Dem rifts over derivatives develop

Rifts are developing among Senate Democrats over regulating the multitrillion-dollar market for financial derivatives.

Key Senate Democrats unveiled a compromise bill on Monday in an effort to remake part of the financial industry that many blame for exacerbating the crisis in 2008.

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But the bill, sponsored by Senate Banking Committee Chairman Chris Dodd (D-Conn.) and Senate Agriculture Committee Chairwoman Blanche Lincoln (D-Ark.), is facing criticism from rank-and-file Democrats.

Some Democrats are concerned it might go too far and suffocate the market. Others, meanwhile, are starting to eye even stronger provisions.

The derivatives bill is just one part of a broad effort to overhaul the financial industry. The Democratic differences underscore the continued uncertainty more than a year after the crisis about how best to bolster regulations on Wall Street.

Adding to the uncertainty is that Dodd and Sen. Richard Shelby (Ala.), the top Republican on the Banking panel, continue bipartisan negotiations on derivatives legislation that could dramatically alter the final Senate bill.

“There are some legitimate issues that need to be worked on,” Dodd said of the derivatives portion of the bill.

The Dodd and Lincoln bill includes a controversial provision that requires banks to spin off their derivatives desks. The measure targets Wall Street banks in particular, which have made billions of dollars off derivatives trading.

But centrist Democrats, including Sens. Kirsten Gillibrand (N.Y.) and Mark Warner (Va.), are concerned the provision, which is strongly opposed by the financial industry, may go too far.

New York banks, in particular, would face major changes if the bill became law. Five large commercial banks represent 88 percent of the total credit exposure to derivatives, according to the Office of the Comptroller of the Currency.

Gillibrand had supported an amendment earlier in committee debate that would have limited the provision and required a study.

Matt Canter, spokesman for Gillibrand, said the senator isn’t pursuing an amendment at the moment, but is raising concerns about the issue with colleagues.

“She is in contact with everyone, from her colleagues, the administration, Treasury in particular, leadership and colleagues in the New York delegation, as well as the mayor,” he said, referring to New York City Mayor Michael Bloomberg. Canter said the senator is concerned the measure would hurt lending to small businesses.

The financial industry has said that if banks are forced to spin off their derivatives desks they could be forced to limit their other businesses. The banks might need to shift money to the new derivatives operations to ensure they are well-capitalized and attractive partners in derivatives deals. That could take money away from lending.

Warner said he has concerns that the provision may wind up shifting business away from big banks and to relatively small and less regulated hedge funds.

“I think there could be some unforeseen consequences,” said Sen. Mark Warner (D-Va.). “It could actually push greater concentration, because you might have this activity taken up by hedge funds in certain markets, and I’ve got some remaining questions.”

Other Democrats are looking to ensure that the legislation does not wind up harming manufacturing interests as it seeks to regulate Wall Street.

Sen. Debbie Stabenow (D-Mich.), for example, is looking to pass “common-sense legislation,” but also has concerns about the impact the bill would have on Michigan businesses.

“She will continue working to make sure that regulations do not burden Michigan manufacturers, farmers and small businesses, all of whom were victims of this financial collapse and now need our help to rebuild and create jobs,” said Matt Williams, a spokesman for Stabenow.

Manufacturing and business interests, including the U.S. Chamber of Commerce, Business Roundtable and Edison Electric Institute (EEI), have pushed for a broad exemption for commercial “end users” of derivatives.

Meanwhile, other Democrats are looking to push for even stronger legislation.

Sen. Byron Dorgan (D-N.D.) on Monday said he wanted to completely ban the market for “naked” credit default swaps.

Credit default swaps are a type of derivative that is tied to the potential for default of an underlying asset. A “naked” swap is one in which the traders don’t have a stake in the underlying asset.

“I’m interested in offering an amendment that bans naked credit default swaps. You know what a naked credit swap is? That’s one that has no insurable interest on either side. It’s just flat-out betting rather than investing,” Dorgan said.