Behind Blanche Lincoln's Insincere Ploy to Eject Wall Street From Derivatives: Mere Electioneering

Last Updated May 17, 2010 3:57 PM EDT

Sen. Blanche Lincoln is crying uncle over her plan to force big banks out of the derivatives business. Bowing to pressure from fellow Democrats, Obama administration officials and, of course, financial industry lobbyists, the lawmaker this weekend signaled her willingness to, you know, forget the whole thing. Told ya.

"I've told people consistently that I'm willing to work with them on suggestions or ideas that they think might do a better job at this," Lincoln told the FT. That's Beltwayese for "Ah, the hell with it."

Not that it took any great insight to recognize that her proposal, part of the Senate's broader financial reform package, has more to do with election-year theatrics than with a serious effort to crack down on Wall Street. The Arkansas Democrat and avowed Blue Dog is locked in a tight primary race. Liberals were murdering Lincoln for straying off the reservation -- until she announced the derivatives amendment in mid-April.

It worked. Lincoln got a bump in the polls while flanking her Democratic foes, with President Obama praising the Senator for "leading the fight to hold Wall Street accountable." Of course, in sports, when the team owner expresses support for the coach, you know the latter is done for. The same applies here.

Behind the scenes, the White House was already moving to scuttle "Section 106," the part of the Lincoln bill that would've barred federal bailouts for companies that deal in derivatives, including Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM) and other big banks (It goes without saying that most Republican lawmakers oppose the measure.) Soon, ardent champions of financial reform such as Paul Volcker, one of Obama's top economic advisers, and FDIC chief Sheila Bair were attacking the idea by saying it would chase derivatives into the unlit corners of the industry. Ben Bernanke and Tim Geithner also piled on.

Although Lincoln continued to trumpet Sec. 106 (or Sec. 716, as it's alternatively known), the provision was effectively dead. The trick is to make it jerk around as if it were still alive. Democratic party leaders must continue the shadow play at least until Arkansas voters head to the polls tomorrow, and possibly longer if Lincoln is forced to enter a run-off. The game in Congress -- not only for derivatives but for all areas of reform -- is to milk anti-Wall Street sentiment for all it's worth, without pushing solutions that kill the golden cow.

Other elements of Lincoln's bill are likely to survive. Perhaps most important is a plan to move derivatives trading to formal clearinghouses and exchanges. That's a good thing. It should do something to insulate the capital markets from harm the next time the credit markets snap shut.

But make no mistake -- failing to curb Wall Street's appetite for these securities is a huge missed opportunity. Numerous economists reject the idea that forcing banks to shed their swaps units would weaken financial regulation. Other parts of the financial reform bill will uphold standards for capital adequacy, transparency and other requirements for all derivatives dealers, including non-bank players, they note. And such firms couldn't be any less shaky than Wall Street firms are now. Writes Nobel laureate Joe Stiglitz in a May 14 letter to Senators:

By quarantining highly risky swaps trading from banking altogether, federally insured deposits (and our basic payments mechanism) will not be put at risk by toxic swaps transactions. Moreover, banks will be forced to behave like banks, focusing on extending credit in a manner that builds economic strength as opposed to fostering worldwide economic instability.
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