Nov. 5 (Bloomberg) -- The U.S. presidential-campaign financing system spawned by the Watergate scandal is on the verge of collapse, with the death blow delivered by Democrats who long championed controls on political giving.

Democrats Hillary Clinton and Barack Obama have joined Republicans including former New York Mayor Rudy Giuliani in declining federal subsidies. Instead, they are raising millions from corporate executives and wealthy supporters, threatening to make 2008 the first election since Richard Nixon won his second term in 1972 in which both parties' nominees will have been completely financed by private sources.

The lack of public financing will magnify the power of lobbyists and other well-connected givers who collect and ``bundle'' donations from their family, friends and associates. Besides enhancing fundraisers' influence in Washington, supporters of campaign limits say, it may also sow the seeds for another massive scandal like Watergate, which drove Nixon from office and shook citizens' faith in their government for a generation.

``The amount of money that's being raised this cycle raises the specter of the presidency going back on the auction block,'' says Meredith McGehee, policy director for the Campaign Legal Center, a Washington group that favors curbs on political donations.

The current system dates back to 1974, when reports of secret slush funds and illegal activities paid for by the Nixon re-election committee led a Democratic Congress to rewrite the rules for paying for presidential races.

Limited Spending

The rules established a system allowing taxpayers to check a box on their income-tax returns to contribute to the public- financing system. The government uses the money to match the first $250 of each individual contribution to a candidate who agrees to limit his or her spending. The spending limit for the 2008 election is $50 million for the primaries, of which $21 million can come from public funds.

Until 2004, only three presidential candidates rejected the public money and associated spending caps: Republicans John Connally, Steve Forbes -- twice -- and George W. Bush. In the last presidential race, Democrats John Kerry and Howard Dean joined Bush in rejecting the primary-campaign subsidy.

This time around, former North Carolina Senator John Edwards, a Democrat, is the only major candidate to say he will accept public money; Arizona Senator John McCain, a Republican, may do so as well. Both lag far behind their rivals in fundraising.

Unlimited Cash

Their rivals, meanwhile, are bringing in unlimited cash from private sources rather than accept the spending limits. Freed from the constraints, the candidates collected $377.5 million in donations through Sept. 30, more than double the $176.1 million raised during the same period four years ago, Federal Election Commission figures show. Clinton and Obama each raised around $79 million.

``The biggest upshot of not having a functional public- financing system is a fundraising arms race,'' says former FEC Chairman Michael Toner, a Republican who now works on former Tennessee Senator Fred Thompson's campaign.

Democrats who forgo subsidies say the choice is a distasteful but necessary step to keep pace with better-funded rivals. Obama, 46, has refused donations from registered federal lobbyists and political-action committees. At the same time, he has declined to limit his primary spending and is already raising cash for a general-election campaign.

Surrender

``We would have essentially been surrendering if we had stayed within the system in the primaries,'' says David Axelrod, Obama's chief strategist. Obama ``is not going to be able to articulate any reforms if he can't get elected.''

Obama says that if he were to win the Democratic nomination, he would accept the $85 million federal subsidy for the November election and skip private money -- as long as the eventual Republican nominee did the same. Blake Zeff, a spokesman for Clinton, says she would consider making a similar pledge to support public financing of campaigns. Among Republicans, though, only McCain has agreed to such an arrangement.

``In the general election, public funds are still substantial,'' says Craig Holman, a lobbyist for Public Citizen, a Washington-based campaign-watchdog group. ``However, the Democratic candidates clearly can raise much more than that, probably three to four times that.''

Money Scouts

While federal law now bans the $100,000 contributions Nixon received, candidates often get that much from bundlers --it's just that the money is coming from several people, rather from a single individual. Public Citizen estimates that the top candidates have more than 2,000 such money scouts working for them.

Campaign bundlers first came into prominence during the 2000 election, when a group of donors called ``Pioneers'' raised at least $100,000 each for candidate Bush, who was then the governor of Texas.

The growing popularity of such fundraising sometimes embarrasses candidates. Through Sept. 30, Clinton returned $1.8 million in tainted donations, more than anyone else. About $850,000 came from Norman Hsu, one of her top fundraisers and a former fugitive who has been charged with defrauding investors and violating campaign laws.

Obama, an Illinois senator, has enlisted 314 bundlers, according to Public Citizen. While none of his money scouts are registered lobbyists, several work for law firms that also lobby, including Thomas Reed of Kirkpatrick & Lockhart Preston Gates Ellis LLP and Robert Litt of Arnold & Porter LLP.

Lobbyists for Clinton

Lobbyists among Clinton's 322 bundlers include Steve Ricchetti and Matthew Bernstein. Ricchetti Inc.'s clients include Detroit-based General Motors Corp. Bernstein's law firm, DLA Piper US LLP, represents Bethesda, Maryland-based Lockheed Martin Corp., among others.

``The game in Washington is how you get your issues up on the radar screen of a policy maker,'' McGehee says. ``Being a bundler is probably one of the best ways to do that.''

Clinton, 60, a New York senator, announced in press releases that she landed $5 million in home-state earmarks --pet projects attached to spending bills -- for a GM hydrogen-fuel- cell vehicle project and $271 million for Lockheed's development of a new presidential helicopter fleet.

Changes Since 1974

Even some proponents of public financing say the current rules don't reflect the changes in presidential politics that have taken place since 1974. Campaigning in the early states of Iowa and New Hampshire now starts months before the first delegates are selected, while the actual primary season is compressed into weeks rather than months and the maximum individual donation has more than doubled, to $2,300 from $1,000.

Fixing the rules ``is essential,'' says Fred Wertheimer, head of Democracy 21, a Washington-based advocacy group.

Senator Russell Feingold, a Wisconsin Democrat, and Representative Christopher Shays, a Connecticut Republican, have introduced legislation to update the system. Their plan includes a 4-to-1 match of the first $200 of a contribution, allows candidates to spend as much as $150 million to win the nomination and provides another $100 million for the general election. All amounts would be indexed for inflation. The legislation also would increase the voluntary income-tax check- off to $10 from $3.

`True Reform'

Even with the outdated limits, ``people should stay within the system,'' Feingold says. ``Being a true reform candidate could be a benefit.''

So far, only one other senator has signed on to the Feingold-Shays proposal: Obama, who has made revamping lobbying and campaign-finance laws a theme of his campaign.

While lawmakers debate how to reinvigorate spending limits, another school of thought holds that the problem isn't that there's too much spending, but that there isn't enough.

``There's insufficient money being spent to inform the voters about the candidates' positions on issues,'' says James Bopp Jr., general counsel of the James Madison Center for Free Speech in Terre Haute, Indiana. Many Americans don't know the names of their elected representatives, let alone the presidential candidates' views, Bopp says, adding, ``That's one of the reasons so many people don't vote.''

Supporters of campaign overhaul counter that big money will inevitably breed corruption, and that it's only a matter of time before campaigns are rocked by more scandals.

``There are many, many more Norman Hsus out there,'' says Holman.

To contact the reporter on this story: Jonathan D. Salant in Washington at jsalant@bloomberg.net.

Last Updated: November 4, 2007 19:30 EST