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Blanche Lincoln's derivatives proposal 'sent shudders through Wall Street'

lincolnchamber.JPG

Blanche Lincoln is really preparing to lay the smack down on the derivatives market.

The proposal by Sen. Blanche Lincoln (D-Ark.), who chairs the Agriculture Committee, sent shudders through Wall Street. For nearly two decades, five U.S. banks -- J.P. Morgan Chase, Goldman Sachs, Morgan Stanley, Bank of America and Citigroup -- have acted as middlemen, allowing commercial firms and financial speculators to trade vital goods such as oil, natural gas and cotton, as well as contracts called derivatives. These are essentially side bets on which way such commodities, stocks and other assets will move.

Under Lincoln's plan, as described by her aides, the companies would have to spin off that activity if they wanted to remain banks.

The proposal is tougher than what the administration has sought. The Senate bill, which largely reflects administration thinking, stops short of an outright ban on derivatives trading by the Wall Street companies. Lincoln's proposal, which her staff said is due out this week, could be added to that legislation.

To my knowledge, that's the first time anything proposed by a relevant legislator has "sent shudders through Wall Street." So Lincoln gets extra credit for that. If the financial sector's behavior doesn't lead to legislation that makes it shudder a bit, something is terribly, terribly wrong.

But ask about the chances that Lincoln's package will end up in the final bill and you'll hear that it's doomed, laughable, a transparent effort to protect against a primary challenge back in Arkansas (the relevance of this last objection is a little unclear). That may all be so. But I don't think people sufficiently appreciate how much Lincoln is changing the politics of financial-regulation reform.

To view the politics of Lincoln's hard advocacy for an aggressive derivatives package more clearly, imagine that Max Baucus or Kent Conrad had made a strong public option the core of their health-care reform strategy. Like Baucus and Conrad, Lincoln chairs a relevant committee (the Senate Agricultural Committee, for better or worse, governs derivatives) and has a long-standing reputation as a conservative Democrat. Her position makes it a lot harder for other conservative Democrats to hold firm against a serious regulation of derivatives. With Lincoln's name on the plan, you can't say that it's an unrealistic pipe dream from the party's liberal wing.

By making a strong bill more credible, Lincoln's proposal might make a bill less likely. Democrats will have a harder time conceding on the issue and Wall Street money will flood in to make sure that Republicans hold the line. Given that this bill needs 60 to pass, that makes the math a lot tougher. Wall Street might shudder. But it's not yet clear that it needs to be scared.

Photo credit: Brendan Hoffman/Bloomberg

By Ezra Klein  |  April 15, 2010; 3:50 PM ET
Categories:  Financial Regulation  
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Comments

"and Wall Street money will flood in to make sure that Republicans hold the line"

Why just Republicans? Wall Street gave more to Hillary and Obama in 2008 than to McCain, or Republicans generally, by a wide margin.

Arguably, well-funded Democrats could have a lot more power over the future success of the bill. Or are we saying that every single Democrat cannot be bought, while every Republican can be?

If so, they investments Wall Street and the big banks have been making in the Democratic party are ill-considered. Not that Wall Street doesn't have a history of making ill-considered decisions.

After the Clinton 90s and the dot.com boom, who did Wall Street give the most money to? The Republicans. After a relatively friend 8 years of Bush, who did Wall Street give the most money to? The Democrats. Maybe they just play the odds regarding who they think is going to win.

Or perhaps our presidents, Democrat or Republican, are chosen by a shady cabal of super-wealthy Wall Street elite. I think that's a fair interpretation of the data.

Posted by: Kevin_Willis | April 15, 2010 4:03 PM | Report abuse

BTW, kudos to Blanche Lincoln. I've got a lot of respect for this, because I think it's a serious effort to do something hard, that's going to be extremely unpopular with lots of extremely rich people, that would be good, in the long run, for the economy.

It's very straight forward, and seems to avoid the failing of much legislation (Chris Dodd's bill having some, in my opinion): it's not about micromanaging. It just says: this is stupid and dangerous, and you can't do it. There's a reason drunk driving is against the law. There's a reason that the county comptroller isn't allowed to take the yearly budget out to the dogtrack because he feels he's going to for sure double or triple it. Rather than demand big companies draw up plans for how they are going to be broken up after management loots the company and recklessly throws away their clients money, why not just say: no, you can't do that.

Posted by: Kevin_Willis | April 15, 2010 4:12 PM | Report abuse

Huzzah for Lincoln. I don't think this has to do with her primary challenge. I think she sees the writing on the wall re: her chances of reelection, and she's falling on her sword in the name of principle.

Posted by: roquelaure_79 | April 15, 2010 4:30 PM | Report abuse

Kevin, I think the implication is that Democrats are going to be getting pressure to support the bill from their base, from their colleagues, and from their leadership. On the other hand, many of them will be getting pressure in the other direction from Wall Street campaign contributors.

On the other side of the aisle, Republicans will be getting pressure to fight the bill from their base, from their colleagues, and from their leadership. They'll also be getting pressure from Wall Street campaign contributors.

This bill doesn't pass without at least one Republican vote in the Senate. If it were just a matter of concience voting, the Dems might be able to peel one or two Republicans off. With all the institutional pressures, including Wall Street execs pressing in the same direction as all the rest of the pressure, Republicans like Corker are going to have a hard time voting for this thing, or even for cloture.

Of course, you're right that that assumes you can get every Dem on board. That'll be tough, but I think it's possible. Opposition is just the path of least resistance for Republicans on this one.

Posted by: MosBen | April 15, 2010 4:46 PM | Report abuse

@MosBen: Excellent point. We'll see how the Republican's fare regarding party unity. I don't think the base is going to be as excited by FinReg as HCR, but they might be. If so, that puts the pressure on them, but being a strictly "part of no" approach on FinReg may not work as well as it would with immigration reform or cap and trade.

It might serve the Republicans to really try and structure a relatively conservative bill, so that if it passes anyway, they can claim some victories. Despite the relatively Republican nature of HCR, the Republicans could claim any victories because they had attacked it so vigorously.

Time will tell. I still think there's a Ben Nelson out there for Wall Street to pluck.

Posted by: Kevin_Willis | April 15, 2010 4:56 PM | Report abuse

I've still never understood, considering how afraid Republicans are of Tea Party anger, and given that the Tea Party really hates Wall St, how it it is that Republicans can unite against Financial Reform.

Posted by: Quant | April 15, 2010 5:05 PM | Report abuse

Lincoln is blowing smoke, nothing more. Politicians like her tend to be "for" things right up until they have a chance of passing, then they are suddenly against them.

Lieberman was for a Medicare buy in, until it had a chance to pass, then he was against it.

The Republicans loved the individual mandate, it was their idea, until it had a chance to pass, then they were against it.

Many Democrats were for the public option, until it had a chance to pass, then they were against it.

The examples are abundant and bipartisan. Don't take Linconln's words at face value.

Posted by: nisleib | April 15, 2010 5:07 PM | Report abuse

I've still never fully understood, considering how afraid Republicans are of Tea Party anger, and given that the Tea Party really hates Wall St, how it it is that Republicans can unite against Financial Reform. Or how some Tea Partiers haven't supported Financial Reform, even if they instinctually hate democrats. I'd think there would at least be a little "the enemy of my enemy is my friend" sentiment here.

I know both the Tea Party and the Republican Party are wildly irrational, but it's still a little surprising

Posted by: Quant | April 15, 2010 5:09 PM | Report abuse

Lincoln is blowing smoke, nothing more. Politicians like her tend to be "for" things right up until they have a chance of passing, then they are suddenly against them.

Lieberman was for a Medicare buy in, until it had a chance to pass, then he was against it.

The Republicans loved the individual mandate, it was their idea, until it had a chance to pass, then they were against it.

Many Democrats were for the public option, until it had a chance to pass, then they were against it.

The examples are abundant and bipartisan. Don't take Linconln's words at face value.

Posted by: nisleib | April 15, 2010 5:12 PM | Report abuse

Absolutely brilliant. It doesn't matter if financial reform passes or not so long as it remains the center of attention. Swing for the fences and show that the real populist option is taking Wall Street down a notch.

Posted by: theamazingjex | April 15, 2010 5:18 PM | Report abuse

Ezra,

Any word on what is meant by 'swaps'? Banks using deriviatives for legitimate risk management purposes as well as trading.

Posted by: justin84 | April 15, 2010 6:19 PM | Report abuse

Ezra, your comparison to the public option fight is interesting except that precisely because this proposal comes from Lincoln, organized progressives can't support it. They are already deeply involved in Bill Halter's campaign. Right now they are scrambling to find reasons to oppose Lincoln's derivatives proposal -even if it is what they want on policy - not support it the way they would have if a moderate Dem had come out strongly for the public option.

Of course, complicating the position of progressives and the Halter campaign was precisely the point here.

Posted by: jbossch | April 15, 2010 8:13 PM | Report abuse

why do i get the impression Lincoln doesn't have a clue what she's talking about?

Posted by: visionbrkr | April 15, 2010 8:39 PM | Report abuse


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Posted by: 898551828 | April 16, 2010 8:50 AM | Report abuse

World-wide, there is a total of over $650 TRILLION dollars invested in derivatives. That's why Wall Street shuddered.

What causes me to shudder is the fact that there are very few (if any) regulations in effect to protect economies should the derivative market go bust.

SOONER OR LATER, EVERY MARKET GOES BUST.

Posted by: bwshook1 | April 16, 2010 10:33 AM | Report abuse

The $650 trillion number (which I believe is from '07, the number is smaller now) is a bit misleading.

Consider a hypothetical credit default swap book at a large bank's flow trading desk (vastly simplified to 4 index products, all positions aggregated into these 4).

IG14 long: $500Bn, @ 133bps on average
IG14 short: $520Bn @ 131bps on average
HV14 long: $100Bn @ 197bps on average
HV14 short: $80Bn @ 199bps on average

This $1.2 trillion worth of total 'notional exposure'. However, on a directional basis, the bank is neutral from a long/short perspective, with some slight exposure as the basis between investment grade and high vol fluctuates.

The actual amount of net cash transfered by premium each year is only $216 million.

The primary risk here is that one of the indexes starts seeing lots of defaults, and the counterparties you have the short side of the trade on don't pay up. This is why collateral requirements/exchange trading is necessary.

Remember, derviatives didn't cause the financial crisis - the problem was always bad mortgage and home equity loans. If there was no such thing as a credit default swap there still would have been bailouts in '08, just not of AIG.


Posted by: justin84 | April 16, 2010 11:39 AM | Report abuse

Don't kids yourselves, what this is really about is Blanche is in for the fight of her life here in Arkansas. She has to now try and make it look like she's tough on the boys and she better do it fast. She has over 2 million dollars in campaign contributions from big business and we know it. Her story is this has no effect, she always puts people first over large amounts of money but the general line of thinking here is, "We sure wouldn't!" A wounded animal is the most dangerous and since she's been wounded now, nothing is safe that gets in her path. But do we really want to fix things right now that aren't broken and also didn't break during the worst time we've had in over 50 years just to try and win an election? Blanche will definitely tinker with this to that end and I've also learned over the years, she will not listen for free either. Silly me but when the Chairman of Agriculture passes on farm subsidies to Brazil, I think she's the one that needs the regulation here. I think she will be.

Posted by: LuckyGrad68 | April 21, 2010 12:51 AM | Report abuse

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