By DAMIAN PALETTA And SCOTT PATTERSON
WASHINGTON—Democrats took a step toward their goal of overhauling financial regulation, reaching a tentative deal to set restrictions on trading in exotic financial instruments known as derivatives.
Among the considerations still in the balance: A big provision being sought by Warren Buffett in recent weeks. A key Senate committee had changed its proposed overhaul of derivatives regulation after lobbying by Mr. Buffett's Berkshire Hathaway Inc., potentially helping the famed investor avoid a financial hit, congressional aides say.
Sunday night's deal, hammered out by Senate Banking Chairman Chris Dodd (D., Conn.) and Senate Agriculture Chairwoman Blanche Lincoln (D., Ark.) reflects the populist, anti-bank sentiments simmering on Capitol Hill. A Senate Democratic official said the two have "worked out a deal," which is expected to be folded into a broader Democratic measure that revamps the U.S. system of financial regulation in the wake of the catastrophic financial collapse that occurred in 2008. The agreement includes a proposal that could force banks to spin off their lucrative derivative trading operations, reshaping Wall Street.
The fate of Berkshire's effort to influence the legislation remains uncertain. Senate officials said Sunday night that most of the details of the agreement haven't yet been finalized.
The provision, sought by Berkshire and pushed by Nebraska Sen. Ben Nelson in the Senate Agriculture Committee, would largely exempt existing derivatives contracts from the proposed rules. Previously, the legislation could have allowed regulators to require that companies such as Nebraska-based Berkshire put aside large sums to cover potential losses. The change thus would aid Berkshire, which has a $63 billion derivatives portfolio, according to Barclays Capital.
Mr. Buffett's push is especially notable because he has warned of the potential dangers of derivatives, famously branding them "financial weapons of mass destruction."
The White House has been trying to kill the Berkshire provision on the grounds that it would weaken the government's ability to regulate the enormous market for derivatives. Berkshire Hathaway argued that it shouldn't be made to redo existing contracts and that it is already healthy enough to cover its obligations. The battle over the provision shows how lobbying by businesses and lawmakers to insert just a few words into a complex bill can have a major impact on the country's biggest companies.
President Barack Obama is close to securing his revamp of financial-market rules, a package aimed at preventing a repeat of the financial crisis. Tightening the regulation of derivatives—complex financial instruments used across finance and business—is a central element. The Senate could begin debate on Democrats' broader package of changes to financial regulation Monday.
The change Mr. Buffett has sought would apply only to existing contracts, assuming the bill becomes law. It would apply broadly, not just to Berkshire. Many newly written derivatives contracts, including Berkshire's, would have to post collateral.
Mr. Buffett has been a vocal critic of how some in the financial markets use derivatives. In making his case for regulation, Mr. Obama in a New York speech last week quoted Mr. Buffett's "financial weapons of mass destruction" remark, which was made in Berkshire's 2002 annual report. In his letter to investors this year, Mr. Buffett, an Obama supporter, wrote that while Berkshire has "long invested in derivatives," the contracts "can be dynamite."
A fracas over the measure could hurt Democrats. The Obama administration wants to avoid the home-state horse-trading that almost sank its health-care overhaul. Berkshire is based in Omaha, Neb., and has longstanding ties to the state's Sen. Nelson.
Derivatives are bets between two parties on the future price of a good, such as oil or mortgages. They are typically used by companies to manage risks; airlines use derivatives to lock in future fuel prices. In addition, investors trade them for profit.
In the financial crisis, American International Group Inc. was nearly felled by trading in derivatives related to mortgage securities. The company wasn't required to hold significant cash in reserve for the deals and couldn't meet its obligations when the housing market tanked, threatening to kill its trading partners and prompting a federal bailout.
The legislation under consideration would require certain companies to put up a chunk of cash, known as collateral, when they enter such contracts to cover possible losses. The legislation could require that derivatives trade more like stocks or bonds—on exchanges, instead of in private deals.
Berkshire has argued Congress doesn't have authority to make it redo existing contracts, especially since the company is sitting on about $20 billion in cash. Mr. Buffett has said he rarely has to post collateral, which is why for Berkshire the new rules could hurt.
Berkshire representatives declined to comment. But the company's position, said a person close to Berkshire, is that the new language will aid the majority of companies that legitimately use derivatives to insure against risks. Under the original wording, hundreds of major U.S. businesses, not just Berkshire, might have been hurt by the requirement that collateral be posted for existing contracts, said the person close to Berkshire. If the language isn't amended, the big beneficiaries would be Wall Street firms that create the derivatives. That's because if the businesses have to post collateral, the Wall Street firms can dispense with buying their own insurance against a default on the instruments.
Lawmakers began considering the Berkshire proposal after Sen. Nelson relayed concerns raised by David Sokol, chairman of Berkshire Hathaway subsidiary MidAmerican Energy Holdings Co., people familiar with the matter said. Mr. Sokol is a close lieutenant of Mr. Buffett and is considered the investor's likely successor.
A representative for Mr. Sokol didn't respond to telephone calls and written messages seeking comment.
Mr. Buffett has accumulated huge positions in derivatives through Berkshire. MidAmerican, one of the nation's largest utility operators, uses derivatives to hedge against changes in the price of energy.
Capitol Hill aides from both parties said Berkshire's lobbying campaign has been forceful. Mr. Sokol often invoked his boss's name, saying how important the issue was to Mr. Buffett, aides say.
Mr. Sokol told lawmakers the Senate bill would force Berkshire to post collateral against good-faith contracts into which it had already entered, for a total congressional aides put in the billions of dollars. Renegotiating those contracts would be a logistical headache, people familiar with his arguments said.
He met scores of lawmakers, aides and government officials, including the offices of Sens. Dodd, Richard Shelby (R., Ala.), Judd Gregg (R., N.H.) and Mike Johanns (R., Neb.).
In March, Nebraska's other senator, Mr. Johanns, pushed a similar amendment in the Senate Banking Committee. It wasn't formally offered after Republican lawmakers decided to pull all their amendments. "There is bipartisan agreement that changing the requirements of existing contracts midstream is wrong and unreasonable," Mr. Johanns said in a statement.
The Senate Agriculture Committee shares jurisdiction over derivatives because it oversees the Commodity Futures Trading Commission. Berkshire officials approached Mr. Nelson, a member of that committee, to press their concerns.
Berkshire officials have long supported Mr. Nelson. Berkshire employees, including Mr. Buffett, have given Sen. Nelson $75,550 over his political career, more than any other company, according to the Center for Responsive Politics, a nonpartisan group that tracks such data.
The derivatives bill passed the Senate Agriculture Committee on a 13-8 vote last week with Mr. Nelson in favor. Mr. Johanns opposed, citing the potential impact on farmers.
Jake Thompson, a spokesman for Mr. Nelson, said arguments made by Berkshire officials are consistent with the senator's philosophy: New rules shouldn't apply retroactively.
Mr. Thompson said political contributions had no bearing on the matter. "There might be a perception of a big company having some effect, but I think it's more the argument and the principle they were making that had the effect," he said.
A spokeswoman for Sen. Lincoln, who chairs the Senate Agriculture Committee, said the change was a "technical correction to the legal certainty issue" after "a number of parties" raised concerns about the impact on such long-term contracts.
Berkshire often isn't required to post collateral on derivatives because of its strong financial position. That means the company can use the upfront cash it gets from these deals for other investments. At the end of 2009, that capital totaled $6.3 billion.
Analysts say Berkshire may deserve an exemption. In the financial crisis, the company's strength allowed it to invest in shaky firms such as Goldman Sachs, bolstering the financial system. The new regulations would punish Berkshire for the bad behavior of others, they say. "Claiming Berkshire poses a risk to the financial system is a difficult case to make," says Morningstar analyst Bill Bergman.—Susan Pulliam contributed to this article.
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