Wall Street’s Victory May Have Steep Political Costs.

Why did fierce fighting on Capitol Hill over an arcane piece of financial regulation nearly derail the $1.1 trillion spending bill passed by Congress on Thursday night? The provision largely repeals a rule that required banks to push some derivatives into subsidiaries that aren’t eligible for government support, such as deposit insurance or access to the Federal Reserve’s discount window. So far, none of the big banks have explained why such a fight was worth having. There has been talk of it helping small businesses and midsize financial firms, or clearing up regulatory inconsistencies. That rings hollow. As with so much else on Wall Street, short-term profit was the likely motive along with reluctance to give up what is essentially a taxpayer subsidy.

For starters, the banks’ own actions show there was a good deal at stake. J.P. Morgan Chase chief James Dimon called to lobby lawmakers Thursday, according to people familiar with the calls. And the provision’s language was reportedly authored by lobbyists for Citigroup . That led Sen. Elizabeth Warren to say, “This is a democracy and the American people didn’t elect us to stand up for Citigroup.” And while 1,404 U.S. banks had derivatives activities at the end of the second quarter, according to the Office of the Comptroller of the Currency, just five accounted for 95% of the total notional derivatives of $302 trillion. They are: J.P. Morgan, Citigroup, Goldman Sachs Group , Bank of America and Morgan Stanley.

Of vital importance, especially for Citi, is where the derivatives are legally housed. Except for Morgan Stanley, the banks hold most derivatives in their depository unit. The advantage: The bank subsidiaries, with implicit government backing, are considered less risky than parent holding companies. Being seen as a less-risky counterparty gives banks an advantage in pricing and collateralization of derivatives.

The result: Each would suffer from having to push derivatives out of their depository units. In effect, they would lose the advantage of the higher rating and perception of government support. Resistance on Capitol Hill wasn’t baseless. The rule would have pushed out nearly $10.4 trillion in credit default swaps, of which J.P. Morgan owns 44%, according to Thomas Hoenig, Federal Deposit Insurance Corp. vice chairman. That is three times the amount of such swaps American International Group had when it was bailed out.

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