Financial regulations coming as Wall Street shows first signs of recovery

Lawmakers took a major step toward overhauling the nation’s financial system Wednesday as a House panel prepared to pass legislation.

The House Financial Services Committee is slated to vote Thursday morning on a measure reining in the multitrillion-dollar market for complicated financial derivatives that many blame for exacerbating the crisis last year.

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The panel’s work to bolster the regulatory system comes as Wall Street shows new signs of recovering from the worst of the financial crisis. The Dow Jones Industrial Average, in the middle of a bull rally, closed above 10,000 points, the highest level in more than a year.

Meanwhile, JPMorgan Chase & Co. on Wednesday posted $3.6 billion in profits for the quarter, more than six times the profit in the same period in 2008. The Wall Street Journal reported that major banks and securities firms are slated to pay employees record compensation.

Financial derivatives, tools used by a wide range of banks and other industries to hedge risks, have played a major role in the recent Wall Street profits. Commercial banks in the United States recorded a record $9.2 billion in revenue on derivatives in the first three months and another $5.8 billion in the second quarter, according to the Office of the Comptroller of the Currency.

The House committee sped through debate on the derivatives bill on Wednesday, but is now turning to the more contentious issue of creating a new federal Consumer Financial Protection Agency (CFPA). Both are central elements of President Barack Obama’s efforts to revamp the regulatory system and have been the source of major lobbying battles.

The proposal for a new consumer agency has come under attack from a wide range of industries and business groups, including the U.S. Chamber of Commerce. Financial Services Committee Chairman Barney Frank (D-Mass.) indicated he expects this to be a tougher battle.

“We will be debating this bill for several days, but at some point this bill is coming to a vote,” Frank said.

Frank said lawmakers on the panel would continue to mark up legislation until the end of the month, with other divisive issues yet to arise. Democratic leaders are eyeing a vote on the House floor as early as mid-November.

Senate Banking Committee Chairman Chris Dodd (D-Conn.) and Sen. Richard Shelby (R-Ala.) continue to negotiate behind the scenes, and a vote in the upper chamber could be delayed until early next year.

On the derivatives legislation, Frank appeared to balance the major concerns of centrists worried about going too far in overhauling derivatives and liberal Democrats who have called for strong regulations.

Frank included amendments tweaking the legislation to include a presumption that derivatives trades be placed on public exchanges if they are between financial institutions.

But Frank included a broad exemption for “end-users.” The exemption covers firms with substantial derivatives positions, “primarily for hedging, reducing or otherwise mitigating commercial risk.”

Big industrial associations, including the Business Roundtable and U.S. Chamber of Commerce, have lobbied heavily to carve out exceptions for these end-users of derivatives. The exemption would help firms that are big clients for derivatives from Wall Street banks.

Scott Talbott, senior vice president at the Financial Services Roundtable, said the committee is “moving in the right direction” but the industry would like to see additional efforts to help end-users and non-financial businesses.

Frank also removed a provision that he said could be “unsettling” that would have allowed government regulators to ban “abusive swaps.”

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Republicans appeared headed to oppose the bill, with Rep. Spencer Bachus (R-Ala.) calling it “fundamentally wrong” and others worried that it would cripple business.

“We’re moving in the right direction, but it’s still not where most of the people with knowledge on the subject think we should be,” said Rep. Scott Garrett (R-N.J.).

But centrist Democrats, including Reps. Melissa Bean (D-Ill.) and Walt Minnick (D-Idaho), who have worked hard to shape the legislation ahead of the markup, appeared largely satisfied.

“The bill we’re considering seeks to modernize and reform derivatives regulation to make sure that what happened last fall doesn’t happen again,” Bean said.

The debate over the new CFPA agency will likely be tougher. The financial industry and Republicans are overwhelmingly opposed to a new agency that would have regulatory power over products, including home loans, credit cards and payday loans.

Rep. Jeb Hensarling (R-Texas) said it was a “draconian federal agency.”

One of the biggest battles will be over whether the agency should allow state officials to pursue additional or stronger regulations beyond what the federal agency decides. Centrist Democrats and the industry are in favor of the agency having the power to pre-empt state officials.

Separately, Democrats are considering changes aimed at narrowing the new agency’s authority over small banks and credit unions. The changes could leave most of the examination and supervision responsibilities with the existing federal regulators.

Reps. Dennis Moore (D-Kan.) and Brad Miller (D-N.C.) intend to help banks with less than $10 billion in assets and credit unions with less than $1.5 billion in assets, according to a draft copy of their amendment.

Such an effort could help ease concerns among community bankers and credit unions, both powerful lobbying groups that have major reservations about the new agency.