Structural Reforms to Improve Cost-Benefit Analyses of Financial Regulation

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Independent agencies should mirror executive branch practices to overcome judicial scrutiny.

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In recent years, financial service regulations have fared poorly in the courts as a result of the low quality of the cost-benefit analyses that regulatory agencies have prepared to support their rules. The scholarly debate that has resulted from the string of court losses suffered by these agencies has focused on whether the benefits of financial regulation are monetizable. But this debate misses an important part of the problem posed by repeated judicial disapproval: institutional shortcomings stand in the way of the high-quality analyses needed to pass judicial muster.

Most of the major financial regulators, including the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) are so-called independent agencies—agencies that enjoy certain protections from presidential control. These agencies lack the capacity for rigorous cost-benefit analysis seen in executive branch agencies, which must comply with a centralized set of standards and practices, including sharing information and best practices and undergoing extensive review by the Office of Information and Regulatory Affairs (OIRA).

Recent efforts by the Nuclear Regulatory Commission (NRC), an independent agency, to update its value of a statistical life (VSL) measure underscore the weaknesses of cost-benefit analysis at independent agencies. NRC’s VSL measure—used to value mortality risk reductions—had remained constant for some two decades, but in 2015 the NRC decided to revise it. Although executive branch agencies have performed extensive research and analysis to determine what VSLs to use for their own purposes, the NRC opted to determine a new value on its own. After a multi-year review project, the NRC arrived at a value that is simply the average of values used by two executive branch agencies. If the NRC had embraced the executive branch’s efforts and expertise from the beginning, it would have saved years of legwork, including an extensive and redundant review process.

Similarly, the SEC’s recent rulemaking problems demonstrate the shortcomings of regulatory analysis at independent agencies. Since the early 1990s, the federal courts have invalidated a slew of SEC rules as a result of the lack of an adequate cost-benefit analysis. Following several judicial rebukes, the SEC decided to update its rulemaking guidance to stave off further such roadblocks to the implementation of its policies. The resulting guidance document borrows very heavily from the White House Office of Management and Budget’s Circular A-4, which instructs executive branch agencies on how to perform cost-benefit analyses. Since adopting protocols that mirror that used in the executive branch, the SEC’s cost-benefit analysis has become, according to the Committee on Capital Markets Regulation, “a candidate for the ‘gold standard’ of cost-benefit analysis in the United States.”

Finally, the CFTC has likewise relied on the executive branch to improve its deficient cost-benefit practices. In the wake of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the CFTC faced a significant rulemaking burden but lacked sufficient cost-benefit expertise to bear that burden effectively. Eager for help, the CFTC entered into a memorandum of understanding with OIRA that focused on “technical assistance…particularly with respect to the consideration of the costs and benefits of proposed and final rules.” This uncommon arrangement has shown promising initial results in the quality and depth of CFTC regulatory analyses, although it is too early to assess the full impact of the partnership.

These three case studies—the NRC’s VSL update, the SEC’s rulemaking guidance established after losses in court, and the CFTC’s memorandum of understanding with OIRA—demonstrate the inferiority of independent agency cost-benefit analysis and how that analysis improves when financial regulators adopt practices from the executive branch.

To facilitate still further improvements in regulatory analysis across independent financial agencies, I recommend three promising approaches: cross-agency coordination, the extension of OIRA review, and bolstering internal economic analysis capacities.

The first option for improving cost-benefit analysis is for independent regulators to coordinate across agencies and harmonize their work with that of other agencies. The executive branch has a long tradition of inter-agency cooperation, the most recent incarnation of which was the Interagency Working Group on the Social Cost of Carbon. That cooperative model among a group of government bodies has allowed regulators to make significant progress on quantifying the costs of carbon emissions. The Financial Stability Oversight Council (FSOC), a Dodd-Frank creation, could perform a similar function for independent financial regulatory agencies.

A second viable option is to extend OIRA review—currently limited to executive branch agencies—to independent agencies. OIRA review ensures that rules promulgated by executive agencies include robust cost-benefit analyses. There is no reason that this scrutiny should not extend to independent agencies and thus force the evolution of those agencies’ analyses. Previous presidents have shied away from this option, although it is generally regarded by scholars as legally permissible. If independent agencies were subjected to OIRA review, they would benefit from the diffusion of knowledge and expertise that OIRA facilitates.

Finally, the independent agencies should build up their own in-house economics expertise, which is desirable independently of any FSOC or OIRA review. The U.S. Environmental Protection Agency (EPA) is a compelling example of the value of strengthening an agency’s own economic analytic capacities. Since it began performing economic analysis in 1971, the EPA has built a sophisticated economics team, employing perhaps “more economists working on environmental issues…than at any other single institution in the world.” Independent financial agencies would be wise to follow that model by hiring sophisticated professionals, not only to perform the subject-matter work of the agencies, but also to understand better the economic impact of their policies.

As recent court actions have demonstrated, the requirement that financial regulatory agencies must justify their rules in cost-benefit terms is here to stay. It is therefore vital that these agencies take advantage of existing resources and expertise to be able to perform effectively the important task of cost-benefit analysis.

Richard L. Revesz

Richard L. Revesz is the Lawrence King Professor of Law and Dean Emeritus at New York University School of Law.

This essay draws on Professor Revesz’s recent article, “Cost-Benefit Analysis and the Structure of the Administrative State: The Case of Financial Services Regulation,” 34 Yale Journal on Regulation 545 (2017).