Deal Near on Sweeping Financial Overhaul Bill

WASHINGTON -- Working into early Friday, lawmakers drafting an overhaul of bank regulations softened a contentious Wall Street restriction that would force large bank holding companies to spin off their lucrative derivatives business.

The deal, negotiated between the White House and Sen. Blanche Lincoln, D-Ark., eliminated one of the last major sticking points in a sweeping overhaul of financial regulations. Congressional leaders were eager to wrap the bill up, with hopes of getting final House and Senate passage before July 4.

Negotiators agreed to limit the reach of the provision to only the riskiest derivatives trades. Banks would be allowed to keep some of their more common derivatives business.

Negotiators also broke a deadlock on another potential obstacle, limiting the ability of banks to carry out high-risk trades or invest in hedge funds and private equity funds.

The House-Senate panel has been working late over the past two weeks to resolve differences between the two bills. The legislation aims to avoid a recurrences of the 2008 financial meltdown by requiring a regulatory council to look for threats to the system, by creating a consumer protection bureau, forcing large failing firms to liquidate and policing financial instruments that have been largely unregulated.

But Rep Barney Frank, the chairman of the House-Senate panel assembling the bill, and Senate Banking Committee Chairman Christopher Dodd left the most contentious issues for last. Lobbyists, government regulators and administration officials ducked in and out of the panel's meeting room, holding sidebar meetings with lawmakers over details in the bill.

The derivatives issue was the most nettlesome. Derivatives are complex securities often used by corporations to hedge against market fluctuations. But they also have become speculative instruments for financial institutions, the most notorious of which were credit default swaps that hedged against loan failures.

Sen. Blanche Lincoln, D-Ark., was the leading advocate of a Senate provision that would force large bank holding companies -- firms like JPMorgan Chase and Bank of America -- to place their derivatives business in subsidiaries with their own source of funds.

"That is what we ask in terms of making sure that risky business is taken outside the banking institutions so that it is not a liability to the depositors or to the Treasury, and therefore the taxpayers," Lincoln said.

Lawmakers were eager to accommodate Lincoln because her vote is crucial in the Senate, which typically needs 60 vote margins to clear procedural obstacles in major pieces of legislation.

But in the House, moderate Democrats and members of the New York congressional delegation fought to remove it. Several still opposed the final compromise.

Under the agreement banks would only spin off their riskiest derivatives trades, including the credit default swaps blamed for precipitating the crisis. The compromise offer would permit banks to keep some of their lucrative business based on trades in derivatives related to interest rates, foreign exchanges, gold and silver. Banks would be allowed to trade in derivatives to hedge against market fluctuations.

It prohibits any federal assistance to banks to prevent losses that result from derivatives trading activity.

The Obama administration had pushed for restrictions on all bank trades, a proposal especially championed by former Federal Reserve Chairman Paul Volcker. In general, the House Senate agreement, bank holding companies that have commercial banking operations would not be permitted to trade in speculative investments.

House and Senate negotiators agreed to let bank holding companies invest in hedge funds and private equity funds but would be limited to investing no more than 3 percent of their capital in hedge funds or private equity funds. There are no such conditions on banks now.

The proposal also would bar banks from betting against their clients on certain investments deals.

House and Senate negotiators were checking off agreements on smaller differences between the bills. They agreed to:

-- Set new standards for what banks keep in reserve to protect against losses, carving out a grandfather exception for banks with assets of less than $15 billion. The Securities and Exchange Commission has been working on new regulations and the negotiated provision requires the SEC to consider the result

-- Authorize the SEC to adopt rules that give shareholders of publicly owned companies the right to nominate candidates for corporate boards of directors. They also agreed to require regulators to study whether stock brokers should be more accountable for the advice they give clients and use the study results in writing new rules.

-- Big banks succeeded in a last-ditch lobbying effort to kill a House proposal to add ailing mortgage giants Fannie Mae and Freddie Mac to the type of firms that would be subject to liquidation at financial industry expense. Their collapse has already cost $145 billion. Banks worried they would be on the hook for the cost.