A U.S. House of Representatives' panel voted Thursday to regulate for the first time privately traded derivatives, the kind of exotic financial instruments that helped bring down Lehman Brothers and nearly toppled American International Group.
The 43-26 vote by the House Financial Services Committee, was a first major step for President Barack Obama's plans to overhaul federal regulations governing the nation's financial institutions.
The mostly party line vote showed that Democrats were prepared to band together to override objections by Republicans and the financial lobby and demand increased oversight of Wall Street.
No Democrat on the panel opposed the measure. One Republican, North Carolina Rep. Walter Jones, sided with them to approve it.
Next week, the panel is expected to approve another big piece of Obama regulatory plan that would create a federal agency dedicated solely to protecting financial consumers. Both measures would still face scrutiny by the full House, as well as in the Senate where business-minded Republicans are likely to wield more influence.
But for now, the administration is hailing Thursday's vote as a critical step toward throwing sunlight on an opaque and growing $600 trillion global market.
The bill "is absolutely essential to preserving a strong marketplace, preserving transparency (and) getting incentives right in the system," said Michael Barr, Treasury's assistant secretary for financial institutions.
"We don't want to allow any firm like an AIG to be able to engage in derivatives transactions without requiring those transactions be reported and to be traded on an exchange," he said.
In the case of AIG, the company sold a form of derivatives, called credit-default swaps, to investors who were looking to protect themselves against losses in the housing market. When home defaults rose, AIG didn't have enough resources to make good on all of its promises and required a hefty government bailout to avoid folding.
Under the proposed bill, AIG would have to conduct those transactions on a monitored exchange and prove to federal regulators that they had sufficient reserves as a back up.
Democrats included an exemption for companies that use derivatives to protect against risk. The exemption was intended to distinguish between AIG and other financial institutions that use derivatives to make money, and manufacturers that rely on them to protect against a spike in fuel prices or fluctuating exchange rates.
Companies could lose that exemption if regulators see a pattern of activity that places other participants in the transactions at risk. Exempt or not, companies also would have to report their trades and the prices.
"There will be no more hidden trades where we don't know the price," said Rep. Barney Frank, the Democrat who chairs the panel.
Republicans said derivative transactions should be disclosed and operate under great visibility but object to trading them in regulated exchanges.
"You'll price out smaller companies," said Rep. Spencer Bachus, the panel's top Republican. "And you put something on an exchange and you are going to attract a less sophisticated participant."
While the derivatives bill was considered more complex, Mr. Obama's proposed Consumer Financial Protection Agency faces a tougher political climb. Republicans oppose the measure and industry has lobbied mightily against it. Moderate Democrats say they will support it but have already pushed to scale it back. credit unions should be spared agency examinations.