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Want more accountability of Wall Street? Start with their regulators. Financial regulators are rewriting the rules of finance with little to no consideration about how their actions will impact the economy. The result is unnecessary and potentially serious costs on consumers, investors, and economic growth.
The Dodd-Frank Act greatly expanded the power of financial regulators. It charged them with writing and enforcing 398 new rules, according to law firm Davis-Polk. While approximately half of the rules have not been finalized, regulators already have written roughly 13,000 pages of regulation, requiring over 60 million hours of paperwork by the American Action Forum’s count.
We already know the new rules will affect the economy in big ways. Numerous reports show how Dodd-Frank could increase the cost of credit, slow growth, increase consumer costs, and shut down community banks. Designating institutions “systemically important” could spread the too-big-to-fail problem.
But federal financial regulators – with few exceptions – answer to no one about potential economic downsides, nor are they required to consider alternatives with fewer undesirable consequences.
The lack of regulatory accountability stands in sharp contrast to what is required of most federal agencies. Since President Reagan, executive orders have required federal agencies-such as the Environmental Protection Agency or the Department of Health and Human Services-to consider the costs and benefits of the rules they promulgate. There are detailed standards for the analysis, and the Office of Information and Regulatory Affairs (OIRA)-part of the Office of Management and Budget-reviews rules at various stages during the rule-writing process. However, financial regulators are excluded from these orders because they are independent regulatory agencies.
Numerous rationales have been offered for why economic analysis is inappropriate for financial regulators. None hold much water. A common reason is that financial regulation is uniquely difficult to analyze using cost-benefit tools. Even the agencies themselves use this excuse. The Federal Reserve wrote a letter saying, “conducting benefit-cost analysis on financial regulations is inherently difficult,” when approached by the GAO with a recommendation for more economic analysis.
However, there is precedent for conducting economic analysis on financial regulations abroad and domestically. For example, the United Kingdom’s financial regulators must consider whether the burden of a new rule is proportionate to the benefits. In the U.S., the SEC, CFPB, and CFTC are required by organic statutes to conduct some analysis on their rules. Unfortunately, these agencies have too often hidden behind the lack of precision in these mandates to avoid conducting real analysis.
Another oft-cited objection is that economic analysis would slow down needed regulation. This is probably true. However, the marginal delay in writing a rule likely is a fraction of the time the rule will be in place. Numerous presidents have deemed the trade-off worthwhile for the executive branch, so again, it is hard to see why financial regulation is any less worthy of careful consideration.
The trump card used by many critics is that the difficult-to-quantify benefits of preventing another financial crisis certainly outweigh the costs of any new rules. These critics argue that cost of any rule is pennies compared to the trillions lost in the last crisis.
This is a straw man. Many of the rules mandated by Dodd-Frank-such as the Durbin Amendment, proxy access, or the conflict mineral provisions-have nothing to do with preventing another financial crisis. Moreover, Dodd-Frank mandates many different rules purportedly working towards the same end. Economic analysis would help identify and streamline overlapping efforts and also help to flag unintended consequences of regulation that could destabilize the financial system.
It would not be hard to add more accountability to the financial markets rule-writing process. In our new study published by the American Enterprise Institute, we show how analysis would improve if Congress required the financial regulators simply to follow the OIRA directives the executive agencies follow. This includes, among other things, that regulators identify the problem the agency is setting to solve, the source of the problem, various possible solutions, and the costs and benefits of each solution.
Transparency is needed to ensure economic analysis is not a mindless, check-the-box exercise. Congress could require agencies to publish the economic analysis-together with its underlying assumptions and data-in the notice of proposed rulemaking and open it up for public comment.
If the costs of a new rule outweigh the benefits, federal financial regulators could be required to notify the relevant congressional committees. Public notification would encourage the agencies to make a greater effort to find solutions that maximize net benefits, or if they cannot, provide an impetus for Congress to repeal the statutory mandate for the rule.
Congress could even empower affected parties to sue if agencies ducked the required procedure. Judicial review would not be an avenue for courts to recreate the challenged economic analysis, but rather a process for ensuring that an agency has complied with the statutorily mandated procedural elements.
Critics of economic analysis like to point out that all of the costs and benefits cannot possibly be known on the front-end. They are right. To this end, Congress could also require five-year retrospective review to enable agencies to reconsider the costs and benefits of rules after they have taken effect.
The power of U.S. financial regulators has never been greater. A requirement to conduct economic analysis would balance increased authority with increased accountability and transparency. Otherwise, the same Main Street individuals and companies who paid dearly for the financial crisis could be forced to pay up again, this time for the costs of unbridled regulation.
Hester Peirce is a senior research fellow at the Mercatus Center at George Mason University. Abby McCloskey is the program director of economic policy at the American Enterprise Institute.
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