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Fratto: Regulatory Reform Redux: Be very afraid...

Thursday, 26 Feb 2009 | 4:19 PM ET

The public is outraged.

Trillions of dollars in equity value have evaporated.

The retirement savings of individual investors wiped out.

The behavior of executives resulting in investigations, lawsuits, and criminal and civil charges. Large, once high-flying firms bankrupt, and tens of thousands of their former employees out of work. The economy on the rocks. And members of Congress, determined to match (or exceed) the outrage of their constituents, step in to legislate new regulations to ensure that this never happens again...

Today?

No. That was the scene in 2002 — the last time Congress rushed to regulate how we practice business in America.

In 2002, outrageous and truly scandalous behavior at some firms led Congress to respond with the Sarbanes-Oxley Act — intended to bolster accountability at public boardrooms and restore investor confidence in company financial reports. SOX had some success in achieving those aims, but at great cost: it also resulted in the unintended consequences of weakening the competitive position of the U.S. as a place to list a public firm; heaped enormous fixed costs on public corporations; stymied the ability of small- and middle-sized firms to go public; and damaged the once-thriving venture capital system in America.

During the SOX debate, the legislative environment was largely driven by populist sentiment. Today — in addition to populism — Congress is dominated by a more dangerous sentiment: retribution.

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However necessary, members of Congress have been asked to do some very painful and unpopular things in the current crisis — like approving $700 billion financial rescue package — and they'll be asked to do more. And if members of Congress are asked to do something painful, your can be sure they'll find a way to share that pain.

Yesterday, President Obama presented his principles to guide regulatory reform legislation. Being merely principles, they're hardly objectionable on their own. But they leave an angry Congress ample room for mischief and the capacity to strike with vengeance on the financial sector.

Add to this mix the terrifying reality that of 535 members of the House and Senate, there doesn't appear to be more than a dozen with a thimbleful of knowledge of banking, financial markets, and global capital flows. This has the makings of a horror-show worthy of an NC-17 rating.

Efforts to deal with the financial crisis have already resulted in a breathtaking re-ordering of the financial sector: the disappearance of Wall Street investment banks; the massive application of official assistance from Treasury, the Fed and FDIC; and stepped up enforcement and rule changes from the SEC and other regulators.

Neither Sarbanes nor Oxley are in Congress for this go-around, having since retired. Sen. Chris Dodd and Rep. Barney Frank will wield the knife in this slasher sequel. But with the SOX experience still fresh, Congress and the Obama Administration should resist to race regulate, allow the financial sector to settle, and take the time to consider the long-term consequences of new regulation.

If they instead choose to regulate in an environment dominated by populism, vengeance and ignorance, avert your eyes -- this one will be scary to watch.

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Tony Fratto is a CNBC on-air contributor and most recently served as Deputy Assistant to the President and Deputy Press Secretary for the Bush Administration.

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