Afunny thing happened on the way to the Senate — the Securities and Exchange Commission started coming to its senses in respect of hedge fund regulation. The commission’s chairman, Christopher Cox, testifying before the Banking Committee earlier this week, sounded like he’s finding his way onto the right track.Surprisingly, key congressmen appear to be getting there, too. Congress’s restraint may just be dumb luck or heat-induced stupor, but Mr. Cox is certainly justifying President Bush’s faith in him. The real challenge now is to keep Senator Clinton out of the majority.

Mr. Cox was called before the committee in the wake of an appeals court ruling last month striking down an SEC effort to regulate hedge funds. Mr. Cox’s predecessor, William Donaldson, had pushed the rule through with minimal thought for its economic rationale or even such a trifling concern as whether the SEC has the legal authority to regulate hedge funds at all. The court’s voiced a resounding “no”on the latter issue, but debate has only intensified on the former since the ruling throws regulation back up in the air just as lawmakers and the public are starting to notice the $1.2 trillion industry.

All eyes have been on Mr. Cox to see how he would respond to the mounting pressure to “do something” about hedge funds.To judge by his testimony, he’s going to avoid doing anything for the time being while the commission studies the issue more carefully. Although he announced some new regulations, those are only housekeeping measures designed to sweep up the shards of the shattered hedge fund rule. He did not ask the senators for the congressional authorization the court said the SEC would need to regulate hedge funds.

More importantly, he signaled that his understanding of financial markets is still sharp even after a year working with the SEC’s economics-challenged staff. He uttered such magic words as “capital formation, market efficiency, price discovery, and liquidity” when describing the benefits of hedge funds. That hearkens to the “efficiency, competition, and capital formation” that the SEC was instructed to encourage under the 1996 National Securities Market Improvement Act but that few SEC chairmen up to now have bothered with. Mr. Cox also sketched his views on important limitations for any hedge fund regulation, including his belief that “there should be no portfolio disclosure provisions.” Considering that the secrecy under which many funds operate has contributed to the calls for more regulation, Mr. Cox’s statement is a sign that someone realizes such secrecy is economically important.

So far, Mr. Cox is selling the right view on hedge funds, but are the solons buying? The chairman of the banking committee, Senator Shelby, has waxed poetic about hedge funds as “a dynamic industry that has delivered considerable returns for its investors and important liquidity benefits to the markets.” His spokesman, Andrew Gray, tells us that the hearing was merely informational and that no legislation is in the works.

On the House side, a Democrat, Rep. Barney Frank, who had initially introduced a bill handing hedge funds to the SEC on a silver platter, now may be willing to forego that approach in favor of handing some oversight to the Federal Reserve, a tack supported by Rep. Richard Baker, chairman of the capital markets subcommittee. To the extent hedge funds warrant any additional regulation, it’s because they can sometimes pose a systemic risk, particularly if they’re highly leveraged. The Fed, with a track record monitoring that kind of risk and with the trust of the markets, is better suited to keep an eye on that than is the SEC. The SEC is better off sticking to the fraud and market manipulation investigations it is already allowed to launch against hedge funds even without the more invasive regulation.

Hedge funds are not in the clear by any stretch of the imagination. For all the optimistic signs in Mr. Cox’s testimony, he stopped short of swearing off any further attempts at regulating hedge funds. Congressional restraint is contingent on Republicans holding their majority. Just this week, Senator Clinton unveiled a moderate Democratic agenda that demands “greater oversight” of hedge funds to force funds to focus on “the long term” despite the fact that hedge funds are so popular because their supposedly “short-term” strategies can help investors reduce the overall risk of their long-term portfolios. One observer we spoke to recently suggested that Congress and the SEC are still trying to understand hedge funds. Mr. Cox seems to be getting close. Investors are just hoping Mrs. Clinton and her ilk don’t get in the way.