Derivatives won’t officially come up in the Wall Street reform conference committee until next week. But we’re already seeing a lot of behind-the-scenes work. Blanche Lincoln, that tireless slayer of Wall Street dragons, has already softened her Section 716 reform to spin-off the lucrative swaps trading desk. Not everyone is totally worried by these changes; Mary Bottari of BanksterUSA, a reform advocate, told FDL News that giving swaps desk subsidiaries of the big banks access to emergency lending isn’t a big deal:

By forcing big banks to create a separately capitalized affiliate for their derivatives desk, Sec. 716 cuts off taxpayer subsidies for reckless derivatives gambling. Those subsidies are Federal Reserve discount window & FDIC insurance. Continued access to the Fed Reserve emergency lending facility (so-called Sec. 13. 3 loans ) is disappointing but 13. 3 is changed in other areas of the bill. Access to 13. 3 will now be limited to solvent companies only. So these are loans that every institution has access to now (solvent, insolvent, banks, nonbanks), but they will now be limited to solvent companies in a credit crunch and theoretically they will be paid back. In the bigger picture, the fact that these swaps desks will now be separately capitalized is a big deal and will go a long way towards protecting taxpayers and the financial system as a whole.

But that only holds if Section 716 stays in the bill. And now conservative Democrats are going to work:

The New Democrat Coalition, a group of 69 centrist House Democrats, is preparing a letter that will urge lawmakers to drop the provision, championed by Senate Agriculture Committee Chairwoman Blanche Lincoln (D-Ark.). Members are still collecting signatures for the letter [...]

The aim of the provision is to prevent federal emergency assistance from helping derivatives trading operations. House Financial Services Committee Chairman Barney Frank (D-Mass.) and Senate Banking Committee Chairman Chris Dodd (D-Conn.), among others, continue to negotiate in private on the provision, which is likely to be considered next week in the conference.

The New Democrats argue the provision would increase risks in the financial system and shift derivatives trading to less-regulated financial firms. The lawmakers argue the conflict-of-interest concerns are addressed by a separate proposed ban on proprietary trading at banks that is dubbed the “Volcker rule.”

This is just garbage. If anyone tells you that Section 716 is already covered by some other piece, they’re telling you that they want the banks to have far fewer loopholes to surmount. There’s no reason not to be redundant, given the facility with which banks get around regulations. And Section 716 removes the subsidy for gambling, forces banks to actually capitalize their swap trading operations, and hopefully reduces the size of that market. That’s not at all what the also-important Volcker rule accomplishes.

New Dems also want more exemptions for “end-users” from Lincoln’s derivative requirements. This completely upends their argument against 716, that it would move derivatives into the shadows: that’s what they want! Pat Garofalo has a good primer on why the House exemptions are a terrible idea. I liked this from Gary Gensler, head of the Commodity Futures Trading Commission:

“Every exemption for financial companies creates a link in the chain between a dealer’s failure and a taxpayer bailout. Every slice of the financial system that we cut out through an exemption could allow one bank’s failure to spread like fire throughout the economy. It is essential that financial reform does not allow loopholes that leave interconnectedness in the system. Such exemptions will only come back to haunt us in the future.”

It’s not just New Dems like Melissa Bean and Jim Himes working against derivatives reform; several New York Representatives, led by Gary Ackerman (D), are threatening to withhold their votes if Wall Street is not protected:

New York Democrats are putting House and Senate conferees on notice that their 26 votes can’t be taken for granted. At last night’s Dem caucus meeting, New Yorker Gary Ackerman warned his colleagues that if Blanche Lincoln’s derivatives legislation remained in the final proposal, and if the Volcker Rule was tightened too much, the bill would be difficult for New York Democrats to back. “Those of us in New York represent not only Main Street, but Wall Street as well, and understand very much that Main Street is affected by Wall Street,” Ackerman told HuffPost Hill.

Ackerman expects practically the entire New York delegation to sign a letter with their demands. Barney Frank called this “a legitimate concern” and encouraged them to keep making the argument. I call it a hostage situation. “Protect my rich constituents or else.”

Lincoln is talking about “fighting hard” for her provisions, but she’s already buckling. Needless to say, all those hopes about the bill improving in the conference committee because of the increased transparency, or about Lincoln’s primary election win saving the best parts of the bill, aren’t totally coming to fruition.

UPDATE: The PCCC is going after Gary Ackerman for selling out to Wall Street. They note that he has taken “over $365,000 in campaign contributions from the securities and investment sector” during his career. You can add to their petition at the link.