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Senators Send Letter To Harry Reid Urging Strong Derivatives Reform

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A bipartisan coalition of Senators concerned about weak oversight of derivatives sent a letter to Senate Majority Leader Harry Reid urging him to strengthen the current financial reform bill and resist efforts to weaken it.

The letter, dated Friday, details 11 principles the Senators hope the final bill will incorporate.

Derivatives -- financial instruments that derive their value from other financial instruments -- are used to hedge against risk, like rising interest rates or fluctuations in currency prices. Largely unregulated, they're also used to create financial securities out of thin air (a bet on a bet on a bet, for instance), and they're used to make bets without parties needing to front the necessary cash. It's the implosion of these that contributed to the worst financial crisis and economic downturn since the Great Depression.

The Senate is expected to begin debating the main bill, authored by Banking Committee Chairman Christopher J. Dodd, this week. A complementary bill, authored by Agriculture Committee Chairman Blanche L. Lincoln, which has jurisdiction over the Commodity Futures Trading Commission, which regulates some derivatives products, is largely viewed as the stronger of the two bills. The bipartisan coalition wants the final bill to incorporate the strongest provisions from the two measures, or at the very least adopt Lincoln's bill as the derivatives section of the final product.

The bill authored by Lincoln, of Arkansas, shines more light on megabanks' derivatives operations than the bill put forward by Dodd, of Connecticut, experts say.

"If we are to effectively regulate the derivatives market, we must start the Senate floor debate with the strongest proposal we can craft and defend against the inevitable attempts to weaken it -- rather than rely upon later amendments to add essential reforms," the letter reads. "Starting the amendment process from a position of weakness is no way to start."

Among the provisions the seven Senators hope the final bill will feature are tougher rules requiring parties to trade on regulated exchanges and exchange-like facilities, mandated collateral-posting requirements so parties put cash on the table when making their bets, position limits to prevent market manipulation (which also could deter wild swings in prices for commodities that don't reflect the underlying economic situation), and a requirement that derivatives dealers be legally compelled to act in the best interests of their pension fund, university endowment and state and local government customers.

Derivatives dealers, like Goldman Sachs and JPMorgan Chase, currently are not legally required to act in the best interests of their customers.

"We urge a constructive process in which the strongest provisions of each bill are combined into a proposal to reform the derivatives market that is more effective than either current proposal, and is supported by both Chairmen," the letter states. "In the absence of such an agreement, we would find it difficult to support comprehensive reform legislation unless the best provisions of the Agriculture Committee's bill were included as the derivatives title of the legislation."

The letter is signed by Republican Olympia J. Snowe of Maine, and Democrats Dianne Feinstein of California, Bill Nelson of Florida, Tom Harkin of Iowa, Maria Cantwell of Washington, Byron L. Dorgan of North Dakota, and Sherrod Brown of Ohio.

Read the letter below:

Letter to Senate Majority Leader Reid Regarding Derivatives