UPDATE: Ted Kaufman and Sherrod Brown release an important bill that would set leverage and size caps on the big banks.

The headline story in the Washington Post today states that Republicans, worried about being seen as too close to the big banks, especially in the wake of the Goldman Sachs scandal, are returning to the bargaining table and supportive of a bipartisan deal. This was how Democrats hoped this would turn out, that they could play a game of chicken and win, and that appears to be the case right now.

However, there’s nothing specific about any deal being discussed, just the notion that there is one in the works. So now it’s time to assess the nuts and bolts of the policy. Noam Scheiber is correct to say that the derivatives piece has actually strengthened as the bill has moved through the legislative process, first with the Dodd placeholder and then with Blanche Lincoln’s tougher bill. However, Scheiber neglects to mention that the sharp move on derivatives could be motivating Republicans to get back to negotiations to weaken it. In fact, everybody seems to be missing the big story that Banking Committee Republican Judd Gregg “basically has an agreement” on derivatives language with Jack Reed. If it brings his vote, the Gregg-Reed agreement would supersede Lincoln’s bill, making discussion on it fairly moot. And if that happens across the board, this “breakthrough” on Wall Street reform will be anything but.

In fact, the real action on this bill, what will make it passable or useless, is not coming from Republicans but from the left:

Finally, there’s the argument, which top Wall Street executives have conveyed directly to senior White House officials in recent days, that the administration faces almost as much peril as Wall Street does if it brings a partisan bill to the Senate floor. Should that happen, the argument goes, Senate liberals like Maria Cantwell and Byron Dorgan could triumph on amendments that would move the bill well to the left of where even the administration wants it. (In a telephone interview Monday afternoon, Dorgan allowed that he was “thinking through how to approach the too-big-to-fail piece” and that he might offer an amendment, though he was amused by the idea that it would represent a radical leftward thrust.)

This is written in the typical left=hippies style so prevalent in Washington, but it’s perfectly legitimate to ask whether the Dodd bill does anything to rein in the financial sector and prevent the next financial crisis. Whether it’s Cantwell’s Glass-Steagall act or Dorgan and Sanders pushing TBTF legislation or Sherrod Brown and Ted Kaufman really taking on bank size, the facts are that some Democrats actually want this policy to work rather than just wanting a policy.

In the last year and a half, the largest financial institutions have only grown bigger, mainly as a result of government-brokered mergers. They now enjoy borrowing at significantly lower rates than their smaller competitors, a result of the bond markets’ implicit assumption that the giant banks are “too big to fail.”

In the sweeping legislation before the Senate, there is no attempt to break up big banks as a means of creating a less risky financial system. Treasury Department and Federal Reserve officials have rejected calls for doing so, saying bank size alone is not the most important threat [...]

“By splitting up these megabanks, we by definition will make them smaller, safer and more manageable,” Senator Edward E. Kaufman Jr., Democrat of Delaware, said in a speech Tuesday.

The president of the Federal Reserve Bank of Dallas, Richard W. Fisher, broke ranks with most of his colleagues within the central bank last week, declaring, “The disagreeable but sound thing to do regarding institutions that are too big to fail is to dismantle them over time into institutions that can be prudently managed and regulated across borders.”

This article even includes Republicans and Alan Greenspan (!) making the argument about breaking up the megabanks. Ben Bernanke, while favoring limits on excessive risk-taking over size, conceded at yesterday’s Lehman Brothers hearing that allowing regulators to break up the big banks would be “constructive.” Sherrod Brown and Kaufman have legislation they plan to introduce later today that would cap bank size at 3 or 4% of GDP. We now have six banks – Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, Goldman Sachs and Morgan Stanley – which hold assets totaling 63% of GDP. That’s simply dangerous, not only because of the amounts of money involved, but because of the political impact of letting firms get that big.

We’re finally seeing the intellectual argument needed to ensure that Wall Street reform is worthy of the name. If Republicans want to obstruct something, it might as well be something that could work.

UPDATE: This is the mentality that is absolutely killing Democrats right now:

Democrats should drop areas of disagreement with Republicans from their Wall Street reform bill in order to move forward, Sen. Tom Carper (D-Del.) suggested Wednesday.

Carper, a member of the Senate Finance Committee, said that he thinks a bipartisan deal can be reached on financial regulatory reform legislation, and argued it should be done by dropping the most contentious areas of the bill.

“At the end of the day…we agree on about 80 percent of the stuff here,” Carper said during an appearance on Fox News. “I think what we need to do is focus on the 80 percent on which we agree and set aside the 20 percent for another day.”

Hard to believe that Ted Kaufman and Tom Carper come from the same state, but of course, Kaufman isn’t running for re-election, while Carper is a wholly owned entity of the credit card and banking industry in Delaware.