Why Lincoln's Win Still Won't Help Financial Reform

APTOPIX Arkansas Primary,x-default
Sen. Blanche Lincoln greets supporters before claiming victory in the Arkansas Democratic primary runoff election. Danny Johnston / AP

Even though Arkansas Sen. Blanche Lincoln narrowly won the Democratic primary Tuesday night, her signature derivatives legislation won't survive the summer. Politico is reporting that Congress plans to consider the final version of the financial reform bill during the last week in June, but that ramped-up schedule and Lincoln's victory are unlikely to add any heft to the derivatives legislation, a key part of the financial-reform package, which still lacks basic political support.

As The Atlantic points out, most major regulators—which are more powerful than Lincoln—oppose her plans: "Those opponents include the White House (and Treasury), FDIC Chair Sheila Bair, Fed Chair Ben Bernanke, and Former Fed Chair Paul Volcker. It's not entirely clear where House Financial Services Chairman Barney Frank stands. But since his knowledge and understanding of the financial industry should make him well aware of damage the provision would do, it's hard to believe that he would allow it to live in the final bill."

It's also unclear what Lincoln's derivatives legislation would actually accomplish. As the chairwoman of the Senate agriculture committee, Lincoln proposed trading derivatives on open exchanges to give people a better sense of how they worked and forcing banks to spin off their derivatives-trading departments into subsidiaries to isolate the risk. But it's hard to regulate derivatives unless you can properly define them. Would it be a trade derived from an insurance policy or from a home mortgage? "I think it would be very hard to get a broad-based definition, and two years from now, there will be new ones we've never considered," says Richard Zekhauser, a professor of political economy at Harvard University's John F. Kennedy School of Government. Isolating the trading of the derivatives from other functions of a bank also is not realistic, some critics argue, and would still give hedge funds or overseas companies latitude. "If you spin off a risky activity, it's still risky," says Paul Wachtel, a professor of economics at the Stern School of Business at New York University. "A better approach, in my mind, is to regulate or tax risky activities."

In the end, the strongest part of Lincoln's derivatives legislation may have been its political capital. During the financial-reform negotiations, Lincoln's name became synonymous with restricting risky financial instruments, the same ones that helped to cause the financial collapse. And although she opposed other Democratic causes, such as health-care reform and a cap-and-trade bill, her derivatives legislation imbued her with the aura of an anti–Wall Street folk hero. It gave Lincoln a political platform much sexier and relevant than the usual agriculture-committee business. That may have been all it was meant for. "Lincoln overplayed her hand with the derivatives, but it was nice to have somebody overplay it, because it provided a healthy balance," Wachtel says.

As Lincoln starts to campaign for a tough general-election fight in the fall, she will be able to say that she tried to regulate derivatives and was thwarted. Although she did not change the law, this alone will serve as a rallying cry for her on the campaign trail—and a lesson for other vulnerable Democratic incumbents.