Effective evaluation helps to guard against regulatory capture.
The Dodd-Frank Wall Street Reform and Consumer Protection Act has raised the stakes for financial regulation by requiring more than twenty federal agencies to promulgate nearly 400 new rules and regulations. Now more than ever, financial regulators need to take bold steps to improve the quality of the cost-benefit analysis in their rulemaking. Cost-benefit analysis not only improves agency decision making, but also serves as an important good-governance tool to enhance the democratic accountability of independent agencies.
Regulated entities and investor protection groups are vigorously debating whether (and how) financial regulators should engage in cost-benefit analysis, as are a variety of policymakers, academics, and commentators. Even before Dodd-Frank’s passage, the D.C. Circuit had struck down financial regulations for inadequate cost-benefit analysis in three separate cases and has considered three similar challenges this year. Legislation to improve the economic analysis of financial regulation is pending in Congress. One bill would authorize the President to require independent agencies, including financial regulators, to produce the same exacting economic analyses required of new rules promulgated by executive agencies. Another bill, opposed by President Obama, would require the Securities and Exchange Commission to undertake more rigorous cost-benefit analysis and reconsider “its regulations every five years to determine whether they are outmoded, ineffective, or excessively burdensome.”
Absent from these debates, however, is a serious discussion of the importance of cost-benefit analysis in promoting good governance and democratic accountability. Financial regulators—as well as legislators, the White House, and the courts—should consider more seriously the democratic accountability concerns at play when regulating financial markets.
To appreciate the value of cost-benefit analysis as a good-governance tool, consider the nature of federal regulation: Despite Congress’s ultimate legislative power and the President’s oversight responsibility for much agency rulemaking, tension remains between democratic values and the modern regulatory state. Unelected federal agency officials have been given substantial rulemaking authority, but citizens neither directly select these administrators nor have the power to directly vote them out of office.
Cost-benefit analysis helps alleviate democratic concerns about agency decision making by making rulemaking more transparent both to the public and to the elected officials who can exercise influence over the agencies. As is stated in the executive order authorizing White House review of executive branch agencies’ rules, cost-benefit analysis seeks “to make the [regulatory] process more accessible and open to the public.” Cost-benefit analysis requires an agency to attempt to quantify its reasoning process—revealing which aspects of a problem the agency has taken into account. It allows the public and elected officials to understand and challenge the agency’s calculations or even its choices about which factors count in the decision making process.
In addition, cost-benefit analysis leverages the expertise of government regulators. Cost-benefit analysis facilitates the exercise of this expertise by providing a framework that insulates agencies from powerful political pressures. It does so, in part, by focusing on the objective effects of the regulation. As financial markets and attendant regulatory interventions increase in complexity, Dodd-Frank regulators’ expertise—and the cost-benefit analysis methodologies that leverage the exercise of this expertise—will take on even greater importance.
Moreover, cost-benefit analysis furthers the important good-governance aim of avoiding agency capture. This is particularly important for independent agencies, where the President cannot exert the same degree of control over agency decision making. (For instance, the President cannot remove heads of independent agencies as freely as heads of executive agencies, and rules made by independent agencies are currently not subject to review by the Executive’s Office of Information and Regulatory Affairs.) Regulated parties can and should provide input into the development of regulations. But the possibility exists that private actors will gain undue influence over the regulators. In the financial regulation context, agencies face pressure not only from those they regulate, but also from groups that represent the interests of investors and others who may benefit from, or be hurt by, a particular regulation.
Cost-benefit analysis does not by itself prevent undue interest group influence. But when combined with notice-and-comment rulemaking, the resulting transparency in agency decision making helps substantially disarm the threat of agency capture. If interest group pressure has distorted the agency’s decision making, the analysis is likely to reveal any such undue influence and provide Congress, the President, the courts, and the public with an opportunity to demand correction. As a result, the costs of capture will increase for regulators; they should be less willing to adopt suboptimal policy positions if they know the captured origin of those positions will be exposed.
This protection against agency capture is particularly important when it comes to implementing the requirements of Dodd-Frank, as most financial agencies are removed from the kind of presidential control that applies to traditional executive agencies. Notice-and-comment rulemaking combined with cost-benefit analysis supports the ultimate defense against capture of independent financial regulators: the public nature of the process itself, combined with the threat of congressional and judicial oversight.