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Close Call

Paul Volcker just saved Wall Street's bankers ... and now he owns them.

Last Wednesday, Arkansas Senator Blanche Lincoln took to the Senate floor and delivered about as fiery a speech as you’ll hear in the chamber, at least on the subject of financial reform. “Currently, five of the largest commercial banks account for ninety-seven percent of the [derivatives market],” she said. “That is a huge concentration of economic power, which is why I am in no way surprised that several individuals are seeking to remove it from the bill.”

The “it” these unnamed individuals were bent on removing is a provision Lincoln wrote that would force banks to spin off their derivatives business if they want access to federal deposit insurance and other safeguards. Lincoln stunned the financial world when she unveiled the hawkish proposal last month and promptly pushed it through the Senate Agriculture Committee, which she chairs. (Derivatives are essentially a bet on the direction of financial data, like bond prices and interest rates.)

Despite the industry’s furious efforts and the private reservations of many Democrats, the provision had survived repeated attempts on its life, and Lincoln was determined to preserve it. “She upped the ante,” one industry lobbyist told me shortly after Lincoln’s floor speech. “It’ll be hard for her to walk back from this.” As of late last week, there was a very real chance she’d get her way. One derivatives industry lawyer I spoke with told me Democrats were so concerned about appearing to oppose the measure that it would become law unless the leadership stripped it out “behind closed doors.”

But then something unforeseen happened: Legendary Fed Chairman Paul Volcker, a hero to Wall Street reformers and scourge of megabanks, penned a letter to Banking Committee Chairman Chris Dodd proclaiming that the Lincoln approach overreached. Volcker was quite possibly the only person in America with the credibility to stop the Lincoln provision—similar pleas from the administration, the Fed, and the FDIC all seemed to fizzle in recent weeks—and it looks like his intervention is having the desired effect. But before the industry rushes to celebrate Paul Volcker as its savior, it should remember why it feared him in the first place.

Politically, opponents of the Lincoln provision faced two big hurdles. The first is that, over the last several weeks, the administration has made a p.r. push touting muscular derivatives regulation as non-negotiable. The president went so far as to say he’d veto a bill that didn’t go far enough on derivatives. With so much focus on the issue, the average Democratic senator wasn’t about to oppose a tough-looking measure even if it technically went further than the administration had advocated.

Beyond that, there was a basic rule of politics at work: It’s much harder to strip a reform measure out of a bill than to prevent it from getting there in the first place. Consider, for example, the fate of another effort to impose structural change on Wall Street—an amendment by senators Sherrod Brown of Ohio and Ted Kaufman of Delaware that would have shrunk the country’s biggest banks.

The idea behind the Brown-Kaufman amendment was that a handful of banks had grown so unwieldy that the government couldn’t credibly promise not to bail them out. The administration opposed the amendment because it believes bright-line rules are actually easier for banks to evade than the prying eyes of regulators. And because Treasury wants the flexibility to negotiate international agreements with other advanced economies and worries that such rules would gum up the process. But the administration had reason to worry as the broader reform bill wound its way to the Senate floor. Majority Whip Dick Durbin, the Senate’s second-ranking Democrat, signed on as a co-sponsor, while Majority Leader Harry Reid called the idea “intriguing” and eventually proclaimed his likely support. Every day, more senators seemed to offer their endorsement.

Yet, by the middle of last week, the amendment was losing altitude. Brown and Kaufman found themselves struggling to elbow their way onto the agenda for a vote. When they finally got it, the amendment garnered a mere 33 yeas. Dodd had let it be known he opposed the bill, and eleven of 13 Democrats on his Banking Committee followed his lead. Because any given senator could claim the amendment would have died even with his vote, no one faced blame for killing it.

By contrast, Lincoln’s aggressive derivatives measure—known as Section 106—was baked into the legislation she served up in mid-April. And when it passed her committee with the vote of every Democrat and even one Republican, it had enough momentum to merit inclusion in the broader financial reform bill that would eventually come before the full Senate.

From the moment Lincoln introduced her bill, repeated attempts to lop off Section 106 have proved futile. Geithner promptly signaled his coolness to the idea by sending Lincoln a letter praising the rest of the bill—which included stiff regulations for trading derivatives—but pointedly omitting mention of 106. Lincoln simply ignored the implied message. Then, during the committee debate, New York Senator Kirsten Gillibrand filed an amendment that would have required regulators to assess the proposal before voting to implement it. But Gillibrand decided to scrap it because she and other Democrats worried about bogging the bill down in a fight.

Once the broader bill moved toward the floor, the Federal Reserve circulated a memo outlining its opposition to Section 106, which had little discernible effect. This was followed by a likeminded letter from Sheila Bair, the widely respected chairman of the FDIC. Bair’s letter got little traction, too. Further complicating the issue, notes one Hill source, Washington Senator Maria Cantwell stood up at a recent Democratic caucus meeting and denounced opposition to the Lincoln provision as thinly-veiled sexism.

Late last week, Republican Senators Judd Gregg and Saxby Chambliss swung into action on an amendment stripping the Lincoln provision from the bill. Many on Wall Street were jubilant to have finally broken through. But, to seasoned lobbyists, the Gregg-Chambliss gambit looked ominous. Democrats would be highly unlikely to support a Republican amendment weakening the bill, they reckoned. And if someone later tried to remove the provision discreetly—say, during a House-Senate conference merging the two chambers’ bills—they’d have to explain how this happened after the Senate had plainly voted to keep it in. “Part of you is like, ‘Ooh great.’ Part of you is like, ‘that’s not a great idea,’ ” one lobbyist told me. “If [the Gregg-Chambliss amendment] is going to be defeated, it doesn’t help.”

It’s only now that Volcker has weighed in that Democrats seem willing to cross Lincoln, according to a source familiar with the thinking of Democratic senators. “If Paul Volcker says it’s okay, he’s unimpeachable in this debate,” the lobbyist elaborates. “You can’t get in too much trouble if you vote to eliminate the provision.” Which means that, should Gregg and Chambliss offer up their amendment later this week, it could conceivably spell the end of Lincoln’s Section 106. At the very least, Democrats have cover to rub it out some other way--perhaps through a maneuver they initiate.*  

But, once again, Wall Street would be advised not to rejoice. Volcker, after all, is the father of the so-called Volcker Rule, the financial reform provision that would prevent banks from making proprietary trades. Those are the bets banks place for their own account, netting them billions of dollars each year by some estimates. As with the Lincoln’s 106, the industry has lobbied furiously against the Volcker Rule. And while it has made little progress to date, many believed there was a chance to limit the damage by defining a proprietary trade as narrowly as possible.

Alas, by further elevating Volcker as the arbiter of all that is good and just in financial reform, this latest development may have all but closed that window. In fact, Volcker suggests as much in his letter, noting that the reason he feels comfortable opposing the Lincoln provision is that the Volcker Rule already prohibits the most noxious form of derivatives trades. He goes on to praise the specific proprietary trading language proposed by Senators Carl Levin and Jeff Merkley—language that limits regulators’ discretion in applying the rule—which could effectively etch it in stone. It’s like the old saying goes: Live by the pronouncements of an 82-year-old financial deity, die by the pronouncements of an 82-year-old financial deity.

Noam Scheiber is a senior editor of The New Republic.

*This sentence was added after the original publication to reflect ongoing developments.