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Swaps-Desk Ban Opposed by Democrats' Coalition as Increasing Systemic Risk

A coalition of U.S. House Democrats asked their colleagues to remove a derivatives rule from the financial-regulation overhaul bill, intensifying the debate over the provision in the days before its final consideration.

Forty-three members of the New Democrat Coalition, a group of 69 self-described “moderate, pro-growth” lawmakers, sent negotiators a letter today opposing Senator Blanche Lincoln’s plan to ban commercial banks from operating swaps-trading desks.

The provision “would increase systemic risk by forcing derivatives transactions into less regulated and less capitalized institutions and impede effective regulatory oversight of the derivatives market,” the group wrote in the letter to congressional leaders and members of the House-Senate panel assigned to merge the two chambers’ versions of the bill.

The New Democrats are now aligned with a group of New York Democrats opposing the provision, which may threaten its inclusion in the final bill. House and Senate Democrats are attempting retain votes needed in each chamber needed to pass the most sweeping regulatory overhaul since the 1930s.

Opponents and supporters of the swaps-desk rule, known by its legislative shorthand Section 716, have mobilized in recent days. Lincoln, an Arkansas Democrat, has gained support from three Federal Reserve Bank regional presidents in the past week and pledged to fight efforts to modify or strip the provision.

Bailouts

“Banks were never intended to perform these activities,” Lincoln said last week in her opening statement to the House- Senate conference committee. “It is this economic activity that contributed to these institutions growing so large that taxpayers had no choice but to bail them out.”

The New Democrats, who played a leading role in shaping the House legislation passed in December, are joined in opposition by a group of New York House Democrats led by Representatives Michael McMahon and Gary Ackerman.

In their letter, the New Democrats said that another measure in the bill -- a ban on proprietary trading, known as the Volcker rule after its author Paul Volcker, the former Federal Reserve chairman -- would better achieve the goals of the Lincoln provision.

The Volcker rule would allow regulators to separate the riskiest trading activities from commercial banking, while allowing banks to use swaps for customer-driven trading and to hedge their business risk, the group said.

Regional Banks

Seven regional lenders including U.S. Bancorp and Fifth Third Bancorp joined lawmakers and industry groups opposing the Lincoln provision, saying in a letter to House-Senate conferees that the measure could reduce oversight of swaps trading.

“Forcing banks to spin off derivatives businesses will result in derivatives contracts migrating away from federally regulated banks and into companies such as hedge funds and foreign banks where there is no oversight or regulation by regulators,” the bankers said in the letter.

The letter, signed by senior executives from U.S. Bancorp, Fifth Third, BB&T Corp., KeyCorp, SunTrust Banks Inc., Regions Financial Corp. and PNC Financial Services Group Inc., was obtained today by Bloomberg News.

End Users

A coalition of business trade groups also came out in opposition to the provision today. The Coalition for Derivatives End-Users, a group including the U.S. Chamber of Commerce and the Business Roundtable, said the provision “presents a number of practical problems for end users” including increased hedging costs and the elimination of counterparties.

End users, businesses such as airlines and manufacturers that use derivatives to hedge risk in producing or consuming commodities, have sought exemptions from regulatory restrictions in the bill.

Derivatives, such as stock options, are financial instruments based on the value of another security or benchmark. Some instruments, including contracts that insured mortgage- backed bonds, have been blamed for fueling a financial crisis that led to the worst recession since the Great Depression.

Representative Barney Frank, the Massachusetts Democrat leading the House-Senate conference, has been working to craft a compromise on the Lincoln plan after saying it “goes too far.”

“Differences narrow in these things, but there will still be some,” Frank said in an interview this week. “Derivatives and bank proprietary activity will be substantially regulated and regulated in this bill and people are moving in the right direction right now.”

To contact the reporter on this story: Phil Mattingly in Washington at pmattingly@bloomberg.net.

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