Rushing Through Reform

| Wed Apr. 28, 2010 12:34 PM EDT

Right now, credit derivatives are the personal fiefdom of five big banks. Blanche Lincoln wants to make those five banks spin off their derivatives operations, but the Fed's technical staff is opposed:

Fed staff members wrote that the provision, advanced by Senate Democrats, "would impair financial stability and strong prudential regulation of derivatives; would have serious consequences for the competitiveness of U.S. financial institutions; and would be highly disruptive and costly, both for banks and their customers."

Democrats rejected the Fed's push and decided to include the controversial provision, originally drafted by Senate Agriculture Committee Chairman Blanche Lincoln (D., Ark.). It would force any financial company that has insured deposits or can borrow from the central bank to spin off its derivatives operations. Ms. Lincoln has said this would protect taxpayers from having to offer public support for speculative trading operations. The Agriculture Committee passed the derivatives bill last week.

I'm not altogether sure where I stand on this. But I will make one comment: Republicans have a habit of complaining that Democrats are "rushing" their legislative agenda, and most of the time the charge is simply ludicrous. Whether it's heathcare or climate change or financial reform, they're usually talking about things that have been publicly discussed for years and actively part of the legislative process for many months at a minimum. It's a useful rhetorical tool for gullible reporters, but nothing more.

But in this case, there's something to it. Lincoln's proposal, as near as I can tell, came out of nowhere a couple of weeks ago. There's a general argument in its favor — namely that it would push risky derivatives away from federally insured banks and reduce the size of those banks at the same time — but not much in the way of serious discussion of the upsides and downsides. That hasn't changed much in the past couple of weeks, either. I've seen virtually no detailed discussion of what this proposal would entail.

I'm sympathetic to the idea on the simplistic grounds that it would (a) reduce the size and profitability of big banks, and (b) probably reduce the size of the derivatives market. I also find the Fed staff's arguments weak. It's the kind of boilerplate that we're fed about practically every proposal to rein in the financial sector. Still, it's hard to believe that we should enact a measure this sweeping with virtually no time for serious discussion. This one really needs a little more time for consideration.

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