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Regional Fed Chiefs Lining Up To Support Tough Derivatives Provision, Obama Admin. Still Opposed

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Another top Federal Reserve official offered his support this week to a Senate provision that would force megabanks to spin off their lucrative and risk-laden swaps desks.

In a letter dated Thursday, Federal Reserve Bank of Dallas President Richard W. Fisher wrote Senate Agriculture Committee Chairman Blanche Lincoln in support of her measure that would significantly change the way Wall Street's financial behemoths sell and trade a type of financial derivatives product.

The provision "appropriately allows banks to hedge their own portfolios with swaps or to offer them to customers in combination with traditional banking products," Fisher wrote in his letter, which was obtained by the Huffington Post. "However, it prohibits them from being a swaps broker or dealer, or conducting proprietary trading in derivatives. The risks related to these latter activities are generally inconsistent with the funding subsidy afforded institutions backed by a public safety net.

"Such activities should be placed in a separate entity that does not have access to government backstops. These entities should be required to place their own funds at risk," he added.

Federal Reserve Bank of Kansas City President Thomas M. Hoenig wrote an identical letter Thursday. Hoenig is the Fed's longest-serving policy maker. He and Fisher are part of a group of Fed officials outside of Washington and New York who support efforts to break up the nation's biggest banks, a position Obama administration officials are firmly against.

Rather than banks dealing in swaps, Lincoln's provision would compel them to reorganize their swaps units into a separate affiliate within the bank holding company, forcing the nation's largest banks to raise tens of billions of dollars to guard against potential losses on their risky bets.

It aims to "let banks be banks," supporters say, by forcing them to shed their riskiest Wall Street operations from the deposit-taking bank. Banks are explicitly supported by taxpayers in the form of federal deposit insurance and access to cheap funds from the Fed's discount window. Supporters argue that taxpayers shouldn't subsidize banks' swaps dealing when they're not offered to customers wishing to hedge risk in conjunction with traditional banking products.

Vigorously opposed by Wall Street, the Fed's Board of Governors in Washington, and the Obama administration, the measure is supported by a few regional Fed presidents outside the Washington-Wall Street nexus, progressive Democrats in the House and Senate, House Speaker Nancy Pelosi, and economists concerned about the growing dominance of the nation's largest banks.

Along with a few foreign banks, the nation's largest domestic banks essentially control the swaps market in the U.S. By forcing them to divest their units into separate affiliates, which in turn would compel them to raise money to capitalize these affiliates, Lincoln's measure could force them to scale down their operations. At the least, supporters say, it would force them to have enough cash on hand in case their bets began to sour, saving taxpayers from having to step in to prop up the banks like they did in 2008. That support continues today.

In addition to supporting Lincoln's provision, Fisher and Hoenig are also two of the more outspoken Fed chiefs in favor of forever ending the perception that the nation's largest financial institutions are too big to fail.

READ the letter:

Richard Fisher on Blanche Lincoln's derivatives measure