Senate Agriculture Committee approves tougher derivatives rules for Wall Street banks

Senate panel approves tougher derivatives rules

WASHINGTON — A Senate panel on Wednesday advanced the toughest limits yet on banks’ ability to profit from complex financial tools called derivatives.

The bill offered by Senate Agriculture Committee Chairman Blanche Lincoln, D-Ark., would also improve transparency of most derivative trades.

The legislation was approved on a 13-8 vote. Sen. Charles Grassley, R-Iowa, joined the panel’s 12 Democrats in supporting the measure. He earlier had supported a Republican substitute amendment that would have softened the bill’s strongest provisions.

Grassley’s defection suggests Republicans might be softening their opposition to the Obama administration’s financial regulatory overhaul.

Lincoln’s derivatives bill is expected to be incorporated into the broader regulatory legislation before it is taken up by the full Senate. But many are skeptical a provision barring big banks from running derivatives desks will survive. Lincoln said after the committee vote that she did not know which provisions would end up in the final bill.

Derivatives are financial products — such as corn futures or stock options— whose values depend on the values of underlying investments. Companies use them to hedge against risks, such as interest rate swings or oil price spikes. Derivatives also became a vehicle for speculation and helped trigger the financial crisis.

American International Group Inc. issued and insurance-like derivative called a credit-default swap. A swap would pay the buyer if a certain bond or other investment defaulted. The use of swaps allowed banks to pile up risky bets and transfer the risk to AIG by buying the insurance.

Once bonds backed by subprime mortgages started to default, AIG was on the hook for billions of dollars it could not repay. AIG’s failure would have threatened the other banks. So the government stepped in with a rescue that eventually totaled $182 billion.

Under Lincoln’s bill and other Democratic proposals, companies such as AIG would be subject to closer regulation. They also would have to keep minimum levels of capital to protect against market downturns.

All the major plans would require that most derivatives be settled in a centralized system and traded over exchanges. Supporters say this would improve market transparency, drive down prices for users of derivatives and provide more information to regulators.

What sets Lincoln’s bill apart is a rule that would bar companies that receive federal guarantees, like insurance from the Federal Deposit Insurance Corp., from most derivatives activities. That would shut down a revenue stream that’s become more important for banks as lending has declined.

The banks could set up separate derivatives operations under their holding companies. But these desks would have to be funded with money from the banks’ capital base. That would further restrict lending.

Last week, all 41 Senate Republicans signed a letter stating they would vote against the broader bill. Centrist Republicans have since appeared more likely to compromise.

One reason may be the backlash against banks. That was fueled Friday after the Securities and Exchange Commission filed civil fraud charges against Goldman Sachs Group Inc. Republicans crowed that the charges were timed to help push the regulatory legislation through.