Financial reform bill unlikely to end taxpayer subsidy of derivative trading on Wall Street

The Wall Street-Washington Axis of See-No-Evil is close to axing Blanche Lincoln’s important proposal for ending the taxpayer subsidy of derivative trading.

For years the big banks have relied on taxpayer-funded deposit insurance to backstop their lucrative derivative businesses. Obviously they want the subsidy to continue. And all the powerful interests are falling into line: Tim Geithner and Ben Bernanke have now joined Republicans and weak-kneed Democrats to argue that the subsidy should stay. (Lincoln has signaled she may even join them, once she’s rid of her primary challenger.)

Bernanke’s logic is absurd on its face. In a May 12 letter to Christopher Dodd, he argues that “depository institutions use derivatives to help mitigate the risks of their normal banking activities.” True, but so what? Lincoln’s measure would allow banks to continue to use derivatives. They just couldn’t rely on their government-insured deposits for the necessary capital.

Banks would have to do their derivative trading in separate entites. This would require them to raise additional capital, but why is that a problem? If derivative trading is so useful to them in order to “mitigate the risks” of other banking activities, the banks should be willing to foot the bill. There’s no reason taxpayers should do so. And absolutely no reason taxpayers should have to pick up the tab when banks make bad bets on derivatives.

Bernanke also says Lincoln’s measure would force derivatives activities “into foreign firms that operate outside the boundaries of our Federal regulatory system,” giving foreign banks “a competitive advantage over U.S. banking firms in the global derivatives marketplace.” Even if Bernanke is right, since when is it the business of American taxpayers to guarantee the profitability of America’s largest banks relative to foreign ones?

If policy makers base their decisions on this specious logic, America’s big banks shouldn’t be required to hold any capital at all – for fear they might lose business to a foreign bank that’s not required to.

The trading of derivatives is not so crucial to the American economy that taxpayers should continue to subsidize the practice. If the last two years have taught us anything, the lesson is just the opposite: Derivatives can generate huge risks for the economy unless carefully regulated. Neither logic nor experience suggests that you and I and every other taxpayer should be subsidizing this gambling.

Worse yet, if we continue to subsidize these derivative trading operations, Wall Street’s biggest banks will grow even bigger. They’re already too big to fail.

Their large size and deep pockets enable them to influence our politics with generous campaign donations, and undermine our democracy. If Blanche Lincoln’s important proposal is stripped out of the finance reform bill – and if specious arguments like Ben Bernanke’s win the day – we’ll know how far this kind of corruption now reaches.

But you’re not powerless. Watch carefully which senators vote to remove Lincoln’s measure from the Dodd bill, and hold those senators accountable when you next vote.

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