August 30th, 2010 
enashtrin This coming week brings a cluster of controversies to stir the markets—the new European bailout, what to do about computerized trading that spurs market turmoil, and the Goldman Sachs case. But it’s the view of this blog that what happens with legislation to regulate the U.S. financial industry is more likely to drive major market moves for the rest of the year.
A big question on the U.S. financial regulation package is whether it will happen with the present Congress, or after the mid-term congressional elections in November. Below the surface is a political calculation the Republican party needs to make: whether to cooperate with President Obama to get legislation passed in this Congress, or to slow-roll Democratic proposals so the legislation doesn’t get passed before the election, giving Republicans the chance to negotiate from a stronger position after winning back congressional seats in November.
If the Democrats do get legislation passed before November, I predict an upside surprise in market reaction. Fear among market players that profits will be lost through greater regulation will cause some losses along the way. But because more stringent regulation is likely to occur if the deal is struck when the Democrats have more power, major economists who advise major market players like Nouriel Roubini are more likely to endorse a package passed before the election, and their approval could trigger a major market move.
On the other hand, if the legislation has not been passed by the election and the Republicans win Congressional seats in the election as expected, there may be a post-election rally as investors perceive that greater Republican negotiating power may result in less intrusive regulations. But if that happens, be careful. A watered down U.S. regulatory package will leave key economic forecasters like Roubini unimpressed, perpetuating the post-crisis market turbulence.
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