BOSTON - The possibility of the Federal Reserve gaining regulatory authority over General Electric Co's hefty finance arm could influence how the company restructures that business.

When President Barack Obama this week unveiled his proposal for the most sweeping overhaul of U.S. financial regulations since the 1930s, he proposed the central bank oversee not just banks but other large firms that pose a risk to the entire economy in the event of failure.

That was a reference to troubled insurer American International Group, which has received roughly $180 billion in government bailout money. But GE investors said the label could just as easily apply to the U.S. conglomerate's finance business, a major commercial lender.

I could definitely see that potentially becoming an issue if companies like GE and their finance arms came under more scrutiny, said Perry Adams, vice president and senior portfolio manager at Huntington Private Financial Group in Traverse City, Michigan, which holds GE shares.

The Fairfield, Connecticut-based company is already working to scale back GE Capital, which has faced a sharp drop in profit through the recession and is a major reason for the 58 percent drop in GE shares over the past year, a sharper decline than the 30 percent slide of the Dow Jones industrial average.

Finance had accounted for half of GE's profit in 2007, but Chief Executive Jeff Immelt said he plans to downsize the unit so that in the future the world's largest maker of jet engines and electricity-producing turbines would rely on it for just 30 percent of earnings.

Last year GE Capital earned $8.6 billion, about one-third of the corporate total, and executives said in March it could earn $2 billion to $2.5 billion this year if the conditions envisioned in the Fed's base case for the economy pan out.

GE aims to reduce its reliance on investments including real estate and on consumer finance, instead focusing more on financing GE products and other heavy equipment.

'POUND OF FLESH'

While Obama did not name GE Capital, investors said it could easily come in for more federal oversight.

Anybody who got aid of some sort, whether it was direct or indirect, probably is going to find that the government is going to extract their pound of flesh, have more regulation just because they don't want to do that again, said Peter Klein, senior portfolio manager at Fifth Third Asset Management in Cleveland, Ohio, which owns GE shares.

GE did not seek capital under the Troubled Asset Relief Program, but it did participate in Washington's Commercial Paper Funding Facility and issue debt backed by the Temporary Liquidity Guarantee Program.

GE Capital has braced for more government oversight, but is waiting to see how it will be affected, said spokesman Russell Wilkerson.

We have anticipated and planned for increased regulation of financial institutions and are supportive of the broad themes of addressing systemic risk and increased transparency, Wilkerson said. However, many elements of the administration's proposal are new and bear further scrutiny.

Given that the company is already working to downsize its finance arm, it may choose to exit businesses that will face substantial new regulations, investors said.

What happens with regulation, obviously, is the returns come down, Klein said. All things being equal, it will find less pleasure in being a regulated entity, and there may be less emphasis on GE Capital.

BANK WITHIN FIVE YEARS?

During the worst of the credit crisis last year, GE officials considered seeking a bank holding company charter, which would have given them access to the Fed's lending window but also would have subjected them to more regulation. They ultimately opted not to seek a federal charter.

But under the new regulatory framework, the company may need to become a bank holding company within the next five years, wrote Goldman Sachs analyst Terry Darling, in a note to clients.

That is not necessarily a bad thing for GE investors, who in March watched the shares fall briefly below $6 -- about half their current level -- as Wall Street worried that GE Capital contained a time bomb or some sort of massive liability that investors did not know about.

GE executives responded by holding a day-long investor briefing where they reviewed GE Capital in great detail, in a bid to assuage Wall Street's anxiety.

We believe the ultimate outcome is unlikely to be perilous for GE shares, Goldman's Darling wrote. A strong (GE Capital) is in the best interest of the economic recovery the government is trying to foster.

(Reporting by Scott Malone, editing by Matthew Lewis)

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