Financial regulatory overhaul likely under Obama

NEW YORK - Financial services firms will likely face a broad new regulatory environment in 2009 that could help regain at least a portion of the profitability enjoyed earlier this decade, analysts said Wednesday.

Exactly how that new landscape will shape up under President-elect Barack Obama and how much of a boost it will be to firms' bottom lines is still a question.

Still, most analysts agreed that Wednesday's stock market sell-off was more tied to concerns about a recession as opposed to the future of regulation in the sector. Financial firms broadly fell with shares of Citigroup Inc. tumbling more than 12 percent, Goldman Sachs Group Inc. sliding more than 6 percent and insurer Genworth Financial Inc. declining more than 8 percent by late afternoon. The Dow Jones industrial average fell more than 400 points.

While it's not the biggest issue on investors' minds, regulatory changes are sure to come under the new administration.

"I see an overhaul in regulation similar to what we saw in the 1930s," said Octavio Marenzi, head of consulting firm Celent. "I see a rethinking of the landscape in the next couple of years on that scale."

Oversight will likely be consolidated under one major federal regulator, instead of the piecemeal system of state and federal regulation currently in place, said Gary DeWaal, a senior managing director and general counsel for Newedge, a joint venture brokerage firm owned by Societe Generale and Calyon.

In the past, financial firms focused on one area of business such as commercial banking or insurance and were regulated separately. More recently, firms have delved into a variety of areas lessening the need for as many regulatory groups.

"Financial institutions and products are basically the same regardless of name," DeWaal said.

After a regulatory overhaul, profitability is not likely to be as strong as it was earlier this decade, because rules will be tighter and some of the broad economic conditions in place since the 1980s are no longer available to spur growth, Marenzi said.

A consistent, broad decline in interest rates from peaks in the 1980s have provided a "tailwind" for bank earnings, Marenzi said. Now that rates have fallen so low, that boost is gone, and with tighter regulations, profits may be only half the size of profits earlier in the decade, he said.

DeWaal is a bit more optimistic, saying a single, simplified regulatory agency could allow financial firms to thrive and build their businesses. If properly put in place, new regulations could make the U.S. a more attractive place for foreign financial firms to do business, he said.

Obama's administration will likely get input for from current Treasury Secretary Henry Paulson's plan, laid out earlier in the year, to consolidate and centralize financial regulations; international groups; and professional groups and academia. Changes could be swift given the market's recent turbulence.

The market is "likely to see an acceleration to a harmonized regulatory landscape," DeWaal said.

A single agency providing broad oversight that does not micromanage the financial services sector would allow for a recovery and be positive for business, DeWaal said. A new regulator would also allow the Federal Reserve to get back to its primary focus dealing with broader economic issues, he added.

Companies could be regulated by size, said Roy Smith, a professor of finance at New York University's Stern School of Business. The largest financial firms might face increased scrutiny to ensure survival. Worries about systemic risk — one financial firm failing and setting off problems elsewhere — will need to be addressed, he said.

One area that will likely face immediate change is the derivatives market, said Michele Gambera, chief economist of Ibbotson Associates, a unit of Morningstar Inc.

Gambera said derivatives, especially complex insurance-like instruments called credit default swaps, have played a large role in the credit crisis and led to investment bank Lehman Brothers Holdings Inc.'s bankruptcy and the government bailout of insurer American International Group Inc.

Banks are afraid to lend to each other now because the current structure makes it hard to evaluate risk, Gambera said. Regulating derivatives markets would create greater transparency.

Better transparency leads to calmer markets and would allow banks to be more comfortable lending to each other and help free up credit markets, Gambera said.

"While there might be a moment of adjustment, there is more trust," Gambera said. Trust is vital to improving the ongoing problem, he said.

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