updated 10/14/2009 2:04:11 PM ET 2009-10-14T18:04:11

A key House panel moved to tighten rules on previously unregulated financial instruments Wednesday, a long-awaited step toward governing the obscure and complex transactions at the heart of the troubles that befell some of Wall Street's most well-known financial houses

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The House Financial Services Committee adopted a proposal close to the Obama's administration's plan to move most private trading in over-the-counter derivatives to regulated exchanges. Committee Chairman Barney Frank dropped his proposal for an outright ban on trades that regulators judge detrimental to markets.

While many companies use derivatives to protect themselves against market fluctuations, these products have also become a means for financial speculation. They grew into a $600 trillion global market that regulators say can threaten the entire economy.

Frank, D-Mass., said exemptions would apply to companies that use derivatives for commercial reasons to protect against risk, not those that use it for financial reasons. Companies could lose that exemption if regulators see a pattern of activity that places other participants in the transactions at risk.

Frank said he was persuaded not to give regulators the power to ban so-called abusive swaps. "There was a concern that a broad grant to ban absolutely abusive swaps was going to be unsettling," he said.

Instead, regulators would be required to oversee transactions and look for potential problems.

Regulating derivatives is one of the elements of President Barack Obama's proposal for correcting the practices of banks, investment houses and other financial institutions that caused last year's economic collapse. Obama also wants a new Consumer Financial Protection Agency to police mortgages, credit cards and other consumer products offered by banks and other financial institutions, a proposal opposed by banks and business groups.

Frank intends to have his committee adopt those measures by the end of the week. House Democratic Leader Steny Hoyer, D-Md., said Wednesday that he would expect the legislation to reach the House floor for a vote in three to four weeks. The Senate has yet to act on the Obama proposals.

Derivatives such as credit default swaps brought down Wall Street banking house Lehman Brothers Holdings Inc. and nearly toppled insurance giant American International Group Inc.

Republicans said they prefer that derivative transaction be disclosed and operate under great visibility, but object to trading them in regulated exchanges.

Spencer Bachus, the top Republican on the committee, said exchanges, together with requirements for more capital to protect against the risks, could backfire and hurt investors that are unfamiliar with the complicated instruments.

"You'll price out smaller companies," Bachus, R-Ala., said. "And you put something on an exchange and you are going to attract a less sophisticated participant."

Bankers and Republicans generally oppose a new consumer agency as well. Community banks and the Chamber of Commerce have wielded the most influence in getting the House panel's Democrats to modify and clarify the regulatory powers that Obama would give it.

Neighborhood banks "have some legitimate concerns we're dealing with," Frank said in a recent interview with The Associated Press.

"The big banks have no clout," added Frank. "Bank of America, JPMorgan Chase. Nobody cares what they think, literally."

However, one sticking point is whether to give states additional powers to regulate the consumer practices of federally chartered banks. Obama and Frank favor doing it; Rep. Melissa Bean, a moderate Democrat from Illinois, is leading the opposition against it.

Obama and Treasury Secretary Timothy Geithner have made the regulatory overhaul a top priority, meeting privately with lawmakers in recent weeks and agreeing to scale back the administration's consumer protection plan in the face of widespread business opposition to it.

Frank dropped several of Obama's proposals, including making banks offer standardized "plain vanilla" mortgages. His draft bill also omits Obama's proposal to make lenders take added measures to ensure that their communications with customers are not deceptive.

"There are some improvements to what we proposed, but the core reforms look intact," Geithner told reporters Tuesday.

The Chamber of Commerce has conducted a $2 million advertising and organizing campaign against the consumer agency, provoking even Obama to criticize their tactics. But after the group's ads warned that small retailers might fall under the new agency's jurisdiction, Frank made clear that businesses that don't offer financial products won't be covered.

Copyright 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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