BY STEPHEN M. BAINBRIDGE

Heads were bound to roll. In 2000-01, the stock market recorded back-to-back years of losses for the first time since 1973-74. If the market suffers a third consecutive losing year in 2002, which seems almost certain, it will have done so for the first time since the Great Depression. On top of which were heaped several high-profile corporate accounting scandals, of which Enron and WorldCom are merely the most notorious. All of which hammered investor confidence.

Economic concerns did not prevent the historic GOP gains in the recent election. Yet, with its eye on the 2004 election, the Bush administration knows that it needs to tackle the economy forthwith. A post-election shake-up in President Bush’s economic team thus was widely expected.

It is no surprise that Securities and Exchange Commission Chairman Harvey Pitt’s head was the first to roll. Political missteps, culminating in the failure to disclose questions about William Webster’s tenure as chair of a corporate audit committee, left Pitt with little support in Congress or the administration. (It was equally unsurprising that William Webster has also stepped aside.)

Restoring investor confidence in the stock market, the economy and his administration is essential for President Bush’s political future. Some demographic splits between Republican and Democrat voters have been well-documented, such as the so-called gender gap. The split between investors and non-investors is less well-documented, but just as dramatic. Investors tend to favor Republicans while non-investors tend to vote for Democrats. This trend favors Republicans because the percentage of Americans who invest continues to steadily rise. Indeed, more than half of Americans are now invested in the stock market either directly or indirectly through pension and mutual funds. Keeping investors on the GOP’s side in the 2004 election cycle thus is critical for the president and congressional Republicans.

What does Pitt’s departure mean for investors? In the short run, it is probably bad news. The Sarbanes-Oxley reform legislation required the SEC to draft a whole host of new regulations. With a controversial lame-duck chairman, the SEC will have a much harder time meeting those deadlines with well-thought-out rules.

In the long run, however, replacing Pitt with a politically savvy chairman will rebound to investors’ benefit. Pitt’s weakness created a power vacuum during a critical period for the market. Just like nature, politics abhors a vacuum. Other regulators rushed in to fill the gap, such as New York’s ambitious Attorney General Elliott Spitzer, big-government liberal Sen. Paul Sarbanes (D-Maryland) and Democrat SEC Commissioner Harvey Goldschmidt, a former SEC staffer who participated in the worst regulatory excesses of former SEC Chairman Arthur Levitt’s regime. These reformers rammed through “reforms” that only substantially increase the regulatory burden on corporations while providing little benefit to investors.

Job one for a strong new SEC chairman will be to stand up for commonsense regulation that is narrowly targeted to addressing real market imperfections. If the new chairman can do so, investors will benefit in the long run.

Bainbridge is professor of law.