The Dow Jones Industrial Average suffered a second straight day of triple-digit losses as investors reacted with trepidation to President Barack Obama's initial proposal to reform financial institutions. On the heels of Wednesday's news that China is reining in bank lending, Obama proposed new rules to restrict the nation's largest banks from making high-risk trades.The Dow plunged 213.27 points, the S&P 500 fell 21.56 points and the Nasdaq dropped 25.55 points on the news. The Dow had been down by as much as 228 points during the day. The negative reaction overshadowed a report that leading economic indicators were up a higher-than-expected 1.1% in December. Also obscured were positive earnings reports from Xerox (XRX), Starbucks (SBUX) and Seagate Technologies (STX).

Regulatory Changes Spook Investors

"[The market drop] is not about earnings, or fundamentals," said Bob Froehlich, senior managing director of The Hartford. "It's all about regulatory changes for the banking sector."

Froehlich said the prospect of new regulation of financial service companies creates a ripple effect of uncertainty across all industries because all industries are affected by the banks. The sell-off says that "shareholders are voting with their feet," he said, noting that investors generally view more regulation as a bad thing. "They are saying we own the company, the government doesn't."

The president's broad proposal for bank reform seeks to prohibit banks from owning hedge funds and private equity funds that may engage in high-risk trades that could endanger the health of the nation's banks. Russell chief market strategist Stephen Wood said the proposal was not really new, but was similar to an agenda put forward by former Federal Reserve chairman Paul Volcker, who joined Obama to announce the new measures Thursday.

Old Rules Still Apply, Obama Says


As he outlined the proposal during his speech, Obama said, "While the financial system is far stronger today than it was one year ago, it's still operating under the same rules that led to its near collapse."

"These are rules that allowed firms to act contrary to the interests of customers, to conceal their exposure to debt through complex financial dealings, to benefit from taxpayer-insured deposits while making speculative investments, and to take on risks so vast that they posed threats to the entire system. That's why we are seeking reforms to protect consumers."

Whether the president's proposal is viewed as a means of protecting consumers, or of attacking Wall Street, the effect on the banks was clear as the sector suffered sharp losses.

"Proprietary trading and investment portfolios are significant revenue and earnings drivers for many financials," said Wood. Curbing those activities "would clearly have an impact on earnings, but we just don't know what."

No Timeline On Changes


Without more specifics, the markets don't know for sure which institutions will be affected most, and no one knows how soon the changes will come. If the new regulations come from a change in the code of already established regulators like the SEC, they could be implemented within a year. If the new rules will be legislative in nature, it could take several years.

"Barney Frank was under the opinion that [the regulations] would be legislative," said Wood. "Until that's clear, you can expect some nervousness in the market."

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