Regulating the Regulators

Always double-check.

Photographer: Andrew H. Walker/Getty Images for HP

U.S. lawmakers say they want regulators -- notably, financial regulators -- to weigh the economic impact of their actions more carefully. That's actually not a bad idea, as long as it doesn't end up neutering rules that the economy badly needs.

With the stated goal of reducing red tape and a modicum of Democratic support, Republicans in Congress have introduced several bills that would force regulators to justify themselves. If enacted, the legislation could make detailed cost-benefit analysis mandatory for the Federal Reserve and other agencies that have been struggling to implement the 2010 Dodd-Frank financial reforms.

Critics suspect a veiled attempt to defang measures aimed at making the financial system more resilient, rather than a respect for analytical rigor. Under existing law, Dodd-Frank has already been challenged on cost-benefit grounds -- for example, in 2011, when a court struck down a Securities and Exchange Commission rule to strengthen shareholders. The new proposals would widen the opportunities for legal challenges. The risk of regulatory paralysis is real.  

Yet cost-benefit analysis is an excellent discipline, one that financial regulators have made too little use of. The SEC lost its case partly because its analysis was weak -- a shortcoming that the commission has tried to remedy by involving economists in its rule making. Other financial regulators, such as the Fed and the Federal Deposit Insurance Corporation, typically don't even try to assess the economic effects of their rules.

Their counterparts outside finance have done a better job of testing their own actions. The Environmental Protection Agency has done rigorous economic-impact assessments for more than 30 years, and it has done a lot to advance the techniques. Done right, by the way, such assessments might toughen, rather than weaken, financial regulation. Eric Posner of the University of Chicago argues that properly weighing the cost of rules on bank capital against the benefit of a more resilient financial system would call for a tightening of the current requirements.

Granted, the application of cost-benefit analysis to finance isn't straightforward: The science, you might say, isn't settled. This makes involving the law especially hazardous: It gives courts and mischief-making litigants too many opportunities to obstruct and delay, with too little assurance that better rules will result.

There's a better way. The White House has an Office of Information and Regulatory Affairs, which has long overseen the cost-benefit analyses conducted by the EPA and other federal agencies. Its authority doesn’t extend to financial regulators. This could be changed by executive order -- or, preferably, by an act of Congress that provided funding and sheltered approved rules from judicial review. This would widen the appropriate application of cost-benefit methods to finance, help spur further research and, over time, improve the quality of assessments.

In any event, financial regulators shouldn't be afraid of cost-benefit analysis. If it's done well, it serves the cause of good policy. They should be leading the way. 

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.