Financial modernization legislation likely to be unveiled late this week has an excellent chance of passage because it repeals the Glass-Steagall Act while avoiding the inter-industry conflicts that have torpedoed efforts to reform the law since the mid-1970s.

According to Senate Banking Committee staffers, both Republican and Democratic members of the committee and industry lobbyists, the legislation says specifically that banks can affiliate with insurance and securities firms. But, as on several other incendiary issues, it is expected to be silent on whether banks can conduct those activities in an operating subsidiary, letting the regulators and the industries fight that issue out.

The bill as currently drafted limits national banks from conducting such activities as merchant banking, securities and insurance underwriting in operating subsidiaries if they have more than $1 billion in assets. However, because of opposition from Treasury Secretary Robert Rubin and Republican members of the committee in private comments to committee chairman Phil Gramm, R-Texas, last week, the cap is expected to be deleted when the bill is finally introduced.

The Obama administration appears optimistic that it can win support from committee Democrats for allowing banks to conduct nonbanking activities in operating subsidiaries. This represents a change in position from last fall, when committee Democrats supported the Federal Reserve Board position on the issue.

The bill is unlikely to include a definition of insurance and a requirement for functional regulation as demanded by the insurance industry, according to the consensus. But it will include some limits to the comptroller’s deference on legal disputes dealing with insurers and agents, a reflection of the strong campaign finance support from insurance agents’ interests in Texas for Gramm, sources said.

At the same time, it will not touch the issue dear to the securities industry, removing the exemption from Securities and Exchange Commission oversight for bank securities activities, the so-called "level playing field" issue. The SEC and the Securities Industry Association are said to be lining up in opposition to the bill already.

While the Gramm version may win support in the House Banking Committee, Commerce Committee support is unlikely because under the Gramm version, the Commerce panel would lose jurisdiction over securities and insurance activities conducted by banks. Reps. Thomas J. Bliley, R-Va., and John Dingell, D-Mich., chairman and ranking minority member of the Commerce Committee respectively, are likely to be vehemently opposed, according to a former House staffer who is now a securities analyst.

Congressional handicappers are giving long odds that Congress will pass financial modernization legislation this year, or in the two-year life of this Congress. While the reportedly imminent nomination of Undersecretary of the Treasury John D. Hawke is a positive sign, partisan rifts may be too strong.

In comments at an insurance agents’ conference in Washington, Rep. Jim Maloney, D-Conn., a member of the House Banking Committee, warned that the key issue remaining is the role that the Treasury Department will play in the future of banking industry regulation.

He predicted that, "If the Treasury is not involved, Secretary Bob Rubin will recommend a veto of the bill to the president." Maloney, a supporter of the insurance industry, called the expansion of bank regulatory powers "dangerous and contradictory.

"Congress should not legislate advantages to one group or another," he said. His comments were made at the National Association of Professional Insurance Agents annual legislative conference, held in Washington last week.

Sen. Phil Gramm, R-Texas, chairman of the Senate Banking Committee, has committed himself to a financial modernization bill by the end of February and will meet with the panel’s ranking minority member, Sen. Paul S. Sarbanes, D-Md., this week to see if a bipartisan approach can be forged. And Reps. James A. Leach, R-Iowa, chairman of the House Banking Committee, and John J. LaFalce, D-N.Y., ranking minority member, have prepared different versions of financial modernization legislation. Three days of intense hearings on the issue will be held in mid-February, Leach said last week. Gramm has not yet planned hearings.

Isaac B. Lustgarten, a partner in Schulte Roth & Zabel in New York, said his talks with House Banking staffers indicate the Leach bill will be little changed from "the final state" of the legislation last fall, when a filibuster by Gramm and other Republicans effectively killed the bill.

But in a private briefing, those attending the conference were told to be pessimistic that the Gramm model will succeed. "The approach that Gramm is taking will only lead to ‘disaster,’" one congressional staffer told the agents’ group. "They are ramming this through," he said.

In the first fallout from a lawsuit seeking to set aside Ohio’s restrictive laws dealing with bank insurance sales, the Ohio Insurance Department told a federal magistrate Jan. 27 it will stipulate that a state law barring banks from selling title insurance is pre-empted by federal law.

But a banking industry lawyer says the stipulation is of little practical value because the main count, which seeks to pre-empt a law which bars banks from selling insurance to no more than 50% of their customers, will remain in place. Lawyers for the Ohio insurance department said they will contest that claim.

After a scheduling conference, Ohio banks and their allies said they are encouraged by a federal court ruling they believe will facilitate a quick decision on a lawsuit that claims state insurance laws unfairly discriminate against national bank sale of insurance.

The case is a derivative suit to the 1996 Supreme Court ruling in Barnett, which held that states cannot "prevent or significantly interfere" with the ability of a national bank to sell insurance.

The Barnett case dealt with overt laws or rules that blatantly and, according to the Supreme Court, illegally barred national banks from selling insurance. This case deals with laws and rules that indirectly bar bank sales of insurance.

The Ohio rule bars bank sales of title insurance outright, and requires that banks can sell other types of insurance only to non-customers. It is done through a law known as the "controlled business statute."

The suit was filed Oct. 6. In a scheduling conference Jan. 27 a federal magistrate in Columbus allowed state and national insurance groups to intervene in the case, but only with the understanding that the issue will be decided based on the law, and not on protracted discovery proceedings. Under the schedule agreed upon by the parties, all briefs in the case must be filed by March 15. A friend-of-the-court brief is due from the Office of the Comptroller of the Currency Feb. 3.

Alan Berliner, assistant director and chief counsel to the Ohio insurance department, said the department will have its stipulation on the title insurance issue in the court’s hands this week. But, he said, the agency will continue to challenge the banking industry’s argument that its controlled business statute unfairly discriminates against bank sales of insurance.

He also said, "We want to dispose of it as promptly as reasonably possible."

Commenting on the title insurance issue, Michael Crotty, deputy general counsel for litigation at the American Bankers Association, said the insurance department stipulation was meaningless–although Berliner contested that interpretation.

Crotty said that even if the state insurance department admits the title insurance law is pre-empted by federal law, "it still means banks can sell insurance only if they promise to comply with the principal purpose statute, which says that banks cannot do more than 50% of their insurance business with their own customers.

"And that is ridiculous because banks are likely to sell title insurance only to their own customers," Crotty said.

The scenario is similar to a case in upstate New York dealing with state laws which barred Canandaigua National Bank from selling property/casualty insurance to its own customers. The law was enacted in response to the Barnett decision.

A federal court judge in Rochester ruled last March that the law illegally, if indirectly, barred national banks from selling insurance. In that case, the judge declined to allow lengthy discovery proceedings, and also decided the case relatively promptly based on the law.

"These restrictions prohibit us from effectively meeting the financial needs of our customers," said William K. Browning, president of Huntington National Bank’s insurance operations. Huntington is based in Columbus. "Consumers in Ohio can benefit from more competition, which these existing Ohio laws actually prohibit," he said.

Approximately 20 states have either elected not to enforce discriminatory state laws against national banks or have amended their laws to give banks operating in those states insurance sales authority since the Supreme Court decision, according to Reynolds. While most other states do not restrict bank insurance sales, Ohio is one of only a handful of states that have not recognized the Barnett Bank decision, he said.

The plaintiffs include Huntington, the ABI, the Ohio Bankers Association and the American Bankers Association Insurance Association.

Legislation establishing a legal scheme to handle the failure of a counterparty to a derivatives transaction will likely be introduced as part of a new bankruptcy bill in the House this week, a move that could ease mortgage lenders’ ability to hedge interest-rate risk and to securitize assets.

Washington sources said the bill is expected to contain a provision that would better isolate the special purpose vehicle in a securitization from bankruptcies via a safe harbor. The provision would clarify that asset-backed and mortgage-backed securities structured with junior tranches do not give a debtor the right to take the whole asset, disrupting the cash flow to the investor. The Bond Market Association enthusiastically endorses this provision.

But despite a consensus that the legislation is necessary and bipartisan support, its chances for passage, either promptly or even later this year, remain cloudy. Insiders said the credit card industry and its supporters in Congress, realizing the importance of the provision, want to link it to the omnibus bankruptcy legislation they are pushing.

The bill is driven by potential problems to the financial system posed by the near failure last fall of Long-Term Capital Management, a hedge fund, according to sources. LTCM was involved in all types of complex derivatives transactions, and market players worried that its failure would have created a domino effect stemming from the inability of mortgage lenders and other financial institutions to close derivatives transactions, and so disrupted the market.

Sources said the bill would impose a means-test on those filing for bankruptcy, a concept opposed by liberals in Congress and the Clinton administration.

The primary provisions of the bill would strengthen language in the bankruptcy code and the Federal Deposit Insurance Act, protecting the enforceability of termination and close-out netting, and relative provisions of certain financial agreements and transactions under the two laws.