Budget bill: Why one Wall Street provision stirs the deepest controversy

The House and Senate are scheduled to vote on a proposed $1.1 trillion budget bill Thursday, just hours before the deadline.

 ​​A key federal budget bill got an 11-hour dose of drama this week, as its prospects for passage were clouded by something that has little to do with the everyday mechanics of government spending: a battle over how to regulate big banks.

The bill in question is something Congress must pass to keep the government funded through the end of the fiscal year 10 months from now.

Lobbyists for Wall Street firms won the inclusion of a provision that would lighten regulation of “swaps,” financial contracts known as derivatives, which banks sell to businesses and investors as a way of hedging against things like changes in commodity prices.

Furor erupted Wednesday among opponents of this provision, who are pushing to strip it out of the spending bill.

The controversy, however, is about more than just derivatives: It’s best understood as part of a broad fight over the future of regulatory efforts to prevent financial crises like the one that engulfed America and the world in 2008.

On a number of fronts, issues that emerged in public view because of the financial crisis remain unresolved. One side in this battle argues that lax regulation of Wall Street poses a fundamental risk to the economy’s stability. The other voices caution against taking regulation too far, saying it could stifle needed flows of credit and financial products that the economy relies on.

You can guess which side the banks and other Wall Street firms are on.

Here are some of the venues to watch as this contest plays out:

Derivatives. The tussle over swaps is the issue in focus right now. A goal of the 2010 Dodd-Frank financial reform law was to shift some complex financial contracts into bank subsidiaries that don’t have federal deposit insurance. That way, if swap trades turn sour, the problems won’t raise doubts about the health of the more plain-vanilla bank.

Banks want to push this provision out of the law, and haven't been able to get it done through stand-alone legislation. So supporters of the idea in Congress have slipped it into a larger must-pass bill.

Federal Reserve. The Fed is the nation's main wall of defense against financial crises, both as a regulator of banks and as the crafter of monetary policies that help the economy through tough times. As the nation's central bank, the Fed was able to help the banking system survive in 2008 amid a domino-style panic over the health of financial firms. But critics say the Fed is too close to the banks it regulates.

Some are calling for reforms that would reduce the banking industry's influence over the selection of presidents for regional Fed branches, among other things. Recently Fed Chair Janet Yellen has met with liberal critics. This week, conservative critics asked for a meeting of their own. And a recent investigative news report, focused on how one Fed employee felt stymied by her supervisor, has raised questions about whether the Fed has a kid-glove approach to the banks it regulates. 

Revolving doors in Washington. Many finance experts say that, even beyond the Fed, private-sector bankers wield enormous clout through a revolving-door system that moves people from Wall Street to policymaking positions in Washington, and back again. Last month AFL-CIO president Richard Trumka sent letters asking large investment banks why they allow employees to reap extra compensation when they leave the firm to take a position in government.

The conservative editorial page of The Wall Street Journal opined that the labor leader is raising an important question – one that pertains to the current Treasury Secretary among others.​​

Credit rules​. The flow of things like mortgages and business loans helps to drive any modern economy, but the financial crisis also revealed the dangers that can erupt when these flows are poorly managed by lenders and poorly regulated. The trick for policymakers is to help foster a financial system that's both dynamic and prudent. Some economists worry that credit conditions in the mortgage market have been too tight since 2010, hindering a housing recovery. Others say regulators are doing pretty well at imposing needed safeguards. 

One example of ongoing to-and-fro in this arena: ​This week, the Fed formalized a proposal for the largest banks (the ones most likely to foment a wider crisis should they get into financial trouble) to maintain an extra supply of capital, beyond the reserves required of other banks.

All this hints at the scope of the maneuvering over the oversight of a financial system that's vital to the economy, but which also carries big risks.

Concern about those risks hasn't faded, even as the economy has been recovering from deep recession. One sign of the times: A forecasting publication, Gerald Celente's Trends Journal, just included "Bankism" as among the hot trends to watch in 2015. "In capitalism, businesses rise and fall on their own merits. No business is too big to fail. In bankism, too-big-to-fail banks don’t rise and fall on their own merits. They are saved by governments that in turn force the public to pay for banks’ mistakes," writer Nomi Prins says in the journal, describing the trend.

Some backers of the Dodd-Frank law say the legislation is paving the way for a new world where no financial firm is "too big to fail."

But many finance experts say it's an open question whether the nation is getting better at preventing and responding to financial crises. 

And the question is very important, they add. The deep recession that followed the meltdown in real estate markets is proof that financial turbulence can have long-lasting effects on the whole economy.

The spending bill may end up passing, despite the concerns raised by financial-safety hawks such as Sen. Elizabeth Warren (D) of Massachusetts. But the budget bill has controversial elements that go beyond the derivatives piece. Some House conservatives reject the bill, as do some liberals in the Democratic-controlled Senate.

Even if it passes, the larger fight over financial regulation will go on.