Markets are off to rough start Monday morning as headlines warn investors that President Obama plans to overhaul the regulation system this Wednesday. In addition, fresh data suggests that manufacturing conditions deteriorated more than expected in New York, while TIC Flows in April were much worse than anticipated. 

Twenty-five minutes into the trading session, Treasuries are rallying as the yield drops four-tenths to 3.71%. In equities, the S&P 500 is down 1.78% to 929, the Dow has fallen 1.65% to 8653, and the Nasdaq has shed 1.89% to 1824.

Tim Geithner, Secretary of the Treasury, and Lawrence Summers, director of the National Economic Council, wrote in the Washington Post that a new course for oversight will be announced on Wednesday. They said the U.S. must play a leading role in implementing new regulation for a sound economic recovery.

“This week -- at the president's direction, and after months of consultation with Congress, regulators, business and consumer groups, academics and experts -- the administration will put forward a plan to modernize financial regulation and supervision,” they wrote. “The goal is to create a more stable regulatory regime that is flexible and effective; that is able to secure the benefits of financial innovation while guarding the system against its own excess.”

In recent months Federal Reserve Chairman Ben Bernanke has been advocating for what he calls ‘macroprudential oversight’ ― regulation that would look at systemwide transactions rather than merely individual institutions ― and this morning’s op-ed also leans in that direction.

In addition, the proposal seeks to extend oversight into the shadow banking system, give consumers more protection, and create an emergency path for banks on the brink of collapse.

“We will establish a resolution mechanism that allows for the orderly resolution of any financial holding company whose failure might threaten the stability of the financial system,” the op-ed said. “This authority will be available only in extraordinary circumstances, but it will help ensure that the government is no longer forced to choose between bailouts and financial collapse.”

Speaking in Chicago at 9:00, Federal Reserve Governor Daniel K. Tarullo added his support for regulation reform.

“As we recover from the crisis and the recession, we will likely be entering a new era in which systemic risk regulation assumes much greater importance for supervisors,” Tarullo said. “But the role of bank management, and of risk management at banks, will also remain what it has always been--to allow these institutions to play an effective intermediating role in a safe and sound fashion.”   

Talk of increased regulation always hurts investor sentiment, and data from the morning only added to pessimistic feelings.

The NY Fed’s Empire State manufacturing survey deteriorated by 5 points to -9.4, against expectations of moderate improvement in June.

“It would seem as though conditions pulled back sharply in June, which definitely makes the ‘green shoots’ story a little harder to swallow,” commented Ian Pollick from TD Securities.

Also before the opening bell were the latest TIC flows results, which showed that foreigners only purchased $11.2 billion in U.S. securities in April, far lower than the expectations of $57.5 billion. 

“Foreign appetite for U.S. Treasuries remained healthy, but there was very little appetite for most other stocks and bonds,” said strategist Charmaine Buskas from TD. 

She added: “Treasuries continue to be one of the securities that investors of all types flock to in times of uncertainty and that has been borne out in today’s report. However, as investors continue to assess the risk level with various other securities they will remain cautious and quick to shed those securities that do not offer good risk/reward ratios.”