Bush regulatory plan could do more harm than good

By Kevin Plumberg - Analysis

NEW YORK (Reuters) - A White House plan to overhaul the U.S. financial regulatory system could usher in an era of smaller investment returns and capital flight overseas as investors shy away from a tough new market cop.

The Bush administration proposals, unveiled on Monday, have quickly summoned bitter memories of Washington's last big reform binge -- Sarbanes-Oxley. A replay of that episode, which unfolded in 2002 in response to the collapse of Enron Corp, could kick the financial sector when it's down and prolong tight lending conditions, fund managers and market participants said.

The plan, giving the Federal Reserve more oversight powers and combining securities and futures-trading regulators was also seen as ancillary to the problems immediately facing investors: falling asset prices, increased market volatility and a very weak economy.

"There will be more regulation of the markets and that will slow already below normal growth and result in lower capital returns in asset prices," said Michael Metz, chief investment strategist at Oppenheimer in New York.

Metz said he still likes only U.S. stocks of companies that do heavy business overseas since foreign economies are relatively healthier.

Other investors feared the tighter regulation of Wall Street could drive foreign investors away from the United States, a phenomenon that many tied initially to the impact of Sarbanes-Oxley, which required a company's top executives to sign off on financial statements.

Such a scenario would be devastating for banks and brokerages increasingly dependent on foreign capital to stay afloat. It would also further undermine the U.S. dollar, which has fallen more than 6 percent in the last three months, the biggest quarterly decline since the fourth quarter of 2004

"We should have a sensible regulatory framework, but if we have a punitive one we could further the migration of world capital markets to outside of the U.S.," said Haag Sherman, chief investment officer of Salient Partners in Houston, a fund with $7 billion in assets under management.