Regulator Rubik’s Cube

· President Obama proposed broad (but not radical) financial sector changes. For the most part they're vague, and it's far too early to foresee how Congress will morph them.

· We hope the outcome streamlines the current mish-mash of financial sector regulation, but it may add extra dysfunctional burden to an already heavily-regulated sector.

· The proposals should not threaten markets in the near future. Most are aimed at preventing the next major financial crisis, which may be years or decades away.

· Investors and businesses want a level, uniform playing field—moving closer to a single agency for oversight isn't necessarily bad.

Today, President Obama pitched a new regulatory framework for financial firms. The long list of proposed changes is reminiscent of the jumbled tiles of a Rubik's Cube—it's hard to see how we get there from here. Rather than break the financial regulatory cube apart to re-order the structure from the ground-up, the administration wants to twist and turn the rules until all the colors match. The proposals are vague and need Congressional approval, so it's far too early to tell how Congress will spin them. With the 2010 midterm elections not so far away, the less sure-footed members of Congress are likely to push for centrist legislation or face dimming re-election prospects. Proposals for international reform further jumble the puzzle—who knows how global efforts at harmonization pan out, but Congress and President Obama don't decide what the rest of the world does.

The list of proposed changes includes a new "Financial Services Oversight Council" chaired by the Treasury and charged with identifying systemic risks. A new "Consumer Financial Protection Agency" would consolidate the regulatory fiefdoms for products like mortgages, savings accounts, and credit cards. A new "Office of National Insurance" (within Treasury) would oversee all aspects of the insurance industry and negotiate international agreements. And the SEC would strengthen regulation over the much-maligned credit rating agencies.

True, the new proposals are not radical, but recent experience demonstrates the unintended consequences of new (and even mundane) regulation can be massive and hard to spot ahead of time. So it's worth stressing now is too soon for conclusions about any of this. We hope the outcome streamlines the current mish-mash of financial sector regulation, but it may add extra dysfunctional burden to an already heavily-regulated financial services sector.

The role of the Federal Reserve shifts over time, but the Fed seems to be broadening its scope; it would gain powers to regulate ALL firms posing a threat to financial stability and oversee all financial settlements, but lose the ability to lend to struggling firms like AIG or Citigroup without Treasury approval.

Despite some troubling proposals (like empowering Washington to break-up large financial institutions as it sees fit), none should threaten markets in the near future—they are aimed at preventing the next big financial crisis which may be years or decades away. The proposals are neither radical nor unexpected, and many would probably have happened without regulatory mandates. Derivatives were already moving onto exchanges. Securitized products and credit ratings would have undoubtedly been more thoroughly scrutinized by investors. Many of the specific recommendations, like forcing hedge funds to register with the SEC and forcing derivatives trading through a clearing-house, probably were inevitable too.

Curious stock markets feigned disinterest at President Obama's remarks today—an encouraging sign. Investors and business want a level, uniform playing field—moving closer to clearer agency boundaries isn't necessarily bad. Some of the changes may streamline over-complicated financial regulation or further burden the industry. Expect more twisting and turning as US Financials wrestle with regulators—an important reason to be wary of them in the period ahead. But today's news is no game changer and most of the proposals were widely expected. The colored squares are shifting, but for the most part, it's the same old regulatory Rubik's Cube.