The financial reform legislation regarding derivatives voted 13-8 out of the Senate Agriculture Committee this morning and on to the Senate floor. It’s intended to fend off any future government bailouts and prohibit the risky behavior banks participate in that caused the 2008 financial meltdown. But of course, the very organizations that these new laws will affect are using their money and expertise to influence the lawmakers in charge of making reform happen.

The proposed bill, introduced by Sen. Blanche Lincoln, D-Ark., is planned to be folded into the bill Sen. Chris Dodd, D-Conn., proposed this week on financial reform. If this bill makes it through, it will limit banks’ ability to become too big to fail, as AIG was in 2008.

The bill attempts to regulate more than $200 trillion of derivatives market and will prohibit back door Wall Street deals and force real time reporting of derivatives trades or purchases that take place. The derivatives market is described as the shadow market or the finance industry’s plumbing. This legislation has the potential to make this process transparent and reduce the possibility of big Wall Street banks from collapsing and destroying small community banks and businesses across the country. It will decentralize power and reduce the occurrence of banks being so inflated with money that just one can bring down the entire global economy by changing the ways banks buy and trade derivatives.

Derivatives trading generally take place behind closed doors and without bank regulators knowing the details. This practice ties the various industries together, such as housing and credit cards, and works to move money around the nation and the world.

Currently, the five largest commercial banks in the U.S. (JP Morgan Chase, Wells Fargo, Bank of America, Citigroup and Goldman Sachs) hold 97 percent of the U.S. derivatives market on their balance sheets, according to the Office of Comptroller of Currency. These banks are connected to everything, from major airline fuel purchases to the 2nd mortgage on your house. Financial analyst and author of riski.us, Cate Long, points out that this is where some major problems lay.

According to Long, JP Morgan Chase, for instance, is invested in the credit card market, the housing market, The Bank of England, Abu Dhabi’s finances and countless other financial endeavors. If JP Morgan Chase gets in trouble, the world would feel the effects, just as was the case for AIG. The reform legislation would likely change that.

Lincoln’s Wall Street Transparency and Accountability Act of 2010 will also require all transactions to go through a clearinghouse like Intercontinental Exchange, Inc., or ICE. Previously, this wasn’t required for all transactions. ICE owns the world’s largest credit-default swap clearinghouse and will likely benefit from this legislation. ICE is listed as one of Lincoln’s top 20 donors for the 2010 campaign, according to data from the Center for Responsive Politics. Also, according to the New York Times, major Wall Street firms raised $60,000 for her reelection campaign in 2009.

Before Lincoln released her bill regulating derivatives, a committee advisor to the Financial Services Committee named Peter Roberson, left his position to join ICE, a classic case of how the revolving door works in Beltway politics. Now Roberson will lobby the bill’s outcome in the Senate, after he worked to form the legislation in the House.

Despite the heavy lobbying and campaign donations coming in, Lincoln’s proposed legislation is still likely to force the nation’s biggest banks to change the way they do business and make the economy safer for consumers and small banks in the future.

Up until this legislation, all of the government’s efforts to fix the economy have been very short sighted, according to critics. The profits the Department of Treasury is taking in from its TARP investments have been viewed as a positive indicator of the state of the economy. For instance, Treasury’s plan to sell its shares of Citigroup’s common stock at a likely profit of $8 billion has been called a smart move on the part of the government.

To compare, TARP is estimated to cost $99 billion, according to the Congressional Budget Office, while $213 trillion is at risk in derivatives market held by U.S. commercial banks. The TARP costs and risks pale in comparison to the risks derivatives pose. Globally, derivatives amount to $604.6 trillion.

Irresponsible gambling in the derivatives market is what caused AIG’s near collapse in 2008 and forced the Bush Administration to label it “too big to fail” and rescue it. According to Long, the bailout led to a “long term destabilization of the economy,” and in fact “institutionalized the idea of too big to fail.” Long says we have to push derivative transactions “out of the dark and into the light.” Doing so would open up the market and ensure fair trading prices for securities and commodities. The Senate Agriculture Committee agrees with her.

The current economic state of Greece and California are good examples of “mini-meltdowns” that are “indications of what could be on the horizon,” if things don’t change, Long said.