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Few like Blanche Lincoln's derivatives proposal

Thumbnail image for lincolnderivs.JPGBlanche Lincoln's derivatives proposal was expected to be a weak compromise that would water down the bill and arouse progressive opposition. Bill Halter, her opponent in the Democratic primary, was previewing his attack on the issue before Lincoln had even released her language.

But Lincoln's actual release shocked everyone. It was strong in all the traditional ways, running most all derivatives through clearinghouses and exchanges and making the exemption for legitimate hedgers very, very tight. (For more background on regulating derivatives, head here.) But it also included something no one had expected: a proposal to split derivatives-trading off from banks by denying institutions that traded derivatives access to the Federal Reserve's cheap money.

This sounded good to a lot of people. It seemed to fit the Glass-Steagall (which split investment banks from commercial banks) or Volcker rule (which stops banks from making speculative trades to pad profits using the federally insured deposits of their customers) mold by driving risky behavior out of the primary banking market. But though the idea sounds good, it's hard to find too many people who think it is good.

The administration, the Treasury Department, the Federal Reserve, and even the FDIC are lockstep against it. Note the FDIC's involvement there: Under Sheila Bair, the FDIC has been pushing for stronger protections, not weaker ones, so she has a lot of credibility on these matters. And she's saying that the change would make the system riskier, not safer. "If all derivatives market-making activities were moved outside of bank holding companies," she wrote in a letter to lawmakers, "most of the activity would no doubt continue, but in less regulated and more highly leveraged venues. Even pushing the activity into a bank holding company affiliate would reduce the amount and quality of capital required to be held against this activity."

In my interviews, I've heard similar concerns from a range of sources. Another consistent theme is that the interim period between passing this law and having a functioning derivatives-market could be a lot messier than people think, with real economic consequences.

That isn't to say that no one supports the idea: Michael Greenberger, who was Brooksley Born's lieutenant when she tried to look at regulating the derivatives market in the '90s, thinks the idea makes sense. So do some others. But in general, reactions have been negative, even from the people who would like to support strong derivatives-legislation. But some of these critiques are remaining quiet because, first, some people think this is a useful place to concentrate fire so that the important derivatives-regulations emerge unscathed, and second, because the politics of being tough on derivatives are pretty good right now, and third, because people feel that Lincoln has unexpectedly come to the rescue of the derivatives-regulation cause and no one wants to alienate such an unexpected and useful ally.

By Ezra Klein  |  May 3, 2010; 9:17 AM ET
Categories:  Financial Regulation  
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If the Volkeresque provision is dropped, I hope the remainder of her propsal, i.e. the exchanges with tight exceptions, remain in place. It seems like that aspect has a lot more support among knowledgeable people.

Posted by: jduptonma | May 3, 2010 9:23 AM | Report abuse

Derivatives have been such a successful tool for investment of large sums of currency, why would anyone want to change or regulate them more? (This is SARCASM!)

Any way to take this lethal bit of magical thinking off the table? Same folks that want the tax laws simplified might think of a few ways to stop these little poison pills.

Posted by: freeholder1 | May 3, 2010 10:40 AM | Report abuse

*****If all derivatives market-making activities were moved outside of bank holding companies," she wrote in a letter to lawmakers, "most of the activity would no doubt continue, but in less regulated and more highly leveraged venues.*****

Maybe. But I thought the whole point wasn't so much that derivatives trades can go awry and people lose money, I thought the whole point was that derivatives trades can go bad, therefore damaging LARGE INSTITUTIONS WE DEPEND ON, if said large institutions are allowed to engage in the activity in question.

Posted by: Jasper999 | May 3, 2010 2:39 PM | Report abuse

Good going Senator Lincoln. Perhaps Arkansas has awaken you at last to the real needs of the people you were elected to represent. True Health Care Reform would have been a great place for you to start but better late than never.

Posted by: CharlieWilliams | May 3, 2010 4:18 PM | Report abuse

The 250 plus organizations of Americans for Financial Reform, made up of consumer, housing and community groups, wrote a detailed letter in support of the Lincoln bill, so its not just one man. That thinks it is a great idea. Please consider a correction. The AFR letter is posted here:

Posted by: Bankster | May 3, 2010 6:06 PM | Report abuse

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