiving support from a variety of players in Washington, including Senate Banking Committee Chairman Chris Dodd (D-CT), who said “at this point, I’m in support of what she has in the bill.” This week, former Federal Reserve Chairman Paul Volcker, who initially opposed Lincoln’s plan, said that “it may be useful in some cases to have particular activities separated out.”

However, not everyone is jumping on board. The New Democrats, a band of bank and Big Business friendly House Democrats, have drafted a letter not only arguing against Section 716, but pushing for the conference to adopt the House’s loophole ridden derivatives reform, instead of the Senate language:

The New Dems worked to craft legislation that dramatically increases oversight, accountability and transparency in the derivatives market, where the inability of regulators and the private sector to evaluate existing risks exacerbated the financial crisis…The House also provided clear protections for end users who pose no risk to the stability of the financial system so they may continue to use derivatives to prudently manage their risks.

The letter adds “we believe Section 716 should be removed from the legislation.” According to Politico, the driving force behind the letter is Rep. Michael McMahon (D-NY), who has also argued for the extension of the Bush tax cuts for the wealthy on the grounds that people making $250,000 per year are “barely making ends meet.”

Contrary to the New Democrats’ assertion, the Senate’s derivatives language is much stronger, as the House crafts overly broad exemptions to the requirements that derivatives henceforth be traded on exchanges or put through clearinghouses. As Commodity Futures Trading Commission Chairman Gary Gensler has said, “language in the House bill may be read to provide for a more liberal exemption…Every exemption for financial companies creates a link in the chain between a dealer’s failure and a taxpayer bailout.”

Section 716, meanwhile, has now earned the support of three Federal Reserve Bank Presidents. Last week, Kansas City Federal Reserve President Thomas Hoenig and Dallas Federal Reserve President Richard Fisher wrote in a letter supporting Section 716 that the risks associated with derivatives trading “are generally inconsistent with the funding subsidy afforded institutions backed by a public safety net. Such activities should be placed in a separate entity that does not have access to government backstops.” According to a Lincoln aide, St. Louis Federal Reserve President James Bullard also supports the provision.

Lincoln, for her part, is still going all-out for her bill. “I don’t disagree at all that there’s a very real need to be able to manage risk — we don’t take that away,” she said. “We just simply say that if you’re going to be the dealer of that risk, you have to separate that dealership risk outside the bank…You need to capitalize it for the true risk that it is and not let that risk be left on the backs of taxpayers and on bank depositors.”