Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications | Yale Law Journal

Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications | Yale Law Journal
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124
January 2015
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Article
Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications
15 January 2015
John C. Coates IV
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abstract
Some
members of Congress, the D.C. Circuit, and the legal academy are promoting a
particular, abstract form of cost-benefit analysis for financial regulation:
judicially enforced quantification. How would CBA work in practice, if applied
to specific, important, representative rules, and what is the alternative?
Detailed case studies of six rules—(1) disclosure rules under Sarbanes-Oxley
section 404; (2) the SEC’s mutual fund governance reforms; (3) Basel III’s
heightened capital requirements for banks; (4) the Volcker Rule; (5) the SEC’s
cross-border swap proposals; and (6) the FSA’s mortgage reforms—show that
precise, reliable, quantified CBA remains unfeasible. Quantified CBA of such
rules can be no more than “guesstimated,” as it entails (a) causal
inferences that are unreliable under standard regulatory conditions; (b) the
use of problematic data; and/or (c) the same contestable, assumption-sensitive
macroeconomic and/or political modeling used to make monetary policy, which
even CBA advocates would exempt from CBA laws. Expert judgment remains an
inevitable part of what advocates label “gold-standard” quantified CBA, because
finance is central to the economy, is social and political, and is
non-stationary. Judicial review of quantified CBA can be expected to do more to
camouflage discretionary choices than to discipline agencies or promote
democracy.
author.
John F. Cogan Jr. Professor of Law and Economics,
Harvard Law School.
Thanks for helpful discussions—but no blame for the
contents of this paper—should go to Stephen
An
solabehere
, John
Armour
Michael Barr, Ryan
Bubb
, John Campbell, Mark Cohen,
Clarke Cooper, Jim Cox, Paul Davies,
Mihir
Desai,
Nancy Doyle,
Eilis
Ferran
Jeff
Frieden
, Jeff Gordon, Howell Jackson, Robert
Jackson, Louis
Kaplow
, Duncan Kennedy, Andrei
Kirilenko
, Bruce Kraus, Alex Lee, Craig Lewis, John
Manning, Miguel de la Mano, Tom Merrill, Robert
Plaze
Eric Posner, Connor
Raso
, Mark Roe, Paul Rose, Ava
Scheibler
, Hal Scott,
Holger
Spamann
Suraj
Srinivasan
, Matthew Stephenson, Larry Summers, Cass
Sunstein
, Meg
Tahyar
, Dan
Tarullo
, Adrian
Vermeule
, Chris
Walker, Scott
Westfahl
, Glen
Weyl
and Richard
Zeckhauser
, and to workshop participants
at Harvard Law School, Harvard Business School, Columbia Law School, the
Securities and Exchange Commission, the Commodity Futures Trading Commission,
and the Public Company Accounting Oversight Board. Any errors are mine.
For disclosure of financial interests
potentially relevant to this Article, see
Faculty
Disclosures re: Related Outside Interests and Activities
Harv
. L. Sch.
, http://www.law.harvard.edu /faculty/COI/2012_Coates_John.html
[http://perma.cc/M3VN-8K2P]; and
Faculty
Disclosures re: Related Outside Interests and Activities
Harv
. L. Sch.
, http://www.law.harvard.edu/faculty/COI
/2013_Coates_John.html [http://perma.cc/TTH6-LNFE].
Introduction
A movement is afoot to impose cost-benefit analysis (CBA) on
financial regulation (CBA/FR).
The housing
and financial crises of 2008 led to the Dodd-Frank Act,
which restructured the financial regulatory agencies, mandated more than 200
new rules, and required changes to many older rules.
The sweep of regulatory change has reignited criticism for failure to base the
changes on adequate CBA/FR.
Bills have been introduced to
provide explicit authority for the President to require CBA/FR from independent
agencies,
even as critics argue that existing law already requires the Securities and Exchange
Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to conduct
a particular form of CBA/FR: judicially enforced quantification.
One panel of the United States Court
of Appeals for the District of Columbia Circuit, composed entirely of
Republican-appointed judges, held that existing law requires the SEC to
quantify the costs and benefits of its proposed rules,
while another judge—appointed by
President Obama to the D.C. Circuit—subsequently held that such quantification
is not mandatory, at least when the SEC is required by statute to adopt a rule,
and the benefits sought to be achieved are humanitarian and not economic in
nature.
This Article critiques efforts to impose judicially reviewed,
quantified CBA on independent financial agencies, while also attempting both to
explore how conceptual CBA/FR could lead to better policy and to advance the
substantive project of quantitative CBA/FR itself. This combination of objectives
represents a moderate stance, between the polar positions that often
characterize debates over CBA; the Article neither rejects it utterly nor
embraces it naively. Rather, the Article explores how CBA is likely to function
in the near term as applied to financial regulation and assesses the costs and
benefits of using CBA/FR. In other words, the Article begins to develop a CBA
of CBA/FR itself. The results of the exploration not only call into question
simplistic efforts to mandate CBA—particularly quantified CBA, and particularly
when enforced through judicial review by generalist courts—but also should help
those who favor economic analysis of law to appreciate how CBA might advance
and clarify policy analysis of financial regulation, rather than retard or
obscure it.
Part I analyzes CBA generally, noting that it (a) can be
either a framework for policy analysis or a legal means to discipline agencies
and (b) can consist of either conceptual analysis or efforts at quantification.
Part I also briefly reviews CBA’s origins in U.S. legal history to show that it
can be used to camouflage as well as to discipline, referring to the Taylor Rule
to explain why even CBA’s advocates do not propose to require CBA for monetary
policy. Often, CBA is defended in part on the grounds that supposed
alternatives—such as expert discretionary judgment—are no better, and often
worse, than CBA. In fact, Part I suggests, CBA may turn out not to be an
alternative to reliance on judgment: instead, expert judgment is a core and
necessary component of CBA, as it is for any process of assessing and adopting
financial regulations.
Part II describes existing law relevant to CBA/FR and
investigates ongoing efforts to promote quantified CBA/FR. Chief among these
efforts has been a string of high-profile CBA cases over the last decade in
which courts have struck down financial regulations. Part II critically
assesses those cases, showing they have been poorly reasoned, premised on
mistakes, inconsistent with precedent, and based on misunderstandings about
what CBA/FR can reasonably be expected to do. Nevertheless, those decisions
have fueled efforts in the agencies themselves to undertake more CBA/FR. More
problematically, those cases have also fueled efforts in Congress to give
courts an even more expanded role in enforcing a general mandate for the
independent agencies to include
quantified
CBA in rulemaking.
Part III develops case studies of how quantified CBA/FR might
be conducted on six significant and representative financial regulations,
drawing on relevant academic research to outline the tasks that need to be
tackled to conduct CBA/FR on those rules. The case studies show that quantified
CBA/FR amounts to no more than “
guesstimation
,”
entailing: (a) causal inferences that are unreliable under standard
regulatory conditions; (b) the use of problematic data; and/or (c) the
same kinds of contestable, assumption-sensitive macroeconomic or political
modeling used to make monetary policy.
Part IV concludes by reviewing the implications of the case
studies. Anyone who supports CBA should agree that CBA should be conducted only
to the extent it passes its own test—that is, only if CBA itself will produce
more benefits than costs. Perhaps surprisingly, given that CBA has been part of
administrative law for decades, CBA of CBA has itself never been adequately
conducted, leaving the first-stage choice of when to perform CBA/FR itself in
the realm of judgment rather than science. Part IV begins the task of outlining
a CBA of CBA, both generally and in the context of financial regulation. It argues
that the benefits of CBA/FR have been low in the past and are likely to remain
low in the near future, while its costs will depend on the precise
institutional and legal context in which it is pursued.
CBA/FR’s benefits are likely to remain low because it is by
definition about finance: finance is at the heart of the economy; is social and
political; and is characterized by non-stationary relationships that exhibit
secular change (that is, long-term structural changes). These features
undermine the ability of science to precisely and reliably estimate the effects
of financial regulations, even retrospectively. Whenever agencies face such
sensitive and speculative forecasting abilities, quantified CBA is not capable
of disciplining regulatory analysis. It will generate low benefits in the form
of reduced agency costs (in part by counteracting cognitive biases) or
increased transparency. Moreover, CBA/FR will produce costs: resources
consumed, regulatory delay, diffusion of regulatory focus, and potential
decreases in regulatory transparency—particularly if regulatory agencies and
courts involved in reviewing agency action do not have strong incentives to be
honest about the limits of the results.
At the same time, CBA/FR is a useful conceptual framework,
and quantified CBA/FR is a worthy long-term research goal.
Attempts
to quantify may advance the research needed to achieve
reliable, precise estimates, and this makes quantified CBA/FR a worthwhile
project for agencies to pursue. But the current benefits of CBA/FR remain low,
because their real effects remain far off in time; like any regulatory
benefits, the benefits of CBA/FR should be discounted to present value.
Completing a full, quantified CBA of CBA would require
evidence and new research methods: studies of the degree to which CBA results
in better regulations or more transparency in the regulatory process, as well
as quantified estimates of the costs—delay, confusion, camouflage,
partisanship—that CBA can introduce. Until evidence is developed to illuminate
when CBA/FR passes its own test, courts and secondary agencies (that is, agencies
other than those charged with rulemaking responsibility) should have no role in
second-guessing the choice of when to conduct CBA/FR, or the details of CBA/FR
when it is used.
Not only should new legal CBA/FR
mandates be resisted as likely to worsen policy outcomes, but existing
interpretations of the Administrative Procedure Act (APA) and financial
agencies’ governing statutes should also be reversed. A safe harbor should be
created to shelter the CBA/FR that the agencies choose to conduct, so as to reduce
the influence of concentrated interests through litigation and of politically
partisan but unaccountable judges on regulatory outcomes.
10
In sum, CBA/FR remains a potentially
valuable regulatory tool, but only if implemented with a light touch.
As reflected in Part IV, this Article’s critique of CBA/FR is
not sweeping. Rather, it is focused on one specific institutional arrangement
for CBA/FR: mandates (whether through new statutes or judicial interpretations
of existing statutes) for judicially reviewed, quantified CBA. Other
arrangements that include CBA—such as the use of conceptual CBA on a voluntary
basis by independent agencies—are much more promising. In between are a wide
variety of possible arrangements, such as interagency review of CBA/FR (whether
conceptual or quantitative) by a separate agency, as is currently done for rulemakings
by executive agencies. Each such arrangement deserves its own fact-specific
analysis. For example, for any interagency process, one should ask: How much of
the interagency dialogue would become part of the public record, available for
use in a subsequent judicial challenge? What real resources could the
alternative agency bring to bear on the discussion? Would that other agency
face genuinely different incentives in evaluating a given regulation, and how
much value would participation by such an agency add if included in
pre-rulemaking discussions? How important is it to achieve uniformity on
specific kinds of CBA inputs, and alternatively, how important is it to allow
for flexibility in such inputs over time and across agencies? As a result of
the complexity of these questions, the full range of possible alternative
institutional arrangements is not analyzed in detail in this Article. However,
some of the reasons offered as to why judicially reviewed quantitative CBA/FR
may not satisfy a cost-benefit test may also extend to those other
arrangements, and the analysis here should at least illuminate policy debates
over those alternatives.
I. what
do people mean by “cost-benefit analysis”?
The literature on cost-benefit analysis is voluminous and
multi-disciplinary.
11
Not surprisingly, writers often talk
past one another when they discuss the topic. Three distinctions are often
elided: whether by CBA one means policy analysis or law; whether by CBA one
means a conceptual framework or quantification; and whether CBA is likely to
camouflage or discipline regulation.
12
In this Part, I begin by presenting
a brief typology of CBA and conclude by sketching the alternatives to CBA.
A. Policy
Versus Law
Lawyers instinctively understand the difference between a
norm or a policy, on the one hand, and a law, on the other—even when that law
tracks a norm or policy. They know, for example, that the effects of a law
(assumed to be justiciable)
requiring
an agency to act reasonably will not simply equate to the actions that an
agency, acting reasonably, would take. A requirement imposes a set of burdens
on the agency that the demands of reason do not. Law introduces new agents into
the picture—usually, courts. Those agents are no more perfect than others, and
their decisions will be uncertain. Agencies subject to court oversight will
anticipate judicial error (or bias).
A law will lead an agency to keep more careful track of what
it does, and why, than reason on its own would do. Agencies will incur costs to
keep track in this way, just as they will incur costs to defend decisions
against court challenges. They will refrain from acting when the expected cost
of a challenge and record keeping falls below the expected benefit of the action,
discounted for the risk that the court will wrongly overturn the decision.
These consequences arise from enforcement and oversight by courts. Law changes
behavior even when a law on its face only requires what someone would try to do
anyway.
13
Lawyers also know that a law requiring an agency to act
reasonably will sound innocuous to most non-lawyers: who could be against
acting reasonably? Lawyers know that non-lawyers systematically underestimate
enforcement costs and their effects. They know that a clever way to shape
regulation is to propose a law that tracks a general norm, the enforcement of
which will have predictable effects that are not intuitive to non-lawyers. The
asymmetry in perceived effect will allow political gains at a lower political
cost than a straightforward law mandating or forbidding regulation.
These themes play themselves out when lawyers discuss CBA
with non-lawyers. Specifically, non-lawyers typically mean by CBA the conduct
of cost-benefit analysis itself—whether by researchers, regulators, or courts.
Lawyers sometimes use CBA in the same way, referring to a particular type of
policy analysis. But lawyers also often mean by CBA a set of legal requirements
aimed at inducing regulatory agencies to conduct CBA exclusively or as part of
their policy analysis in choosing to adopt or change regulations. When
lawmakers, for example, describe a proposed law as requiring CBA, many
non-lawyers will think of CBA as policy analysis and, if they favor using CBA
in policy analysis, will assume that the law is a good idea. They will
effectively conflate CBA as policy analysis with CBA as legal requirement. As
with a requirement of reasonableness, however, a requirement of CBA will
predictably have effects that diverge from those that would arise if CBA were
simply used as a routine part of an agency’s policy toolkit, without a legal
requirement.
14
B. Quantities
(or Guesstimates) Versus Concepts
A second source of confusion arises even within CBA as policy
analysis. Most advocates of CBA expect it to include quantification and
monetization. This type of cost-benefit analysis—if supported by strong
consensus theory, reliable research designs, and good, representative
evidence—could properly be called
quantifiedCBA
15
but—if supported only by weak, contested theory, unreliable research designs,
or poor, unrepresentative evidence—better deserves the label
guesstimated CBA
. Robert W. Hahn and
co-authors, for example, criticized executive agencies for failing to comply
with Executive Orders requiring CBA,
16
based on the authors’ assessment that
agencies
only quantified net
benefits—the dollar value of expected benefits minus expected costs—for 29
percent of the forty-eight rules [reviewed by the authors], even though the
Executive Order directs agencies to show that the benefits of a regulation
“justify” the costs. . . . Although agencies may present reasons not to
quantify and monetize benefits and costs, . . . we believe they should be able
to meet the requirements of the Executive Order for a majority of regulations.
17
Expectations of quantification have
found their way into legal decisions overturning financial regulations, as
discussed in Part II. For example, in
Chamber
of Commerce v. SEC
, the D.C. Circuit held that the SEC acted arbitrarily
and capriciously for failing to undertake some effort to quantify the costs of
the mutual fund governance rule changes it had adopted.
18
Others accept—indeed, often make rhetorical show of conceding
19
—that quantification or monetization
is not possible in some policy areas but nonetheless believe that CBA can
function as a disciplined framework for specifying baselines and alternatives,
for ensuring that (at least conceptually) both costs and benefits of a rule are
considered, and for encouraging reliance on “evidence” rather than
solely
on intuitive judgment.
20
These types of CBA are best
distinguished from quantified or guesstimated CBA with the label
conceptual CBA
Transforming conceptual CBA into quantified CBA is not an all-or-nothing
proposition. Some effects of a given rule might be reliably quantified and monetized,
while others might not be. Some inputs to CBA may be quantified, for example,
to “scope” the domain of a proposed rule—how many people, transactions, entities,
and the like would be covered by the rule. But quantified CBA in its ideal
form—which some of its advocates refer to as “complete” quantified CBA
21
—entails
specification and quantification of all benefits and costs in a single, uniform
bottom-line metric (typically, dollars) representing the net welfare effects of
a proposed rule. Some CBA supporters acknowledge that such an idealized version
will not be feasible in “some” instances and have conceded that in such
instances a more limited CBA—guesstimated CBA—should not determine regulatory
outcomes. For example, in a 1996 policy article in
Science
, Kenneth Arrow and ten other economists advocated CBA but
were careful to note that
b]
enefits
and costs of proposed policies should be quantified wherever possible. . . . In
most instances, it should be possible to describe the effects of proposed
policy changes in quantitative terms; however, not all impacts can be quantified,
let alone be given a monetary value. Therefore, care should be taken to assure
that quantitative factors do not dominate important qualitative factors in
decision-making.
22
Particularly difficult to quantify or
monetize are non-market goods and externalities. In non-financial regulatory
domains, non-market goods, such as life, health, beauty, and biodiversity, have
proven difficult to monetize with any degree of precision and confidence.
23
In financial regulation, relevant non-market goods include
trust, investor confidence, liquidity, and the psychological consequences of
unexpected financial losses.
24
In
non-financial regulation, measurement of externalities has proven difficult,
not only because these externalities are often non-market goods, but also
because simply specifying and estimating their size is challenging. Financial
regulation poses equally if not more difficult problems in measuring
externalities, in part because financial markets are tightly interconnected
systems (hence the now mainstream phrase “systemic risk”), in which one party’s
losses can be rapidly transmitted to multiple related parties.
25
As explained in Part III and discussed further in Part IV, full quantification
in CBA/FR is likely to be difficult because finance is at the heart of the
economy, involves groups of people (firms, markets) interacting in complex,
difficult-to-study ways, and is shaped by forces that change rapidly over time.
Short of full monetization, CBA can include efforts to
estimate ranges of costs and benefits, to bound them, to conduct “threshold”
analyses comparing a rule’s quantified costs to unquantifiable benefits (or
vice versa), and, more generally, to use empirical methods and data to generate
evidence relevant to quantified or conceptual CBA. While ranges, bounds,
threshold analyses, and incomplete but relevant evidence may all be viewed as
part of quantified CBA, they begin to move the final result of CBA toward
guesstimation
, leaving it a matter of judgment whether and
how the results of CBA should influence decision making.
For example,
guidelines from the Office of Management and Budget (OMB) provide little help
in determining how to conduct threshold analyses if important benefits and
costs are both unquantifiable, simply suggesting that agencies “exercise
professional judgment” in weighing unquantifiable elements in the CBA.
26
This recommendation
is hard to criticize. But it also suggests that there may be circumstances in
which a feasible but partial quantification will not be cost-justified. For
example, it may be the case that the quantifiable elements are likely (based on
judgment) to be trivial relative to the unquantifiable elements. It may also be
that partial quantification is costly, or otherwise will undermine the value of
a conceptual CBA, by—for example—conveying a false degree of precision to a
general audience.
One also can draw a distinction within CBA law—analogous to
the one between conceptual and quantified CBA—between
CBA mandates
and
CBA process
,although
this is not typical in prior CBA scholarship. CBA mandates consist of efforts
to require agencies to conduct some or all elements of CBA policy—presumably
because legislators believe agencies must be forced to conduct it. CBA mandates
include laws subjecting the CBA policy analysis itself to review by another
agency (such as the
Office of
Information and Regulatory Affairs (OIRA), a unit of OMB
), or by courts
(as in review of rules as “arbitrary” and “capricious” under the APA).
27
The objectives of this review are to ensure that the agencies take statutory
CBA mandates seriously and (in theory) to improve the quality of CBA analyses.
CBA mandates encompass binding executive orders or other interagency guidelines
that specify particular components of CBA policy analysis, such as discount
rates, or methods to quantify benefits or costs, with the goal of achieving
uniformity across governmental agencies.
28
Finally, CBA mandates can be a component of regulation itself—that is, an
agency could require a private actor to demonstrate that a new activity or
product would have greater benefits than costs before it could be permissibly
sold.
29
CBA process, by contrast, includes requirements for agencies
to publicly disclose any CBA they conduct, or the sources of their data, and to
solicit public comment and feedback on their CBA analyses (as under the APA).
30
CBA process laws can require agencies to discuss how they took comments into account
in their final rulemaking decision, to present their CBAs in particular or
standardized formats, or to include specific kinds of information, such as
standard statistics or data analyses that bear on the reliability of the
primary findings of a quantified CBA. Such indicators of reliability include,
for example, confidence intervals,
-values,
test statistics, correlation matrices, sensitivity analyses, and the results of
“Monte Carlo” simulations. Such “soft law” requirements may be viewed as a
means of enhancing the quality of the agencies’ decisions by encouraging
deliberation and care, or as a means of increasing public understanding and the
legitimacy of adopted rules. These process requirements can also have less
desirable effects, however, including delay, regulatory inertia, ill-informed
judicial second-guessing, creation of incentives for agencies to engage in CBA
for show, and waste of regulatory resources.
Table 1.
dimensions
of cost-benefit analysis
Putting the first two dimensions of CBA together, Table 1
illustrates the multiple meanings that apparently synonymous uses of
“cost-benefit analysis” might have for different speakers or audiences. Table 1
suggests that it is possible to be an advocate for CBA/FR—whether conceptual or
quantified—as a form of policy analysis without wanting to entangle it in the
legal system; or that it is possible to favor efforts to quantify CBA/FR
without wanting to mandate quantification. One might even be skeptical that
CBA/FR law will have any effect at all.
31
Alternatively, if CBA/FR has clear virtues as policy analysis, one might
believe that those virtues would lead agencies to use it, at least sometimes,
without being legally required to do so, just as private businesses adopt “best
practices” on a voluntary basis. Likewise, one can favor CBA/FR process laws
without agreeing that courts or any other agency should have any substantive
role in evaluating or constraining the content of CBA/FR. Or one could imagine
mandating that a second political agent (a specialized court or another agency)
conduct the CBA/FR analysis itself; the analysis would then have to be used by
the primary agencies as inputs into their rulemaking decisions, without
necessarily adding other process requirements to CBA/FR law.
C. Camouflage
Versus Discipline
A third dimension along which CBA can vary is the motive of
the person using it—and, relatedly, its effects on third parties. The
conventional, optimistic view of CBA advocates—generally assumed or asserted
rather than supported with evidence
32
—is that CBA is an agency
cost-control device, used by politically accountable representatives (Congress
or the President) to discipline expert but less accountable agencies (made up
of appointed bureaucrats) in their rulemaking efforts. In this view, CBA will
improve the care that agencies exercise in deciding whether a possible rule
change is good for society while limiting agencies’ ability to adopt
welfare-reducing rules.
33
CBA optimists tend to assume or
assert that CBA will enhance public understanding of why regulations are
adopted (increase transparency
34
and engage more people in the democratic
process, potentially combating pernicious rent seeking by special interests.
35
By specifying how a rule will produce
benefits, by acknowledging the costs involved, and by encouraging the
consideration of alternatives, CBA is expected to improve the allocation of
governmental resources and reduce the drag of regulation on beneficial
activities.
36
Some but not all CBA optimists even assert that CBA can mitigate cognitive
biases of regulators or the public.
37
Despite having potential virtues, however, CBA can have a
different, darker, or more complex mix of effects. It can provide camouflage,
reducing the transparency of a rulemaking process.
38
More disclosure does not always improve transparency, a point that (ironically)
some CBA advocates have made strenuously when resisting disclosure rules for
private actors.
39
Beyond the indeterminate effects of CBA soft law on the ability of the public
to monitor regulatory agencies, CBA can also be a tool of political struggle
over the distribution of rents, and it can serve as a means to increase the
power of unelected expert agents as a tactic in that struggle.
40
The origins of CBA in the United States illustrate this set
of possibilities. It is commonly asserted that Congress “initiated the use of
CBA in 1936, when [it] ordered agencies to weigh the costs and benefits of
projects designed for flood control,”
41
permitting authorization of such projects only if “the benefits to whomsoever
they accrue are in excess of the estimated costs.”
42
This origin story fits the optimistic view of CBA outlined above, making it a
mechanism used by elected and accountable representatives to control costs at a
wayward agency. In fact, however, the use of CBA by the Army Corps of Engineers
emerged earlier, on the initiative of the Corps itself, as described in
Theodore M. Porter’s
Trust in Numbers
43
In Porter’s telling, the first efforts at CBA occurred in 1902, with the
creation of a board within the Corps; opponents of public works spending hoped
that the board’s performance of cost-benefit analysis and its issuance of
recommendations would “reduce opportunities for purely political choices.”
44
Rather than ranking all projects based on CBA, which would have systematized
project choice, the Corps chose to maintain flexibility, “recognizing, it
seems, that congressional choice was the key to congressional favor.”
45
Far from being a tool for the management of the Corps, CBA became a tool by
some politicians and by the Corps to manipulate Congress.
The Corps had developed a “huge civilian labor force” prior
to the 1936 Flood Control Act, which mandated strict CBA for new projects. That
Act, too, Porter concludes, was not aimed at disciplining the Corps, but was
“one of the heroic efforts of the United States Congress to control its own bad
habits.”
46
The Act’s requirements, and particularly the delay requirement, were viewed as
a benefit, and not a necessary cost, of conducting CBA: “A preliminary examination
and then a full survey, each running through several levels of Corps bureaucracy,
required months or years, and could not be completed to satisfy the sudden whim
of a legislator.”
47
Far from reducing
the power of the Corps, the regularization of the project approval process (and
the implementation of CBA) enhanced it, because neither Congress nor the public
exerted the effort needed to evaluate and assess the
Corps’s
numerically impressive but sometimes ad hoc analyses: “The numbers were almost
never questioned.”
48
If some members of Congress favored a particular outcome,
they could attempt to “manage” the Corps by finding unorthodox benefits to
“quantify” (or include in a guesstimated CBA). One local district’s engineer,
faced with an unfavorable CBA report based solely on flood control benefits,
“developed other benefits that he did not find . . . necessary to develop when
he wrote his main report,” including benefits from downstream power, pollution
abatement, and improved water supply.
49
Over time, more benefits were guesstimated, and previously rejected projects
were accepted.
50
The result, in Porter’s view, was that “Corps economic methods [that is, its
CBA] could not, by themselves,
determine
the outcome
of an investigation.”
51
This
observation was particularly true when powerful interest groups, such as the
utility and railroad industries, or other regulatory bodies, such as units of
the Department of Agriculture or the Interior Department, opposed the
Corps’s
initial conclusions.
52
In sum, CBA can in principle provide public-regarding
benefits by disciplining agencies, increasing transparency, and enhancing the
public’s engagement with the regulatory process. In theory, CBA can reduce
agency costs associated with delegation by politically accountable lawmakers to
expert but less
accountable
agencies. But CBA can have
other effects beyond direct costs of the CBA itself. These effects include use
of technically opaque analytics to (1) obscure the issues at play, (2) raise
the risks for lawmakers to question regulators, (3) shift power from Congress
to regulators, (4) hide rent seeking, and (5) favor factions in distributional
struggles among lawmakers. One form of camouflage that seems likely to recur is
the presentation of guesstimated CBA as quantified CBA—which potentially
misleads the public by omitting significant information about the uncertainty,
judgment, and sensitivity of particular numerical results in a CBA.
Depending on one’s assumptions about the alignment of agency
interests with public interests, these effects may be costly or beneficial. But
they should be kept in mind when evaluating a given type of CBA in a given
context, and they suggest that CBA itself needs to be subject to CBA before
being mandated through law. In Part IV, I sketch a third set of effects that
CBA policy can have—stimulating innovation and inducing better regulation over
time—that differs from both the disciplinary role touted by advocates of CBA
law and the camouflaging role illustrated by the
Corps’s
history.
D. Alternatives
to Quantified CBA/FR
CBA is sometimes promoted on the ground that there is no
superior alternative.
53
Leading
proponents of CBA/FR in the United Kingdom, for example, acknowledge problems
with CBA/FR and then argue these problems do “not . . . mean that the
best course would be to fail altogether to deploy the techniques of economic
analysis.”
54
(One would hope not!) Yet viable alternatives exist.
In non-financial areas of regulation, agencies use
feasibility analysis, which focuses on the technical capacity of private actors
to comply with a proposed rule; this procedure pays some attention to costs
rather than attempting to quantify the rule’s full range of costs and benefits.
55
Another alternative is risk-risk analysis, in which the risk addressed by a
rule is compared to risks that can be expected to arise as private actors
respond to the rule.
56
Another
option (sometimes included as a component of CBA) is cost-effectiveness
analysis, in which costs of different methods of achieving stipulated or
assumed benefits are estimated and compared.
57
Yet another, reflected in some important statutes relevant to financial
regulation,
58
is a flat ban on certain kinds of activities—that is, requirements that
agencies enact and enforce mandatory rules regardless of what an agency’s
CBA/FR might suggest about those rules’ net benefits.
59
1. The
“Alternative” of Expert Judgment
But the primary “alternative” to guesstimated CBA/FR is
expert judgment, which typically includes at least some elements of conceptual
CBA (whether or not expressed in writing) and can be elicited and deployed in a
variety of ways. More precisely, however, expert judgment is not an
“alternative,” but a necessary
component
of guesstimated or quantified CBA, as the Office of Management and Budget’s
guidance on CBA (OMB Guidance) makes clear.
60
When defenders of CBA argue that expert judgment may be—as it often is—flawed,
they are also necessarily arguing that CBA is flawed. The question is not,
then, “What is the alternative?” Rather, it is, “Is judgment being camouflaged
as something it is not?” An honest acceptance of the central role of judgment
in policymaking, whether or not decorated with guesstimated CBA, should lower
the stakes in the fight over CBA law.
In the context of financial regulation, the judgment of
regulatory staff is expert because the appointees of the financial agencies
have generally spent their careers in and have developed specialized knowledge
of finance, financial institutions, and financial markets.
61
They have sharpened their intuitive sense of what kinds of regulations work and
why—particularly relative to non-experts, such as generalist judges. Such
intuitions can be disciplined and informed in ways other than through formal
CBA, such as through discussions with other experts (within or outside an
agency); case studies, surveys, and polls; retrospective evaluations;
regulatory experiments that are deliberately adopted without specific
predictions about how they will turn out; and other forms of assessment that
are not part of quantified CBA/FR.
62
The experience and expertise of financial regulators does not
make them infallible: the 2008 financial crisis proves that regulators with
expertise can lack judgment, particularly when the challenges they face are
novel, as with shadow banking, over-the-counter derivatives, and (ironically)
the complex and unanticipated effects of deregulation.
63
More generally, in many domains, experts are no more capable of predicting
certain kinds of complex events than non-experts.
64
Nevertheless, in the realm of
financial regulation, expert judgment has always played a central role in the
setting of monetary policy. This brings us to the Taylor Rule.
2. Monetary
Policy: A Limiting Example
To set the stage for case studies of rules in Part III, this
section recognizes that even CBA/FR’s proponents do not advocate requiring
CBA/FR for monetary policy.
65
As will be
seen, guesstimated CBA/FR of monetary policy would result in conceptual,
theoretical, and empirical challenges identical to those that arise in the case
studies reviewed in Part III. This fact raises the question of why, precisely,
CBA/FR proponents believe a line should be drawn between rules for monetary
policy and other financial regulations.
To think through how CBA/FR might in principle be applied to
monetary policy, consider the Taylor Rule. That “rule”
is a
principle of monetary policy that stipulates how much the
Federal Reserve (or any central bank) should change nominal interest rates in
response to changes in prices, output, or other economic quantities. In
particular, the Rule stipulates that for a percent increase in inflation, a
central bank should raise interest rates by
more
than a percentage point.
66
First proposed in its specifics by
John Taylor in 1993, the Rule sought to reduce uncertainty, limit adaptive
inefficiency, and increase credibility by avoiding frequent changes in monetary
policy as a result of the exercise of discretion.
67
The Federal Reserve, it should be
emphasized, has never “promulgated” the Taylor Rule, nor has it adopted the
Rule in any formal or public fashion.
68
Nevertheless, the Rule does fairly characterize (as a first approximation) the
monetary policy of the Federal Reserve for some of the years under Chairman
Alan Greenspan.
69
Suppose, counterfactually, a future Federal Reserve (or
Congress) wanted to “adopt” the Taylor Rule—or any other rule for conducting
monetary policy—in a formal fashion. Could the Rule be defended through CBA/FR?
Only a few CBA/FR proponents suggest that it could, or should, be defended
through CBA.
70
The numerous proposed bills in Congress
that would extend CBA to the independent agencies have all exempted monetary
policy.
71
Why is monetary policy exempt? Politics and political power
play a role, of course: few politicians want to take on the Federal Reserve
(even if a few have done so, particularly during the public outcry over the
2008 crisis).
72
History and tradition also play a role: monetary policy in the United States
has long been (by consensus) an exercise in discretionary judgment, and it
involves balancing multiple goals—full employment, stable prices, and moderate
long-term interest rates.
73
Any strict
rule to set monetary policy according to a full quantified CBA would have to
reverse this tradition and implicitly choose a priority scheme for the goals;
as a result, the rule would be (to return to politics) highly unlikely to
achieve the supermajority support necessary to enact major legislation in the
United States.
But policy, too, plays a role here. In a context of high
empirical and theoretical uncertainty, multiple competing macroeconomic models
have long coexisted to guide the achievement of monetary policy’s goals.
However, these models are widely conceded to be contestable,
74
and no one model has ever achieved anything close to a consensus among
“mainstream” economists. For this reason, presumably, even the most
rule-oriented members of the Federal Reserve have never seriously attempted to
persuade the Board to tie its own hands by articulating publicly a “rule” that
would eliminate the Board’s discretion to set interest rates.
Absent such
hand-tying
, there is no
need to exempt monetary policy from the proposed CBA/FR laws. So why have they
been exempted? Presumably because CBA/FR proponents recognize that there may be
welfare-enhancing
“rules” (in the sense of
regularities in the exercise of discretion that might come within the legal
definition of “rule” used in the APA)
75
that can discipline regulators but cannot be reliably shown to satisfy a
cost-benefit test. The idea that a “rule” in the general legal sense of the APA
could be valuable without being first validated by quantified CBA/FR prevails
across many domains of discretionary decision making: in an attempt to constrain
itself, a corporate board of directors may decide to adopt rules about the
situations in which it wants officers to present an investment to the board
(instead of pursuing the investment on their own), but such self-imposed rules
may not be defensible under any kind of quantitative framework. Rules, in other
words, can be a part of the way that discretionary judgment is exercised. Rules
can have value even if they cannot be supported by evidence showing that their
quantifiable benefits exceed their quantifiable costs.
Indeed, CBA/FR’s strongest proponents concede that expert
judgment is necessary because CBA/FR can only be as good as the expert judgment
that informs it.
76
Pro-CBA/FR bills pending in Congress exempt monetary policy, presumably for
this reason, and there is no serious call for hard-wiring monetary decisions
into legislation or regulation. While there are economists who believe that
basing monetary policy on simpler rule-like elements may be a good idea, even
they suggest that rule-like monetary policy be adopted as a matter of expert
discretion by the Federal Reserve Board and be subject to discretionary
exceptions.
77
The question remaining, then, is whether discretionary
judgment should be confined to monetary policy or whether it should remain
available for financial regulation more broadly. Put differently, the question
is whether quantified CBA/FR is itself actually an alternative to judgment, or
whether it should be viewed as judgment camouflaged by numbers (“judgment in
drag,” one might say, or less colorfully, “judgment in disguise”). To answer
that question, a detailed analysis of what CBA/FR might look like is needed.
II. a critical assessment of judicial review of cba/fr
As noted at the outset, a movement is afoot to impose CBA/FR
on financial regulation. This movement is flowing through a variety of
channels. Interest groups and advocacy organizations have been promoting CBA/FR
as both policy and law, and regulators themselves have been beefing up their
quantitatively trained staffs. But one big force (perhaps the biggest) that is
promoting the role of CBA/FR has been judicial activism—aggressive review of
agency decisions by courts focused in large part on CBA. After reviewing
statutes relevant to CBA/FR, this Part critically assesses recent cases in the
D.C. Circuit that have overturned financial regulations in whole or in part
because of what some judges have seen as inadequately quantified CBA/FR. This
Part concludes with a summary of how this judicial activism has led some of the
financial agencies to engage in more CBA/FR, and has amplified legislative
efforts to promote CBA/FR through oversight and proposed legislation.
A. Existing
CBA/FR Law
Formally, independent agencies
78
such as the financial regulators are
not subject to explicit CBA/FR law to the same extent as executive agencies,
which have been required (by executive order since 1981 and by statute since
1995) to conduct CBA for new rules.
79
Vice President George H.W. Bush
requested in 1981 that the executive agencies comply with the CBA portions of
the executive orders, and some of the financial agencies have at times
voluntarily, if incompletely and inconsistently, done so.
80
By contrast, in the United Kingdom,
the two main financial regulatory agencies are required by statute to conduct
quantified CBA/FR, unless in the opinion of the agencies the costs or benefits
“cannot reasonably be estimated” or “it is not reasonably practicable to
produce an estimate,” in which case the agency must publish its opinion and
explain it.
81
Three CBA-related statutes cover the independent agencies.
The Paperwork Reduction Act (PRA) requires agencies to justify collection of
information from the public, to minimize the burden of any information
collection process, and to maximize the utility of information gathered.
82
The Regulatory Flexibility Act (RFA)
requires agencies to assess and consider alternatives to the burden of
regulation on small entities.
83
The Congressional Review Act (CRA)
requires agencies to submit proposed rules—along with any CBA the agencies have
conducted—to Congress and the Government Accountability Office (GAO).
84
The statute requires the GAO to
submit an assessment to Congress of any “major rule,” defined as any rule
having an expected impact of $100 million or more.
85
As a result of these statutes, independent agencies include
some CBA-relevant information in rulemakings, the GAO has been submitting
annual reports on CBA for major rules (including rulemakings by independent agencies),
and the OMB has collected and reported on the GAO’s reports on an annual basis.
86
Analyses under the PRA and the RFA
represent only a subset of a full CBA—even of a full conceptual CBA—and the
information in these reports is thin—generally indicating whether CBA was
conducted, without regard to whether it was conceptual or quantified, extensive
or brief, persuasive or perfunctory. Still, the PRA and RFA have generated
information used to critique financial rules on CBA-related grounds, and the
GAO’s and OMB’s reports have made the complete absence of voluntary CBA in many
rulemakings by independent agencies more salient over time. Together, this
information has fueled legislative, inter- and intra-agency, and interest group
pressure on the financial regulatory agencies to do more on their own to conduct
CBA, and has also led to a sharp increase in industry-funded court challenges
to agency rulemakings on CBA/FR grounds.
B. A
Critical Assessment of Judicial Review of CBA/FR
Despite the fact that CBA/FR is not clearly required of
independent agencies, business trade groups have since 2000 invested
significant time and resources to persuade court­­s—primarily the D.C.
Circuit—to strike down a series of rules under the APA and under statutes that
authorize financial regulation. Cited in internal CBA/FR guidance promulgated
by the CFTC and the SEC, these decisions have clouded implementation of the
Dodd-Frank Act, contributing significantly to the rulemaking delays under that
law. These decisions have had an impact on the legislative process, as lawmakers,
lobbyists, and the agencies themselves have noticed that rules receive
different treatment depending on whether Congress has required the agencies to
enact them or has given the agencies discretion and authority to act on their
own.
The first in the recent string of judicial interventions was
Chamber of Commerce v. SEC
87
In that decision, the D.C. Circuit
held that the SEC failed to comply with the Investment Company Act (ICA). The
ICA requires the SEC to “consider . . . whether [regulatory] action will promote
efficiency, competition, and capital formation,”
88
a requirement added to the SEC’s
statutory mandates in 1996.
89
As a result, according to the court,
the SEC had also violated the APA.
90
The rules in question—discussed in Part III.B—made exemptions under other rules
conditional on mutual funds increasing their boards’ independence.
The specific CBA/FR-related failings to which the court
pointed were two small parts of the SEC’s regulatory analysis. The first was
that the SEC declined to quantify costs of requiring more independent directors
because it did not know how funds would respond to the rule.
91
This, the court replied, was no excuse, saying that the SEC could have
determined “the range within which a fund’s cost of compliance [would] fall,
depending on how it responds to the condition.”
92
Presumably the court had in mind that the SEC could quantify costs of each
possible response and guesstimate a range based on assumptions about how many
funds would choose each option.
The second failing was similar, relating to a requirement
that fund boards have an independent chair. There, the SEC declined to quantify
costs of the newly independent chairs’ hiring staff because staffing would be
discretionary and the SEC had no basis for knowing how many chairs would hire
staff (or how many staff each chair would hire). Again, the court held the SEC
needed to guesstimate this subset of costs by estimating the costs for an
individual fund, an exercise that the court asserted (without further
explanation) would be “pertinent” to an “assessment” of the requirement.
93
But the only way that an individual fund cost estimate would be “pertinent” is
if the SEC implicitly or explicitly made further assumptions about how many
funds would incur those costs—even though the SEC explicitly noted that it had
no reliable basis on which to build the assumptions, and the court offered no
reason to doubt the SEC’s claim.
94
The court’s
analysis under the APA was nonexistent: because the SEC had not followed the
ICA, the court reasoned, it had violated the APA.
95
In sum, the court interpreted the requirement that the SEC
“consider” a rule’s effects on “efficiency” to imply a very specific CBA/FR
mandate—calling on the SEC to guesstimate the range of one of a rule’s costs,
rather than merely identifying the type of cost imposed. The court’s
interpretation of the ICA was based on no prior court decision
96
and no legislative history. Nor is
it implicit in the ICA’s words, as “efficiency” is frequently used as a
qualitative and not exclusively quantitative concept.
97
Nowhere did the court cite (much less discuss) Supreme Court precedent under
the APA that had emphasized that courts should be highly deferential in
reviewing an agency’s judgment under the “arbitrary and capricious” standard.
98
Nor did it address precedents more generally admonishing courts to be mindful
of the “complex nature of economic analysis” in deferring to agencies.
99
Finally, the court never explained how a crude guesstimate of
one conditional component of possible costs of a rule could meaningfully inform
the public about the “efficiency” of the rule when the SEC had not quantified
the benefits of the rule—and when the court did not suggest that the SEC try to
do so, whether it could, or how it could if it tried. In other words, the court
read general language in the ICA as if it required the SEC to comply with the
Executive Orders requiring CBA/FR “to the extent feasible,”
100
and then added an interpretive gloss
on OMB Guidance that has little apparent virtue in improving public understanding
of the rule. Whatever the merits of the SEC’s mutual fund rules—and there are
reasons (noted in Part III.B) to suggest that the rules might not be a good
idea on balance—the merits of the court’s decision evaluating the SEC’s
rulemaking under the ICA and the APA are hardly compelling and do not appear to
reflect any meaningful deference to SEC judgment on how to conduct CBA/FR.
Yet this decision was only the first of a rash of judicial
interventions into the financial regulatory process, each opinion growing
steadily less deferential, culminating in the 2011 case
Business Roundtable v. SEC
101
In the seven years after
Chamber of Commerce
, the D.C. Circuit
handed down six more similar decisions, striking down a range of SEC actions
(representing one in seven of the SEC’s major rules over that period).
102
The D.C. Circuit has struck down a rule requiring registration of hedge fund
advisors under the Investment Advisors Act,
103
rule exempting
broker-dealers from registration
under that Act,
104
an order affirming
expulsion of an NASD-member firm,
105
and a rule treating a new class of securities market-linked annuities as
securities.
106
The court also struck down the same mutual fund governance rules from
Chamber of Commerce
a second time: the
SEC, with perhaps tactless speed, patched the guesstimated CBA/FR holes in its
rulemaking analysis, only to have its rule struck down on new grounds.
107
Since
Chamber of Commerce
, only one
decision,
National
Ass’n
of Manufacturers v. SEC
, has upheld an SEC regulation.
108
Another upheld a CFTC regulation,
109
and another upheld a decision of the Office of Thrift Supervision against
CBA/FR-related challenges.
110
Three facts are worth noting about these decisions. First, a
business or trade group initiated and funded each of the cases; so far,
consumer and investor lobbies have been sitting out these court battles.
111
One-sided use of litigation as a lobbying tactic is not typically a stable
feature of enduring battles between interest groups over important regulations.
Second, not all of the decisions strike down new regulations—one struck down a
new
exemption
from a regulation, and
one overturned an enforcement action. Together, these two facts should give
pause to political entrepreneurs who seek to use CBA/FR as a way to attack
regulation generally; these observations suggest that CBA/FR law can slow or
stop
de
regulation as easily as it can
slow or stop new regulation, particularly if consumer or investor advocates
develop and fund their own CBA/FR litigation agendas. Third, each regulatory
action (except the action involved in
National
Ass’n
of Manufacturers
) was taken pursuant to the
SEC’s general statutory authority to use discretion to adopt regulations in
support of the securities laws—and not pursuant to a mandate from Congress to do
so. That the District Court in
National
Ass’n
of Manufacturers
112
distinguished the string of anti-SEC precedents on the ground that the
Dodd-Frank Act mandated the rule in question reinforces this take-away. Under
the current CBA/FR legal regime, regulatory agencies are well advised to seek
statutory language that requires them to adopt rules or to enforce rule-like
legal requirements via enforcement proceedings that are generally exempt from
judicial review under the APA;
113
it is
inadvisable to seek language that promotes SEC discretion and authority in
rulemaking based on the agency’s expertise. Judicial efforts to promote CBA/FR,
in other words, have given expert agencies an incentive to ask an inexpert
Congress to tie their hands with inflexible statutory commands.
The most notorious
114
decision in this line of cases was
Business Roundtable
, which struck down
an SEC rule requiring public companies to include in their annual proxy
statements, under limited circumstances,
115
information about (and the power to vote for) board nominees nominated by large
shareholders rather than solely those nominated by the incumbent board.
116
Despite the SEC’s having debated the issue for over a decade, having developed
an extensive public record before adopting the rule, and having adopted the
rule under the explicit authority and implicit direction of Congress in section
971 of the Dodd-Frank Act, a panel of the D.C. Circuit struck the rule down as
“arbitrary and capricious.”
117
According to
the court, the twenty-five single-spaced pages devoted to cost-benefit and
related analyses in the adopting release was inadequate under the APA and
“failed . . . adequately to assess the economic effects of a new rule.”
118
The D.C. Circuit presented no evidence that there is any available scientific
technique for the SEC to “assess the economic effects” of the rule along the
lines that the court seemed to think legally required—as when the court held
that the SEC “relied upon insufficient empirical data when it concluded that
Rule 14a-11 [would] improve board performance and increase shareholder value by
facilitating the election of dissident shareholder nominees,”
119
or when it held that the SEC had “arbitrarily ignored the effect of the final
rule” because the SEC “does not address whether and to what extent Rule 14a-11
will take the place of traditional proxy contests.”
120
Instead, as in
Chamber
of Commerce
, the U.S. court with “[
s]
tatus
[s]
econd
[o]
nly
to [the]
Supreme Court”
121
ignored
precedents establishing a “deferential” standard of review under the APA and
substituted its own judgment for that of the SEC in evaluating the existing
research relevant to proxy contests. In
Business
Roundtable
, the D.C. Circuit went so far as to characterize (without
explanation) a peer-reviewed article published in the
Journal of Financial Economics
as “relatively unpersuasive.”
122
Even the
Chamber of Commerce
decision
had not gone so far, for while that decision invented an obligation for the SEC
to use guesstimated CBA/FR on the cost side of its rulemaking, it also held
that the SEC need only “determine
as best
it can
the economic implications” of a rule;
123
moreover,
Chamber of Commerce
nowhere
suggested the SEC had to remain inert whenever quantified CBA/FR was simply
unavailable. Hypocritically, it was Judge Ginsburg who penned the
Business Roundtable
decision, just two
years after he joined the decision in
Stilwell
where the same court held that the APA “imposes
no general obligation on agencies to produce empirical evidence
.”
124
In sum, the D.C. Circuit’s new interpretations of the APA and
statutes authorizing financial regulation have permitted panels to overturn
regulatory changes on the ground that a court would conduct its guesstimated
CBA differently than an agency would. Since guesstimated CBA/FR is unreliable
and imprecise, no matter who conducts it, courts have no legitimate role to
second-guess the agencies—even if the agencies are arbitrary in how they go
about the guesstimated CBA/FR. Indeed, the state of CBA/FR is such that one can
reasonably argue that all guesstimated CBA/FR of major financial regulations inevitably
contains multiple arbitrary assumptions and judgments simply to allow for rough
guesstimates to be made. Worse, the judges reviewing these guesstimates are
political appointees tenured for life, and so—while often selected for
political reasons—are immune from conventional forces of political
accountability; nonetheless, they have been frequently
partisan
in their approach to CBA. Because the D.C. Circuit is roughly evenly split
between Republican and Democratic appointees,
125
the partisan-driven outcomes in
CBA/FR cases are unpredictable and depend on a factor (which judges are chosen
for a given case) that has nothing to do with the APA or any other law. The
normative implications of this state of affairs are taken up in Part IV.
C. Congressional
Oversight, Regulatory Initiatives, and Proposed Legislation
Elements of the legislative branch, as well as the financial
agencies’ own initiatives, have reinforced the effect of judicial review of
existing CBA-related mandates on the financial agencies’ organic statutes.
While Congress has not mandated CBA for independent agencies, members of
Congress, in coordination with minority commissioners of the CFTC and the SEC,
have pressured the agencies to engage in CBA, both by attempting to pass
legislation (discussed below) and with soft power, through hearings,
information requests, and public criticism. In 1998, the GAO released a
critique of current law for failing to improve CBA in agency rulemakings.
126
As discussed in Part III.B, Fidelity Management in 2004 persuaded Congress to
require the SEC to justify proposed rules by preparing a report on their
potential benefits.
127
In 2007, the
House held hearings on the Sarbanes-Oxley Act, in which one witness (inaccurately)
critiqued the SEC’s CBA/FR,
128
a criticism
echoed by members of Congress
129
and, more
recently, by Republican SEC Commissioner Daniel M. Gallagher.
130
These pressures, along with the court decisions discussed
above, have led financial agencies to conduct and publish more CBA/FR in recent
years. OMB reports show that this increase in the use of CBA/FR began in the
early 2000s. In September 2010, the CFTC’s General Counsel and Acting Chief
Economist distributed a memo to the CFTC’s rulemaking teams noting that, while
the CFTC’s authorizing statute does not require quantified CBA/FR, it does require
the CFTC to consider costs and benefits, and that recent court decisions had
been expanding the demands of CBA/FR law under the APA.
131
As a result, the memo directed staff to provide summary CBA/FR in proposed
rulemakings and to address conceptual CBA/FR in adopting releases.
132
Despite these efforts, congressional pressures have only
increased, potentially stimulated by the financial industry lobbies seeking to
influence rulemaking under the Dodd-Frank Act. In 2013, Senator Mike Crapo
(Republican of Idaho) pressed the heads of the major financial agencies to
commit to “act on GAO’s recommendation to incorporate OMB’s guidance on [CBA]
into your proposed and final rules [and] interpretive guidance.”
133
Shortly thereafter, ten Senate Banking Committee members requested financial
agency inspector generals to report on CBA under the Dodd-Frank Act, “in response
to concerns raised by Commissioners at both the CFTC and the SEC” regarding
economic analysis at the agencies.
134
Also in 2011, Congress amended the Dodd-Frank Act to require the GAO to analyze
the impact of regulations on the marketplace,
135
and in November 2011, the GAO released a report on the financial agencies’ Dodd-Frank
Act rulemakings, finding that “[
a]
lthough
most of the federal financial regulators told us that they tried to follow [OMB
guidance] in principle or spirit, their policies and procedures did not fully
reflect OMB guidance on regulatory analysis.”
136
While noting that “for 7 of . . . 10
regulations we reviewed, the agencies generally assessed benefits and costs of
the alternative chosen,”
137
the GAO was
particularly critical of the financial agencies for not conducting
quantified
CBA/FR: “[
O]ne
of the seven benefit-cost
analyses monetized the costs of the regulation, but the analysis did not
monetize the benefits. None of the other analyses monetized either the benefits
or costs, identified the type and timing of them, or expressed them in constant
dollars.”
138
Trade groups and political entrepreneurs have picked up these criticisms,
139
as have members of Congress.
140
In March 2012, SEC staff distributed its own internal CBA/FR
guidance. The guidance cited “[
r]
ecent
court decisions, reports of the [GAO] and the SEC’s . . . [OIG], and
Congressional inquiries” that had “raised questions about . . . the [SEC’s]
economic analysis in its rulemaking.”
141
The SEC guidance noted “[
n]o
statute expressly
requires” the SEC to “conduct a formal” CBA but that “SEC chairmen ha[d]
informed Congress since at least the early 1980s—and as rulemaking releases
since that time reflect—the [SEC] considers potential costs and benefits as a
matter of good regulatory practice whenever it adopts rules.”
142
The SEC guidance went on to set out “[
s]
ubstantive
requirements” for CBA/FR, drawing on the CBA Executive Orders and the OMB
Guidance.
143
Rulemaking staff were directed to work with economists on the SEC’s staff to
analyze which costs and benefits a rule might create, to quantify those that
could be quantified, and to explain why others could not feasibly be
quantified.
The bluntest form of congressional pressure has taken the
form of bills that would mandate CBA/FR across the board. In June 2013, three
Senators reintroduced the Independent Agency Regulatory Analysis Act.
144
That bill would permit the President
to order all independent agencies, including all of the financial regulatory
agencies, to (among other things) conduct a CBA of any new “rule and,
recognizing some costs and benefits are difficult to quantify, propose or adopt
a rule only upon a reasoned determination that the benefits of the rule justify
its costs.”
145
The bill incorporates the definition
of “rule” from the APA and
excepts
only rules of the
Federal Reserve “relating to monetary policy.”
146
In addition, for any “economically significant rule” (ESR),
an independent agency could be required to give OIRA and to publicly disclose
(1) “an assessment, including the underlying analysis, of benefits . . . [and]
costs . . . anticipated . . . with, to the extent feasible, a quantification of
those benefits . . . [and] costs,” (2) a similar assessment of all “potentially
effective and reasonably feasible alternatives to the rule, identified by the
agencies or the public,” and (3) a statement of why the rule is superior to
alternatives.
147
For this purpose, the bill defines an ESR as a rule with an annual effect on
the economy of $100 million or more. Independent agencies could be required to
submit any ESR for a ninety-day OIRA review of whether the rule “has complied”
with these requirements, with the OIRA review also to be part of the published
record for the rule. Independent agencies would also be required to publish a
finding that the rule did comply with the bill, with an explanation of that finding,
or “if applicable, an explanation why the independent regulatory agency did not
comply.”
148
The bill states that “compliance” by an independent agency
with the bill is not subject to judicial review. However, it also states that
in any court challenge to an independent agency’s rule under other laws, such
as the APA, all material produced by the independent agency and OIRA under this
bill would be “part of the whole record” for the court to review.
149
As discussed more in Part IV, mandating an open interagency process formally
not subject to judicial review might seem innocuous: how could it impede
rulemaking for an independent agency to simply get the input of another agency?
But this naïve reading misses the fact that any public interagency process will
create a larger record that will be used by litigators to attack particular
agency judgments as arbitrary and capricious under the APA: any disagreement
between the agencies, for example, will provide grist for the litigation mill.
The cases reviewed in this Part show how aggressive some D.C. Circuit panels
have been in overturning agency actions on CBA grounds, particularly when an
agency’s commissioners have been divided over judgments needed for any
regulatory change. Trebling the number of pages or components of a CBA available
for judicial second-guessing, and adding the possibility of interagency
disagreement to the mix, will almost certainly incite more judicial
interventions.
150
Before we can assess whether such
interventions might be net beneficial, however, we need to consider CBA/FR
itself. Could it offer precise, reliable estimates of the costs and benefits of
financial regulation?
III. how might cba of financial regulation
work?
In this Part, I outline how the kind of quantified CBA/FR
envisioned by its proponents might work in practice. The goals of this Part are
to illuminate what we might expect of CBA/FR policy, to advance the substantive
research project of developing CBA/FR, and to provide a better empirical basis
for evaluating CBA/FR law in Part IV.
To accomplish these goals, I outline the CBA/FR that was
performed for four specific rules: (1) SEC regulations under Sarbanes-Oxley Act
section 404 (SOX 404); (2) the SEC’s 2002 mutual fund governance
proposals; (3) Basel III’s enhanced capital requirements for banks; and (4) the
Volcker Rule. These analyses are followed by a review of two rules that have
been subject to CBA/FR and have been held up as the “gold standard” by CBA
advocates: (5) the SEC’s cross-border swap rules and (6) the UK/FSA’s mortgage
market rules.
The first, third, and fourth case studies represent the kind
of significant rulemakings that CBA/FR proponents agree should be the focus of
CBA/FR,
151
and because they are clearly “economically significant rules,” they would trigger
the highest degree of interagency review under the CBA Executive Orders and OMB
Guidance if the independent agencies were brought under those process
requirements. The second case study focuses on rules that led to the D.C.
Circuit decisions reviewed above and stimulated the SEC’s Chief Economist to
publish two extensive CBA/FR-related memos that provide one of the better (if
imperfect) examples of what CBA/FR as conducted by a financial agency could
look like.
In each case the analysis draws on the best research by
economists, finance scholars, and legal scholars, all using the kinds of
methods that are closest to the idealized vision of quantified CBA/FR that its
proponents are asking financial agencies to pursue.
152
This review illustrates that guesstimated CBA/FR of each of the rules reviewed
would (or did) require the same kinds of macroeconomic or political models used
to set monetary policy, or entailed causal inferences that are unreliable under
standard regulatory conditions, or both.
These case studies were also chosen to reflect representative
types of major financial regulations. They focus on regulations promulgated by
a variety of financial regulators: the SEC, the Federal Reserve, the Office of
the Comptroller of the Currency (OCC), the Federal Deposit Insurance
Corporation (FDIC), the CFTC, and the UK’s Financial Services Authority (FSA).
The regulations employ a range of the kinds of regulatory instruments that are
commonly analyzed or proposed for the financial markets: disclosure, governance
regulations, capital requirements, activity restrictions, and transactional restrictions
and process requirements. The regulations address a variety of market failures:
fraud, asymmetric information more broadly, conflicts of interest,
externalities (systemic crises arising from the effects of transactions on
third parties), and the absence of competition. But they also give rise to a
typical array of regulatory costs: compliance costs, constraints on potentially
optimal private governance arrangements, smaller or less complete markets, and
prohibition of potentially optimal transactions, possibly reducing economic
activity and surplus. And, finally, most of the regulations were adopted following
at least some conceptual CBA by the relevant agencies, and two were adopted
after at least some efforts at quantification of the relevant costs and
benefits.
A. Case
Study #1: Control Disclosures for Public Companies153
The first case study is of the Sarbanes-Oxley Act (SOX).
SOX was
Congress’s response to the widespread fraud at Enron,
Tyco,
Worldcom
, and other corporations. The core of
SOX consisted of two parts
154
: (1) the creation of a
quasi-public regulatory body to oversee public company audit firms—the Public
Company Accounting Oversight Board (PCAOB)—and (2) the requirement of new
disclosures by public companies about “control systems.”
155
Among other things, the case study illustrates the way that a common goal of
financial regulation—the reduction of fraud—implicates important externalities,
as well as non-market goods (such as psychological effects of fraud), which
cannot be reliably reduced to precise monetary estimates, given current
research technologies.
1. The
SEC’s CBA of Rules Implementing SOX 404
SOX required the SEC to enact regulations to carry out the goals
of SOX 404.
156
The SEC did this in August 2003, a year after SOX’s passage.
157
In its adopting release, the SEC included a 1400-word CBA, which, as noted
above, was not a legal requirement for the SEC.
158
The release contained a separate 500-word analysis of the rule’s effects on
efficiency, competition, and capital formation,
159
and a longer analysis under the PRA and RFA.
160
In its CBA, the SEC provided a qualitative listing but no quantification of the
rule’s benefits. The benefits identified were: (1) generally to (a) enhance the
quality of public company reporting and (b) increase investor confidence, and
(2) specifically to (a) improve disclosure about management’s
responsibility for financial statements and controls and how management
discharges that responsibility, (b) encourage companies to devote adequate
resources and attention to controls, (c) help companies detect fraud earlier,
and (d) deter fraud or minimize its effects. The bottom-line benefit, then, was
to reduce fraud.
161
The SEC also provided a qualitative listing of the rule’s
direct costs (administrative burdens and fees to attorneys and auditors). The
SEC noted that companies were already required to have a control system under
the Foreign Corrupt Practices Act (FCPA) and that many issuers were already
voluntarily providing the required disclosures, raising conceptual issues
(discussed below) for what baseline and set of effects to assume in any CBA/FR
of the rule—issues that the SEC did not explicitly address. The SEC provided a
partial quantification of the costs of its rules under SOX 404. That estimate focused
exclusively on the requirements of subsection (a) of SOX 404, disclosures by
management, which the SEC estimated would cost covered companies an average of
$91,000 per year.
162
The SEC explicitly
noted it had no information that would allow it to quantify the costs created
by subsection (b) of SOX 404, the auditor attestation requirements, which it
acknowledged could be large.
163
Of note for assessing CBA/FR’s effects on public
understanding, the SEC has been strongly criticized for the CBA/FR in its
release—but only for the part of its CBA/FR that provided a quantitative
estimate of costs, which one commentator has claimed is “off by a factor of
over 48.”
164
However, this critique of the SEC’s
CBA/FR is demonstrably mistaken. The SEC’s estimate was solely for SOX 404(a),
while the FEI/FERF estimate was for both SOX 404(a) and 404(b).
165
For several reasons, auditor
attestation costs can be expected to exceed internal costs by a multiple (as in
fact has been the case).
166
The SEC explicitly
acknowledged this gap in its cost estimate,
167
but the criticisms of the SEC ever since—including by SEC Commissioner
Gallagher himself—have mistakenly claimed the estimate was for SOX 404 as an
entirety.
168
CBA/FR advocates, in other words, have publicly and repeatedly criticized the
SEC for underestimating the cost of apples and oranges when the SEC’s estimate
was for the cost of apples alone. The spectacle may undermine an observer’s
faith in the value of public discourse stimulated by CBA/FR.
A better critique of the SEC’s CBA/FR of SOX 404 is that it
failed as conceptual CBA/FR for not identifying indirect costs of the rule.
Indirect costs include potential reductions in risk-taking, dilution in
strategic focus, and the opportunity costs of devoting excessive management
time to compliance and working through the initial control attestation process
with outside auditors, internal audit staff, and members of companies’ audit
committees (which SOX required to be wholly independent for the first time).
169
While quantifying these costs would have been nearly impossible for the SEC at
the time (as discussed below), the SEC could have pointed to the possibility of
these costs in its rulemaking.
Conversely, the SEC in 2006 did not identify (much less
quantify) increased fraud as a possible cost of the deferral of SOX 404
requirements for small and newly public companies, nor did it identify (much
less quantify) increased fraud as a possible side effect (cost) of the
relaxation of the SOX 404 requirements in 2007.
170
While these efforts were deregulatory in nature, they would be just as subject
to CBA under Executive Order 12,866 for an executive agency as would the imposition
of new regulations.
171
The fact
that the more prominent CBA/FR proponents
172
do not mention these gaps in the SEC’s
deregulatory
rulemaking process under SOX tends to undermine their general depictions of
CBA/FR as a politically neutral procedure for improving regulation generally.
2. An
Overview of CBA/FR of SOX 404
Now that ten years have passed since its adoption, how might
SOX 404 fare under a CBA/FR? Quantifying the costs and benefits of the rule
would require multiple research tasks. These include (1) establishing
better estimates of the incidence and direct costs of fraud,
173
(2) securing consensus on how to treat “transfers” for purposes of
analyzing fraud, (3) generating new models and data on fraud’s
externalities, (4) creating better instruments for estimating the rule’s causal
effects, (5) developing better models and data on the chilling effects
that the rule could have on legitimate activity, and (6) promoting better
understanding of how compliance costs vary across firms and over time. Each
task will be difficult and likely require a separate stream of research before
any plausible quantified estimate of the costs and benefits of a rule under SOX
404 could be developed.
3. Estimating
the Incidence of Fraud and Its Direct Costs
The first task is to develop better methods of measuring the
incidence of corporate fraud and its direct costs. This task is a prerequisite even
to a rough estimate of the effects of regulations aimed at reducing fraud, such
as SOX 404. Yet, with few exceptions, research on fraud to date has only
attempted to establish relationships between fraud and its correlates, and it
does not present evidence of how strong these relationships are, or what the
overall incidence of corporate fraud is.
174
One difficulty confronting such studies is that all concerned
have incentives to hide fraud.
175
Partial
observability
presents challenges to empirical modeling,
176
but until recently, few researchers used models adapted to those challenges.
Such models study both fraud incidence and detection together, exploiting
partial overlap in indicators of fraud incidence and detection to draw better
inferences about correlates of fraud overall from detected frauds.
177
Building on this work, one study exploits the collapse of
Arthur Andersen to estimate an incidence of fraud among public companies at
approximately fifteen percent.
178
The study also estimates that fraud
generates direct losses of between twenty-two percent and forty percent of
enterprise value, implying a lower bound on hidden fraud of three percent of enterprise
value (0.15 × 0.22 = 0.03), or losses of over $500 billion. This study is a
promising start to estimating how much fraud exists and how costly it is. But
it is, as yet, unpublished and relatively isolated,
179
and it needs more scrutiny before it can provide a reliable rulemaking
foundation. Future research could use more comprehensive measures of fraud,
including fraud outside the scope of audits that nevertheless might be revealed
by a stronger control system, such as insider trading and self-dealing (as at
Enron), fraudulently obtained compensation (as at Tyco), frauds involving third
parties (as at
Worldcom
), or technically
GAAP-compliant but deceptive accounting choices (as at Lehman).
4. How
Should Transfers Be Treated?
An open conceptual
issue in estimating the costs of fraud is how to treat transfers accomplished
through fraud
—in other words,
whether
to count the utility of a fraudster in estimating welfare effects of fraud.
180
Data on crime generally suggests the issue
could have a significant effect on a CBA/FR of SOX 404.
181
Canonical economic theory would count the loss as zero, as would the OMB
Guidance on CBA,
182
but it seems implausible as a political,
policy, or legal matter for the SEC to ignore for purposes of CBA/FR of SOX 404
the losses of Enron’s defrauded investors on the ground that they were mere
transfers to Ken Lay and Andrew
Fastow
. OMB Guidance
suggests including transfers in an analysis of “distributional effects” distinct
from quantified costs and benefits,
183
but that does not answer the question of how
an agency should weigh the transfers in its overall CBA.
184
5. Measuring
the Externalities and Psychological Costs of Fraud
If more work is needed to model the incidence of and
transfers caused by fraud, no researchers have systematically attempted to
study and measure the social costs of corporate fraud. Without estimates of
such costs, an assessment of rules that reduce fraud, such as SOX 404, would
have to remain qualitative. Research is needed both on
externalities
185
and
psychological costs
. On externalities, consider these categories
186
(a) fraud increases the
cost of capital
for all firms;
187
(b) fraud results in the
misallocation of resources
188
(c) fraud destroys value through
(costly)
acquisitions
and bankruptcy
189
(d) fraud induces
precautionary costs
190
and (e) fraud imposes costs on non-investor
third parties
191
Consider the
Madoff
scandal, which imposed significant direct
losses on over 15,000 individual investors, each of whom presumably had an
average of two dependents or heirs, and many of whom were co-investors and
borrowers with yet others, or makers of charitable donations to non-profits.
192
To date, the liquidation of the
Madoff
entities has generated over $700 million in
expenses—all a pure loss to investors, over and above the amounts stolen by
Madoff
himself.
193
As a broader example, consider how fraudulent home loans
(whether due to borrower fraud, lender fraud, or both) had ripple effects in
the last financial bubble, partly generated through leverage and
intermediation, so the one fraudulent loan would affect not only the immediate
parties to the loan but also securitization lenders, sponsors, and related
parties; collateralized debt obligation investors, sponsors, and related
parties; structured investment vehicle investors, sponsors, and related
parties; investors in the banks that sponsored those vehicles;
borrower-customers of those banks, whose capital constraints and heightened
risk-aversion following the crisis caused a withdrawal or increase in the cost
of credit; employees and customers of businesses that failed as a result of the
capital constraints generated by the banks’ losses; family members of those
employees; and so on.
Psychological effects (fear, distrust, stress) can result in
tangible consequences, including drug addiction, job loss, reduced income,
health effects, and even suicide. In the context of securities fraud, elevated
levels of post-traumatic stress disorder and related behavioral effects have
been found among
Madoff’s
victims.
194
The take-away from these thought experiments—and they remain
just that—is that the external costs of fraud are likely to exceed, perhaps by
a large amount, direct transfers from victim to fraudster. As a result, the
quantified benefit of SOX 404 is likely to be found not in estimating direct
losses prevented, but in increasing those losses by a
multiple
to reflect its externalities. How do we translate
anecdotal examples into more general methods for estimating the full effects of
fraud on society as a whole?
In the context of SOX, only one unpublished paper attempts to
estimate fraud’s social costs.
195
The authors treat widespread
revelations of fraud as a “shock” to the equity premium and estimate its social
effects with a macroeconomic model. For this purpose—and this is worth
stressing in light of the discussion of the Taylor Rule in Part I.D above—they
adapt a model used by the Treasury Department and the Federal Reserve to set
monetary policy.
196
They first
guesstimate that 25% to 100% of the market decline from March to July 2002 was
caused by the scandals of Enron, Tyco,
Worldcom
, and
other companies.
197
They then
rely on the U.S./Fed.
model
to estimate that
investment would fall 0.8% per year in response to a 20% decline in the stock
market, guesstimating first-year impacts ranging from nineteen to fifty-seven
billion dollars.
198
These
projections underestimate costs if the impact of the frauds lasts longer, and
could over- or underestimate costs if the economy’s response to fraud-driven
equity shocks differs from responses to other kinds of shocks, or if the
assumptions of the U.S./Fed.
model
are varied.
199
Finally, research on fraud’s social costs could draw on
research on crime generally, which uses several families of methods
200
: (1) estimating hedonic models in
which variation in prices affected by crime is used to infer social costs;
201
(2) surveying willingness-to-pay for a reduction in crime;
202
(3) aggregating estimates of each direct and indirect effect;
203
and (4) relating responses to surveys of crime victims to respondent
wealth or income and inferring a “shadow price” for the effects of crime.
204
Each method has limitations
205
guesstimates based on willingness-to-pay surveys have been stringently
criticized as too subjective and internally inconsistent to be reliable for CBA
purposes,
206
and to date these methods have not
been undertaken in the context of fraud.
6. Estimating
Causal Effects of SOX 404
With a better framework for estimating the incidence and
costs of fraud in hand, researchers could then better estimate the benefits of
regulatory changes such as SOX 404. Where a regulation is an innovation,
regulators are not in a position to “study” its causal effects at all, but must
forecast those effects. For SOX 404, this type of prediction would have been
impossible; indeed, few observers (even hostile commentators, who had incentives
to exaggerate) anticipated the full extent of the direct costs that SOX 404
would initially generate.
Ex post or retrospective studies, coupled with regulations
that sunset absent re-adoption based on the result of the ex post studies, are
more promising, and would be better able to enlist academic research in the
service of better financial regulation. To date, however, most retrospective
studies of SOX have not used research designs allowing reliable causal inferences
about its effects. Instead, most researchers have used before-and-after
comparisons that fail to control for contemporaneous changes in the objects of
study.
207
Better are a handful of difference-in-difference studies, such as those used to
study some of the effects of SOX.
208
In such studies, researchers match, as best they can, the companies affected by
a regulation with unaffected companies and compare the before-and-after
effects. But even those studies are commonly misleading in the kinds of rich,
interdependent environments that characterize the financial markets. Long-term
trends may manifest differently in the treated and nominal control group, and
common factors omitted from the matching criteria that affect events in the
nominal control sample may differentially affect the nominally “treated”
sample, creating a spurious impression that the regulation had effects it did
not actually have.
209
Better for identifying causal effects ex post are
discontinuity designs, which look at the before-and-after effects of a regulation
on firms just above a threshold triggering compliance and compare them with
changes at firms just below the threshold.
210
However, the findings of such studies rarely generalize beyond firms “near” the
discontinuity, making them of limited use in CBA/FR.
211
This point is illustrated by Figure 1, which depicts how one of the best
studies of SOX 404, by Peter
Iliev
, used such a
discontinuity design.
212
While that
study provided convincing evidence on causality, it provides very limited information
about SOX’s overall effects, because of how different the firms near the
discontinuity are from the firms most likely to generate significant costs and
benefits.
Figure 1.
limits
on external validity of single best sox study to date
213
Perhaps the best of feasible ex post studies are time-series
designs studying multiple events, which were used by a small number of studies
to analyze SOX 404.
Leuz
and coauthors studied
differences-in-differences among covered and exempt groups of companies over
several events in the phase-in of the rule, including extensions by the SEC of
exemptions for small firms, and
Arping
and
Sautner
studied the staged phase-in for foreign firms
cross-listed in the United States.
214
Neither study attempted comprehensive measurement of changes in fraud or direct
and indirect costs at covered firms, but in principle these types of studies
provide the best path towards a possible retrospective CBA/FR of SOX 404.
7. What
Baseline and Set of Counterfactuals Should Be Used?
Even if a research design could produce reliable inferences
about the effects of financial regulation, it is unclear how (if at all) to
modify the results of such a study to reflect the context in which the rule was
adopted. As mentioned above, the SEC’s CBA/FR of SOX 404 noted two facts about
the rule’s context: (1) covered companies were already subject to the FCPA,
which requires companies to have effective control systems, and (2) many
companies already voluntarily made disclosures similar to ones required by the
rule. These facts raise several open questions about the baselines and
counterfactuals to be used in assessing the rule.
First, what baseline should be used to assess the effects of
SOX? One possibility is to assume a baseline of full compliance with prior law.
Another is to use a realistic baseline of average actual compliance, in which
case both costs and benefits would likely be higher (reflecting the gap between
full and average compliance, on the reasonable assumption that effects of new
enforcement pressures from SOX would have a diminishing effect as compliance
increases). A third possibility is to try to estimate levels of baseline
compliance that vary with observable firm characteristics. Nothing in the SEC’s
governing statutes or other relevant law resolves which baseline to use, but
the answer would likely have a significant effect on any quantified CBA/FR of
the rule.
215
Second, how should analysts treat indirect behavioral effects
of eliciting information for purposes of CBA/FR? Suppose, for example, that
disclosure reduces risk-taking (as SOX 404 may have done) not because it
distracts management but simply because it prevents managers from hiding behind
information asymmetries to deflect blame from losses caused by risks they
caused the firm to take. Assume that in a world of symmetric information, those
risks would not have been taken, but might have generated expected net gains
for a firm (perhaps due to differences in risk aversion between managers and
diversified shareholders). Should the lost gains due to this reduction in
risk-taking be counted? Asymmetric information is treated as a market failure
in conventional economics and in the OMB Guidance on CBA. Does that imply that
“costs” (such as reduced risk-taking) causally attributed to elimination of
some (but not all) information asymmetries should not be counted in CBA/FR?
Such a question arises for all disclosure regulations, which anticipate and
rely on private responses to the disclosure.
216
8. How
Do Compliance Costs Vary Across Firms and over Time?
Better methods are also needed for estimating costs, even
direct costs. Affected companies and their agents (who know the most about the
likely direct costs of a rule) have incentives to exaggerate costs in public
comments.
217
These exaggerations are evident from the strong contrasts between the FEI/FERF
survey results on SOX 404
218
and the
findings on direct costs from surveys by the SEC, the GAO, and CAQ, a firm
catering to the audit industry.
219
Compliance
costs also vary across firms.
220
The SEC’s
own studies of the effects of SOX 404
221
contain information on some relevant differences, but future CBA/FR could
usefully build such differences into better models of direct compliance costs,
rather than relying on rationally biased inputs from private actors.
9. Modeling
and Measuring Chilling Effects of Financial Regulation
Although direct costs of SOX 404 were most salient to firms,
because these costs were borne directly by firms and paid out of their
treasuries, indirect costs of SOX 404 may have been larger. They are likely to
remain high and may increase rather than diminish over time, as direct costs
typically do. Indirect costs include those flowing from changes in risk-taking
and investment, which can plausibly dwarf direct costs in magnitude. SOX 404 is
said to have caused changes in the risk of personal liability facing managers
and directors and in the risk of reputational harms and opportunity costs
created by litigation.
222
If true,
difficult-to-explain and legitimate business risks may be foregone, and firms
may decline to go public or otherwise avoid the burdens of the law, with
resulting social costs. However, the challenges of estimating indirect costs
are also larger than for direct costs. Causal inference for indirect costs is
just as difficult as for a regulation’s benefits, requiring quasi-experimental
research designs that will only be imperfect, even after the fact. Powerful
empirical proxies for risk-taking, investment, and capital costs remain elusive
and contested.
10. Summary and Illustrative Integrated Assessment Model
The previous sections have described the kind of CBA/FR of
SOX 404 that could (in theory) be done today, from the distinctly advantaged
after-the-fact perspective of ten years after the rule was adopted. The bottom
line is that no one could hope to conduct a precise and compelling quantified
CBA/FR of such a rule now or in the near future. The one component of CBA/FR
that could be quantified—direct costs—has generated estimates that vary by an order
of magnitude.
223
Other, larger components, including benefits from reduced fraud and indirect
costs from effects on risk-taking, investment, and management, all remain
unquantifiable.
To produce quantified CBA/FR, the SEC would need an
“integrative assessment model” (IAM) similar to those used in estimating the
social cost of carbon in climate change analysis.
224
An IAM would have to combine a
sub-model of fraud incidence, a sub-model of the costs of fraud, including
transfers and externalities (possibly consisting of a macroeconomic model), and
a predictive empirical sub-model for how SOX 404 would affect the incidence of
fraud. Indirect costs would have to be estimated in yet another sub-model.
To illustrate what an IAM might look like, consider the
following: beginning with the formula for the present value of a perpetuity,
225
an annual per-firm direct cost stream for SOX 404 ranging from $300,000 to
$2 million per year
226
would range
from $10 to $67 million (at a three percent discount rate) or from $4 to $29
million (at a seven percent discount rate).
227
As of 2003, there were roughly 4,400 U.S. public companies covered by SOX 404,
228
producing a present value of direct costs ranging from $19 to $293 billion.
How would this compare to a possible range of benefits for
SOX 404? Suppose fraud incidence was—as estimated by
Dyck
et al.
229
—three
percent of market capitalization, on average, but could range from 50% to 200%
of that estimate. These assumptions produce direct fraud costs ranging from
$140 to $700 billion. Suppose SOX 404 permanently reduced annual fraud
risk by an amount ranging from 1% to 10%.
230
When applied to our direct fraud cost estimates, the range of fraud reduction
implies benefits from SOX 404 ranging from $2 to $84 billion. Finally, assume
fraud externalities range from one to three times direct costs.
231
This implies benefits ranging from $4 to $336 billion.
Table 2.
illustrative
quantitative
cba
fr
of sox
404
Table 2 summarizes. The high end of costs is far higher than
the low end of benefits, producing a net cost of $289 billion, but the low end
of costs is far lower than the high end of benefits, producing a net benefit of
$317 billion. Depending on assumptions, guesstimated CBA suggests that SOX 404
could be a very good idea, a very bad idea, or anything in between. If one
arbitrarily chose the range’s midpoint, SOX 404 created a net benefit of $9
billion. But this bottom line is highly sensitive, as reflected in Table 3,
with net benefits changing by between 2
and 13
as one moves from low to high
values for each of five major inputs into the illustrative IAM.
Table 3.
sensitivity
of output of illustrative
iam
to inputs
This illustrative IAM is crude: it implicitly resolves all of
the open issues reviewed above and uses many assumptions. The IAM could be
challenged on numerous fronts: (a) indirect costs are omitted; (b) open issues
on baselines and counterfactuals are resolved in favor of higher cost
estimates, but discounted by an arbitrary thirty percent; (c) the current
run-rate for direct costs is assumed to last indefinitely, contrary to the
SEC’s survey of SOX 404 costs that suggests that costs can be expected to fall;
232
(d) transfers from U.S. to non-U.S. persons are ignored; (e) transfers
from fraud victims to other shareholders are counted; (f) the ratio of
externalities to transfers is borrowed from research on crime, not fraud; (g)
discount rates are from OMB Guidance; (h) the fraud reduction effect is assumed
to be a one-time permanent reduction; (
) the rate of
fraud reduction is derived from a before-and-after study that may wrongly
misattribute changes to SOX; (j) the rate of fraud reduction is derived from
studies of earnings, and not the full range of fraud that SOX might reduce; and
so on. A change in any of these assumptions would change the bottom line. This
list of serious debatable limits could be extended for many pages. Any serious
contest between opposed analysts would add to the upper ends of ranges of both
costs and benefits.
233
B. Case
Study #2: Independent Boards for Mutual Funds
The second case study is of the mutual fund governance rules proposed
by the SEC in the wake of the market-timing scandals of the early 2000s. Together
with the review of the
Chamber of
Commerce
case in Part II.B, this case study illustrates, among other
things, how judicial review of CBA can penalize an agency for transparency
about the limits of its ability to quantify the costs and benefits of a rule.
The ill-fated mutual fund governance rules had their origins
in 2003, when New York Attorney General Eliot Spitzer ended his prepared
remarks at a Harvard Law School reunion event with a dramatic
J’accuse
Pointing a finger at a fellow
panelist—a lawyer from Fidelity Management
234
—Spitzer
announced that his office was about to reveal widespread fraud in the mutual
fund industry. Over the next year, twenty-six advisory companies settled cases
alleging violations of the securities laws in which select investors were
permitted to harm funds and other investors by engaging in late or frequent
trading that was either contrary to SEC rules or contrary to disclosed fund
policies.
235
Scandals at this scale had not hit the fund industry in
decades, and while the wrongdoing alleged varied from fund complex to fund
complex, the most troubling charges involved conflicts of interest between the
fund advisors and the funds they advised.
236
Conflict-of-interest transactions had been banned in 1940, but because many
conflict-of-interest transactions could benefit funds, the SEC had adopted a
series of exemptions, subject to a fund’s meeting set conditions.
237
In 2001, the SEC had tightened the
conditions, increasing the share of independent directors from forty percent to
a majority for funds wanting to use the exemptions (as most funds wanted).
1. The
Rules
In response to the scandals highlighted by Attorney General
Spitzer, the SEC proposed further tightening of the conditions for exemption,
(1) requiring a fund’s board to contain seventy-five percent independent
directors and (2) adding a requirement that a fund board chair be independent
of the advisor.
238
The latter
requirement was anathema to Fidelity Management—one of the largest fund
complexes, privately held, and dominated by its founder, Ned Johnson, who
chaired boards of all 292 funds advised by Fidelity.
239
Fidelity paid for a study that found a negative correlation between independent
board chairs and fund performance but which acknowledged that the correlation
could be due to “other important differences that may have impacted performance
results,” such as the prevalence of split chairs in bank-sponsored fund groups.
240
The SEC adopted the more stringent conditions by a
three-to-two partisan vote in August 2004. In its rule release, the SEC
included a 1,680-word CBA/FR and a lengthier discussion of the conditions’
benefits in its general assessment of the conditions.
241
The CBA/FR was qualitative, and the rule was justified because, in the SEC’s
view, independent directors and chairs were “more likely to be primarily loyal
to the fund shareholders rather than the fund adviser”;
242
in addition, the independent directors and chairs were more likely to
effectively manage conflicts of interest such as those involved in the 2003
scandals.
243
The SEC explicitly noted it had not conducted a quantified CBA/FR, as it could
not quantify either costs or benefits. The agency also stated that it was “not
aware of any conclusive research that demonstrates that the hiring of an independent
chairman will improve fund performance or reduce expenses, or the reverse.”
244
Within weeks, Fidelity persuaded Senator Judd Gregg (a Republican from New
Hampshire) to include a rider to an omnibus bill;
245
the rider required the SEC to study the need for tightened conditions,
resulting in an SEC study that was released in April 2005. That study contained
seventy-seven pages of conceptual CBA/FR, showing that the Fidelity-commissioned
study was sensitive to assumptions and could not reliably establish what it
purported to show. After the SEC conducted the study, the Chamber of Commerce
sued to overturn the rule under the APA and the ICA, a suit that ended in
Chamber of Commerce v. SEC
as described
in Part II.
246
2. The
Aftermath of Chamber of Commerce II
After the second
Chamber
of Commerce
decision,
247
the SEC
requested that the SEC’s Chief Economist
248
reevaluate the governance rules yet again. That request led to two
memos—publicly released with a request for public comment.
In those memos, the Chief Economist concluded that (1) more
independent boards were more likely to better protect investors, but (2) little
evidence existed to establish that board composition would create higher returns.
249
These two conclusions, seemingly in
tension, could be reconciled by one or more of three further conclusions: (a)
“no sound structural model [exists] . . . to isolate the effect of a . . .
board decision on performance”; (b) “inherent limitations to data and
statistical tools . . . may render it difficult for research to identify relations
that . . . may be economically significant”; or (c) “there may not be a
unique relation between governance and performance.”
250
In other words, the state of finance
research was such that no CBA/FR of the mutual fund governance rules was
feasible. At the same time, economic theory (particularly agency cost theory)
and the Chief Economist’s judgment, based on the research reviewed in the
memos, supported a qualitative judgment that the rules would better protect
investors.
3. What
Would CBA of the Mutual Fund Governance Rules Require?
Implicit in the Chief Economist’s memos is a sketch of what
quantified CBA/FR of the governance rules would look like. As the memos noted,
the best board structure (in terms of independence) depends
on
the . . . consequences of
increasing the influence of outsiders . . . . [
O]
utsiders
may bring expertise and independence [and]
improve the quality of management decisions and manage conflicts of interest
that insiders have, thereby increasing the value of the firm [but] may lack
information about the “inner-workings” of the firm and other firm-specific
knowledge [which if] difficult to extract . . . may diminish the quality of
management decisions and reduce the value of the firm.
251
Because this tradeoff may vary by fund, a fixed minimum share
of independent directors may benefit investors in one fund by preventing an
advisor from influencing the board to nominate too few independent directors.
The same minimum may harm investors in another fund by raising the level of independence
beyond the optimum for that fund.
Because optimal boards likely vary, however, and because
board structure is only one of many factors that influence firm value, an empirical
comparison of value at funds with more independent directors in the pre-rule
context would not generate reliable information about the effect of the rules.
Governance scholars have known this fact—that cross-sectional observational
studies produce only weak information about the merits of endogenously chosen
governance structures—for some time.
252
A source of governance variation that is exogenous with respect to fund value
is a necessary but insufficient condition for identifying the average effect of
a proposed rule about the feature. Few exogenous sources of variation for fund
governance exist, other than as a result of SEC rule changes—and even for those
changes, the effects they have caused are likely to be sufficiently small as to
be difficult to discover, even with the best cross-sectional modeling.
This identification challenge is fundamental and greatly
undermines the reliability of any guesstimated CBA/FR of rules on fund (or
corporate) governance.
253
The
difficulty is even more severe than it was in the SOX case study because the
plausible importance of any detail of governance is lower for SOX, which
combined
multiple
institutional and enforcement
changes. Anything that changes fund values—for example, anything that changes
the value of a fund’s investments—can confound the ability of researchers to
identify the effects of governance changes. Fund investment values undergo
changes that are continuous and large (money funds aside) relative to the
effect of governance details. A shift from fifty percent to seventy-five
percent independent directors will not have an effect on value approaching a
small fraction of common market-affecting events.
254
In the language of econometrics, the “power” of statistical tests given
available data is too weak to detect, much less reliably and precisely
quantify, the effects of most governance changes—even if we had examples of
changes that were plausibly exogenous. All of these points are made plain in
the Chief Economist’s memos, even if they were not explained in the SEC’s
releases or subsequent D.C. Circuit opinions.
255
To be sure, any change in governance mandates will generate
adjustment costs—the focus of both the SEC in the “cost” section of its rule
release and of the Chamber of Commerce in its lawsuit—that could be quantified
(or at least bounded) based on survey evidence. But if benefits of a rule
cannot be quantified, and larger potential costs of the rule due to fund
performance cannot be quantified, it remains unclear why the failure to
quantify adjustment costs is a significant failing or how (if provided) such
information would materially improve public understanding of the effects of the
rule. This point is even more compelling when, as here, even the
quantifications would vary depending on private responses that could not be
forecast with any precision, as the D.C. Circuit acknowledged in
Chamber of Commerce
. Put differently,
litigation challenging the SEC’s rule focused on an immaterial subset of the
likely costs and benefits of the rule, and had the SEC done exactly what the
D.C. Circuit ultimately said it had to do, the result would likely have had no
material effect on any assessment of the rule. Yet one would not know this from
reading the D.C. Circuit’s opinions or much of the commentary on the case.
256
The litigation is a perfect example of how CBA law—here, judicial review of
CBA/FR—can obscure more than illuminate.
4. The
Aftermath of the Aftermath
Because it was unclear if the Chief Economist’s memos
represented the end or the beginning of another stage in the SEC’s efforts to
revise governance rules, Fidelity filed a 141-page comment in response,
including a twenty-two-page analysis of the Chief Economist’s memos by me (for
which I was paid a fee, giving me a financial interest in this topic).
257
In my analysis, I critiqued the memos on the ground that the research used to
support the qualitative conclusion that the rules would better protect
investors was weak, inconsistent, and at times at odds with the summary in the
memos. I also outlined a number of potential costs to the proposed rules that
had not been noted in the Chief Economist’s memos.
258
Subsequently, the SEC has taken no more action to re-propose
its governance reforms. What is unclear, however, is whether its decision was
based on a genuine change of policy. Two less optimistic possibilities exist:
(1) between
Chamber of Commerce
II
and the SEC’s giving up on the rules,
the SEC Chair changed identity (William Donaldson was replaced by Christopher
Cox); and (2) the ongoing litigation threat, coupled with the fact that
reliable quantified CBA/FR for the rules remains unfeasible, led the SEC not to
want to risk another morale-draining, resource-depleting court loss,
259
even if it continued to believe that the governance rules would benefit investors
at a low cost. In favor of the last possibility is the fact that the Chief
Economist’s memos were released
after
Christopher Cox became Chairman, but they supported re-adoption, and nothing in
the public commentary (including my comment) provided any compelling
quantitative
reason for the SEC to
change its mind. While the qualitative reasoning in the public comments may be
part of the explanation, a dysfunctional system of judicial review seems likely
to be a bigger part of the explanation.
C. Case
Study #3: Heightened Capital Requirements for Banks
The third case study is of bank capital rule reforms adopted
in the wake of the 2008 to 2009 financial crisis. Among other things, the case
study illustrates how difficult it is to quantify one of the core benefits of a
great number—perhaps the majority—of financial regulations: reductions in
systemic risk. The difficulty is in part due to the relatively small number of
comparable crises from which to draw reliable inferences about the effects of
crises or the effects of regulations on them.
“[
Y]
ou
only find out who is swimming naked when the tide goes out.”
260
Warren Buffett’s perhaps self-congratulatory moral was occasioned by losses
facing casualty insurers after 9/11, but it captures a central fact of the 2008
crisis: banks were revealed to be grossly undercapitalized for risks they had
been running. Undercapitalization was evident in the failures of both
commercial banks—Washington Mutual, Wachovia—and investment banks—Lehman, Bear
Stearns. But it was also true of the more than 700 banks bailed out by the
United States.
261
Even the
“best” performing U.S. banks during the crisis lost significant amounts of
money, needed to raise capital on terms suggesting pre-crisis
undercapitalization,
262
and would
have failed without massive infusions of liquidity by the Federal Reserve,
through near-zero interest rates and three rounds of “quantitative easing,” six
years after the crisis began.
263
Capital shortfalls were global but not universal. Banks in
the United Kingdom, France, Germany, and Belgium failed or needed government
support to stay open, while banks in Canada and Australia did not, in part due
to tight capital regulation.
264
In a
cross-section of banks, those with more capital and those based in countries
with more stringent capital regulation did better than banks elsewhere,
controlling for other factors.
265
1. Regulatory
Response
It was thus inevitable that regulators around the world would
impose new, higher capital requirements. Capital regulation is coordinated for global
banks (on a voluntary multilateral basis) by the Bank for International
Settlements (BIS) based in Basel. More precisely, BIS hosts the Basel Committee
on Banking Supervision (Basel Committee), composed of members from twenty-seven
countries, which from time to time reaches consensus on a unified set of
capital regulations for banks.
266
Bank
regulators in the member countries then transpose the consensus to national
regulation.
Each U.S. banking agency (the Federal Reserve, the Office of
the Comptroller of the Currency (OCC), and the Federal Deposit Insurance
Corporation (FDIC))
267
participates
in the Basel Committee.
268
Following
the crisis, the Committee hosted talks on new capital guidelines (called Basel
III to distinguish them from two prior guidelines). This new round focused on
tougher capital guidelines for large banks engaged in cross-border transactions
or activities with a lack of substitutes,
269
and on liquidity requirements—with the aim of addressing liquidity risks that
played a greater role in 2008 than in prior crises.
270
The new capital guidelines included leverage ratios so banks will need to hold
a minimum ratio of capital to assets, even if those assets nominally have a low
level of risk, such as highly rated mortgage-backed securities.
271
Other requirements in the guidelines included more common equity; tougher treatment
for credit default swaps and counterparty risk; securitizations; and risk
management; and a surcharge for the very largest, most complex, and interconnected
banks, known as “systemically important financial institutions,” or SIFIs.
272
The Committee circulated capital guidelines in December 2010 (revised in June
2011) and liquidity guidelines in January 2013. The U.S. agencies proposed
capital requirements for U.S. banks in August 2012, eliciting over 2,500
comments before being finalized in October 2013, and proposed new liquidity
requirements in November 2013.
273
2. CBA/FR
of Basel III
Although U.S. banking agencies briefly discussed costs in
reviewing comments on their rules,
274
none of the U.S. banking regulators included formal CBA in transposing Basel
III to U.S. law. However, the Basel Committee itself, in consultation with the
International Monetary Fund, published its own CBA/F
275
The Committee elicited CBA/FR that
focused on costs to its members (central banks and bank regulatory agencies),
twenty-three of which obtained data and analyses from 263 large banks
worldwide.
276
Subsequently, the Fed’s counterpart in the United Kingdom (then the FSA)
277
extended the Basel Committee’s CBA/FR
in published white papers.
278
Collectively, the work of the Basel Committee and the FSA on
Basel III’s higher capital rules provides another detailed illustration of what
CBA/FR looks like for a financial regulation with large if narrow significance.
A review of these publications does not leave a reader with much confidence in
using guesstimated CBA/FR to guide regulation. CBA/FR of the new rules required
complex social and economic predictions. First, the analysis had to estimate
benefits of heightened capital and liquidity requirements; those benefits were
identified as less frequent and/or severe financial crises. Two sub-models were
needed, one to estimate the cost of a crisis and one to predict the frequency
of crises. The CBA/FR then faced the challenge of forecasting the causal effect
of the requirements on each modeled relationship (incidence and effects). Finally,
the CBA/FR had to estimate the costs of the requirements—posited to be lower
lending by the banks subject to the rules. Each of these models is discussed below.
3. Costs
of a Financial Crisis
Focus first on the costs of a crisis. One pair of
commentators has suggested that this element of CBA/FR should be “easy”:
“Agreement on a figure in the range 150 billion to 3 trillion dollars (viz. a crisis
cost between 1 percent and 20 percent of US GDP . . .) would seem relatively
easy to reach given the widely respected estimates of Reinhart and
Rogoff
.”
279
Unfortunately, this view is too
sanguine by more than half. Other estimates of the costs of financial crises
range from 90% to 350% of world GDP (Bank of England); 18% to 48% of UK GDP
(FSA 42); and 10% to 210% of UK GDP.
280
To state the obvious: these ranges do not even overlap. The
high end of Posner and
Weyl’s
range (20% of U.S. GDP)
is less than one-fourth of the low end of the Bank of England’s range and is
barely above the low end of the FSA’s range. The high end of the Bank of
England’s estimate is seventeen times that of Posner and
Weyl’s
and Yan et al.’s estimate is eleven-and-a-half times larger than Posner and
Weyl’s
. In absolute, comparable, present value dollars,
these differences are enormous: trillions, not billions.
One may object, fairly, that Posner and
Weyl’s
estimate is for all future crises, whereas the other ranges are for the recent
crisis. But there are two responses. First, with respect to the recent crisis,
the ranges still vary substantially. Second, as discussed more below, no
consensus approach exists to resolve which historical data one should use in
estimating the cost of future crises. Data from 1929, included in Reinhart and
Rogoff
, on which Posner and
Weyl
rely,
281
are not obviously more or equally relevant to future crises than data from
2008. A longer set of historical data has the advantage of allowing costs to
vary with factors that fluctuate or cycle over decades, and dampens the effect
of differences of estimated costs of any particular crisis. A shorter set of
data from more recent periods has several advantages as well. First, a shorter
dataset promotes better modeling of current economic, legal, and political
conditions, including the centrality of finance to the economy,
282
which has arguably increased over time; it also allows one to account for the
presence of laws and institutions that socialize some of the risks of crises,
such as FDIC deposit insurance, and that did not exist in 1929. Second, a
shorter dataset enables one to reduce the number of disputes that can be
expected over which crises to include in the dataset. Given the tradeoffs
between a shorter and a longer dataset, neither choice clearly dominates.
An examination of CBA/FR conducted for the Basel Committee
reveals methodologies and estimates of the costs of crises more disparate than
in the studies just summarized. The Committee reviewed twenty-one studies. Two
provided estimates of peak-to-trough losses during the crises studied, while
thirteen provided cumulative loss estimates. The present value of the average
cost in the latter studies ranged from 16% to 302% of pre-crisis GDP (sometimes
measured against domestic GDP, sometimes global). Several include a lower bound
of
zero(
!),
283
while the highest upper bound was 1041% of pre-crisis GDP. One study presented
results from two methods that varied at the mean by a factor of five and at the
high end by a factor of ten.
284
The Basel Committee’s qualitative summary is “that results in
the literature are surprisingly consistent.”
285
But this conclusion is inconsistent with the committee’s statement elsewhere in
its report that one can find “a significant range of crisis outcomes across
studies and individual episodes.”
286
Presumably, the “significant range” of outcomes is “surprisingly consistent”
when measured against prior expectations that the results would lack coherence
altogether.
The table summarizing the committee’s findings,
287
converted into Figure 2 here, shows the sensitivity of the results to
assumptions and methodological choices. The primary drivers of the sensitivity
of results are: (1) selection of historical data points; (2) assumptions about
whether economic losses will be permanent or temporary, and if temporary, how
long crises will last; and (3) what policy response will be triggered by
the crisis. For each driver, a number of choices must be made, and each choice
has large effects on the bottom line of the CBA/FR.
Figure 2.
range
of estimates of costs of financial crisis
288
For the simplest driver—choice of data—at least three
contestable choices are required. First, a “financial crisis” must be defined:
crises can be subjectively and judgmentally chosen (“I know it when I see it”
approach)
289
or objectively chosen, and either way can be based on a variety of data,
including data regarding market volatility,
290
bank runs,
291
bank closures or nationalizations,
292
bank bailouts,
293
stock market
declines,
294
and ratios of non-performing loans to bank assets.
295
Some distinguish banking from market crises; others include banking crises as a
subset of financial crises.
296
Second, time
periods must be chosen—both for the overall dataset (how far back to go in
history?) and for each crisis (because the duration of a crisis affects the
count and size of effects).
297
Third, one
must decide what geographic scope to consider: should one consider only crises
in the United States, in developed countries (and if so, how to define “developed”?),
or all countries?
These choices have large effects on outputs. One study of the
costs of financial crises presents two historical samples, with its bottom line
estimate doubling depending on which sample is used.
298
Even over the same historical period, one study counts 160 banking crises,
including many that caused relatively small losses, reducing the average loss
caused by the crises counted, while another study counts twenty-three, which
caused large average losses.
299
The
differences are attributable to (a) basic definitional choices; (b) whether to
count poor, developing nations or nations with poorly developed financial
markets; and (c) how (and whether) to count countries that experienced multiple
crises close in time: if all crises are counted separately, the average cost
falls, because some of the crises are brief episodes paving the way to a larger
crisis.
300
Further illustrating the fragility of cost-of-crisis models
is the recent kerfuffle involving Reinhart and
Rogoff
(R&R), on whose “widely respected estimates” Posner and
Weyl
rely. R&R’s publications on the effects of crises turned out to be indisputably
301
flawed because of a spreadsheet error that went undetected for over three years
302
(in spite of the fact that the study
was cited prominently in policy debates).
303
While the spreadsheet error caused R&R’s analysis to drop data for five
countries they intended to include, the error had no effect on their estimates
of the
direct
costs of financial
crises—that is, the fiscal costs incurred by governments attempting to resolve
crises. However, the error did affect estimates of the
indirect
costs of financial crises—that is, the depressive effects
on growth caused by higher levels of debt incurred as part of a policy response.
As discussed below, whether and how to count indirect effects of policy
responses are further sources of sensitivity in modeling the cost of crises.
The same researchers who discovered the spreadsheet error also challenged
separate choices by R&R in their analyses—what the critics termed a
“selective exclusion of . . . data” (for Australia, New Zealand, and Canada)
and an “unconventional weighting of summary statistics” that amplified the
effects of exclusion of New Zealand.
304
While R&R disagree on these points, they do so in part on the ground that
their work is historical, consisting of “archival research, involving constant
judgments at every step.”
305
Even if observers agreed on historical crises to estimate the
cost of future crises, two additional output-sensitive inputs—temporary versus
permanent effects and policy responses—intensify the unreliability of CBA/FR of
Basel III. Some studies assume the effects of a crisis on the economy are
transient—that is, a crisis causes a temporary drop in activity, followed
eventually by higher-than-normal “catch-up” growth, bringing long-term output
trends back to where they would have been without the crisis. Other studies
assume that the effects are permanent—that is, economic activity never catches
up to where it would have been without the crisis. If one takes the median of
the average of estimated losses across studies, as the authors of the BCBS 173
did, the difference caused by this one assumption triples the losses.
306
If harms are large (for example, 158% of pre-crisis GDP in BCBS 173), then
differences between permanent-harm and temporary-harm models are even larger—up
to
a hundred times
larger.
307
A related force increasing the sensitivity of results in permanent-harm models—which
by definition extend into the indefinite future—is the choice of discount rate.
308
A third source of sensitivity of social costs to modeling
assumptions is perhaps the most troubling for anyone hoping CBA/FR can produce
reliable information: the political and policy response to the crisis. As the
last crisis reminded us, a major financial crisis can provoke a range of policy
responses. Politicians may bail out banks; tighten, loosen, or repeal regulations;
increase liquidity through conventional monetary policy (cutting interest
rates) and less conventional instruments (“quantitative easing”); stimulate
activity directly with government spending or tax cuts; other responses; or
some combination. Each response can have benefits and costs, ranging from
lending constraints, moral hazard, and the future frequency of crises;
inflation; deficits; debt
and reduced medium- to
long-term growth. These policy responses can vary in intensity as well.
Depending on the policy response, the effect of a crisis can vary
significantly, and the models reviewed in the Basel Committee CBA/FR make
assumptions about the policy responses and their effects.
To predict policy responses, CBA/FR must include what amounts
to political speculation. For if economic inputs to CBA/FR models are
uncertain, political inputs are even more so.
309
To see this, simply note the varying policy responses across developed
economies to the recent crisis. The United States created a very large
(relative to the economy or the tax base) fiscal stimulus through deficit
spending, while the United Kingdom “committed itself to early fiscal
retrenchment.”
310
The United
States implemented the most aggressive monetary program in history, through the
novel technique of buying massive amounts of mortgage-backed and other fixed
income securities, while the European Central Bank remained more focused on
preventing inflation, and the Bank of Japan’s balance sheet increased only
slightly over the crisis period.
311
Policy responses also change in response to learning (or claims to learning)
from past crises—compare recent U.S. monetary and fiscal policy to responses to
the Great Depression
312
and to that of Japan during the
1990s
313
—but
that implies that predicting future policy requires predicting the future path
of economic theory and the results of retrospective analyses of past policy
interventions. This is not to mention financial rescue programs, such as TARP.
These are not second-order considerations. Informed observers
have attributed much of the difference in the duration of the current U.S.
recession, on the one hand, and the contemporaneous U.K. recession and the
historical U.S. Great Depression, on the other hand, to policy responses.
314
Should the current legitimacy of otherwise desirable regulation turn, to any
significant degree, on debates or assumptions about predictions of future
politics? That is what CBA/FR
advocates
effectively,
if tacitly, presume.
315
4. Frequency
of Financial Crises
Even if the costs of financial crises could be estimated with
precision and reliability, these costs would have to be paired with estimates
of the frequency of crises to arrive at an estimate of the benefit from
regulations that reduce crises’ frequency. This modeling faces similar
challenges as estimating effects: subjectivity in selection among relatively
small numbers of historical data points and sensitivity of results to choice of
data points. The Basel Committee simply took average frequencies from two
studies
316
over an arbitrarily chosen period and set of countries (1985 to 2009 for G10
and BCBS countries, except Russia and China, which were included from 1992 on)
and made the heroic assumption that this average was a good estimate of the
probability of a crisis for any given year and country.
317
The FSA, by contrast, used a longer time period (1970 to
2007), a narrower set of countries (OECD countries), and relied on a
multivariable
logit
approach relating the likelihood
of a crisis in a given year “to a vector of explanatory variables,” with
observed crises in the past coded one and non-crisis years coded zero.
318
This approach relies on the logistic cumulative distribution to predict future
crises and is an improvement over BCBS 173 if interdependencies among
time-varying observables affect crisis frequency, as seems likely. For example,
housing prices have varied over time, and crises often coincide with (partly
causing, partly being caused by) bubbles in housing prices, so crisis odds
would not be uniform over time but would vary in cycles and across countries.
However, the small number of crises that can be modeled this way (FSA 38’s data
included fourteen) limits the value of this approach, in statistical degrees of
freedom and in robustness, and the functional form imposes assumptions on the
shape of the distribution of crisis probabilities that is nowhere defended in
the FSA’s publications.
Because of differences in approach, the FSA’s results differ
markedly from the Committee’s results. BCBS 173 reports an estimated baseline
probability of a crisis per year for all countries of 4.5%.
319
FSA 38 reports a baseline probability ranging from 0.7% (for Germany) to 21.7%
(for the United Kingdom)—that is, from one-sixth to five times the estimate
used by BCBS 173.
320
Again, the
sensitivity of outputs to assumptions illustrates how fragile CBA/FR of capital
regulation remains.
321
5. Effects
of Higher Capital Requirements on Financial Crises
A third task necessary to estimate the
benefits
of higher capital requirements is
to estimate how higher capital will
affect the frequency and effects of future crises. The challenges are similar
to those outlined in the case studies of SOX and mutual fund governance above,
if slightly less difficult. The challenges are less difficult because capital
levels have a more mechanical relationship to bank failure than disclosure and
governance regulations have to fraud and fund performance, respectively. If a
bank’s capital falls below zero, it is by definition insolvent and will be
either closed, nationalized, or bailed out (and/or suffer a bank run)—all of
which (at least by most definitions) feed directly into the occurrence of a
financial crisis.
Nevertheless, the modeling exercise remains difficult here,
too, and includes a long list of challenges. Three are reviewed here: (1)
baselines; (2) packages
and (3) international
externalities.
322
The first
question in any CBA is what baseline to use. Similar to the effect of fraud
revelation on disclosure practices in the SOX case study, financial crises
stimulate banks to raise their capital levels even without regulatory reform,
as private actors increase the price of lending or investing in now apparently
riskier banks. So how should one measure the effect of a regulatory mandate for
new capital—against the baseline of pre-crisis capital levels, or against
levels that could be expected in the wake of the crisis without the regulation?
The argument for the former—advanced in FSA 42—is that “banks will tend to
relax their post-crisis holdings of capital as the economic cycle strengthens.”
323
This seems sensible as a rough prediction, but it is not anchored in an equilibrium
model of bank behavior. After all, banks observe the same indicia of the
probability of a crisis as used in the FSA’s CBA/FR of Basel III. Bank
investors can observe those indicia and bank capital levels, so why should we
assume that bank capital levels only subside, rather than rise and fall as the
risk of a systemic crisis rises and falls? It may be that private actors lack
sufficient incentives to demand that an optimal level of capital be retained by
banks, but for CBA/FR of capital requirements, the baseline itself—the capital
that private actors would demand—is likely to change over time in unpredictable
ways.
Part of the reason that private actors may lack incentives to
demand that banks retain optimal capital is that they face moral hazard due to
the likelihood of bailouts and other policy interventions. But that fact calls
into question the validity of using pre-crisis capital levels as appropriate
baselines altogether. Has moral hazard increased, decreased, or remained the
same after the bailouts of 2008? Lehman failed, and Bear Stearns and Merrill
Lynch were forced to sell at fire-sale prices—so perhaps investors are now less
certain about future bailouts. But, of course, more than 700 U.S. banks were
bailed out,
324
not to mention the indirect bailouts through the various liquidity facilities
established by the Federal Reserve Board—so perhaps investors face even more
moral hazard than before. FSA 42 asserts that the pre-crisis period was one in
which “banks’ decisions . . . were not distorted by the
immediate influence of the crisis or regulators’ response to the crisis.”
325
But it presents no evidence to support that assertion. Any rational actor who
anticipates a crisis should, given policy responses to past crises, also
anticipate that a bailout may occur with some probability, and the capital
levels it will demand will be affected by that anticipation. The better point,
then, is that a model of the effect of future capital regulation should start
with a baseline that explicitly takes into account moral hazard as a permanent
condition of financial markets without adequate regulation. However,
establishing such a baseline would require estimating the subsidy provided by
the moral hazard to bank investors—a task not yet convincingly tackled by
researchers.
Another challenge is that Basel III consists of a package of
reforms, not one reform. As FSA 42 notes, if the probability of a crisis is
non-linear in the level of bank capital, as assumed in a
logit
model (and as seems likely), then the effect on that probability of each piece
of the reform package will depend on the sequence in which the pieces are
adopted.
326
As with SOX, the best one may be able to do in estimating the causal impact of
a package of reforms is to evaluate the package as a whole. For the CBA/FR of
any given package of reforms, this is not a critical problem, but it does
undermine the value of CBA/FR because it allows regulators to determine (to an
extent) what is being evaluated—and may allow a package to include some reforms
that are net positive (if evaluated on their own) with other reforms that are
net negative (if evaluated on their own), as long as the former outweigh the
latter.
A third challenge to estimating the causal impact of Basel
III, also noted in FSA 42,
327
is that it
is a voluntary multilateral initiative, which means that it will be implemented
in different ways at different times in different countries. Implementation in
one country will affect how banks in other countries act, independent of the
effect of implementation by their own regulators. If, for example, U.K. banks
are required to increase capital, they may not only reduce lending but focus
continued lending on geographies or sectors where interest margins are highest,
which in turn may affect currency and trade flows. An increase in U.S. capital
regulation under Basel III, being evaluated in a CBA/FR by a U.S. regulator,
should take into account the simultaneous shift in lending activity by U.K.
banks, as well as the direct effect on U.S. banks. In a global financial market,
the externalities of regulation create modeling difficulties of their
own—adding yet more necessary assumptions regarding how the regulations will
actually affect the probability or impact of future crises.
6. Costs
of Higher Capital Requirements: Less Lending?
Finally, the costs of higher capital requirements must be
estimated. The standard framework, employed by the Basel Committee and the FSA,
328
is to assume that a bank required to hold an increased amount of capital will
raise
corporate borrowing costs and so cut lending. The
reasoning is simple: banks must pay their investors a minimum expected rate of
return on their invested capital; if more capital is required, the bank will
have to generate greater return; to generate a higher return, a bank must
charge more to its borrowers; at a higher cost of borrowing, less lending will
occur. The model further assumes that with lower lending by banks, economic
output will fall.
As with the models of the benefits of capital requirements,
however, models of the effects on the amount of lending (and its knock-on
effects on output) require numerous contestable assumptions, and their outputs
are sensitive to those assumptions. Among the assumptions are: (a) the
cost of bank equity and whether it will fall in response to the change in
capital levels required by the rule; (b) the ability of borrowers to substitute
among different sources of financing (and at what cost); and (c) how
non-bank sources will be affected by an increase in bank capital requirements and
the reduction in risks and effects of financial crises.
329
Each has major impacts on the output
of the cost model alone.
The uncertainties associated with these assumptions are
underscored by the fact that one prominent set of economists believes the
social costs of higher capital requirements “would be, if there were any at
all, very small.”
330
The authors point out that higher
taxes, if paid by banks as a result of shifting from debt to equity finance in
response to capital requirements, are not a social cost, because the shift
reduces the distortive effects of a socially harmful tax code.
331
The authors argue that moral hazard induces banks to remain larger than is socially
efficient, so that even if higher capital induced large banks to shrink, the
overall impact on lending would be offset by increases in lending by other
banks or financial institutions.
332
By contrast, the Basel Committee, based on its modeling and inputs from
self-interested banks, concluded that the proposed requirements in Basel III
would reduce steady-state output (gross domestic product) by between 0.25 and
0.92 percentage points,
333
which translates into $1.4
trillion
in present value terms at the
mid-point of this range for the United States alone. As with estimates of
benefits, respectable CBA/FR opinions vary in their assessments of the present
value of Basel III’s costs by more than $1 trillion.
D. Case
Study #4: The Volcker Rule
The fourth case study also focuses on a rule emerging from
the financial crisis: section 619 of the Dodd-Frank Act, colloquially known as
the “Volcker Rule.” That rule bans U.S. banks from speculating for their own
account (that is, from engaging in “proprietary trading” or holding “ownership
interests” in hedge or private equity funds, subject to a number of exceptions).
334
This case study reinforces the points made in the prior case study, and also
illustrates how difficult it is to assess many important kinds of financial
regulations in advance, given the lack of any past data on how new markets will
operate.
Specific regulations
implementing the Volcker Rule were approved (after many delays) in December
2013 and went into effect on April 1, 2014.
335
The formal releases published by the
financial agencies in the
Federal
contain no general CBA/FR, presumably because (1) as discussed in
Part II.A, no general CBA/FR mandate exists for those agencies; (2) the
statutory requirement for and authorization of the rules is part of the Bank
Holding Company Act of 1956,
336
which does
not contain any equivalent to the requirement in the securities laws that the
SEC consider “efficiency” or in the commodities laws that the CFTC consider
costs and benefits;
337
and (3) nothing in the language
of section 619 requires CBA.
338
The formal
rulemaking contained limited cost-related information in its analyses under the
RFA and the PRA
339
but no information about benefits or
non-compliance costs.
The OCC, however, did release separately a CBA/FR of the
Volcker Rule.
340
It identified a number of
“non-monetized” (qualitative) benefits: improved supervision by bank regulators
(due to metrics reporting required by the rule); better management of risk by
bank managers (for the same reason); reduced conflicts of interest; protecting
“core banking services” and improved bank safety and soundness (reduced risk of
bank failures); reduced “tail risk” from trading activities and reduced risks
of financial crises; improved corporate governance of banks resulting from
reduced stock market liquidity; and reduced harms caused by excess liquidity.
341
As the OCC noted, “benefits of the regulation can be difficult to quantify
including the value of enhanced economic stability.”
342
The OCC also identified a number of costs. For a subset, the
OCC provides quantified estimates: compliance costs ($405 to $541 million);
additional capital costs for permissible investments in covered funds ($0 to
$165 million); the OCC’s own costs of supervising compliance with the new rule
($10 million); and a one-time hit to the value of assets owned by banks but
restricted by the rule, resulting from reductions in demand for those assets
due to the rule. For the last type of cost, the OCC drew on academic research
estimating a similar haircut in corporate bond values when bonds are downgraded
by credit rating agencies and insurance companies (subject to regulations
limiting their ownership of junk bonds) are forced to sell such bonds, deriving
a range of costs from $0 to $3.6 billion.
However, the types of costs that are likely to be the largest
ongoing costs were not quantified. Foremost among these non-quantified costs is
the reduced liquidity in markets where banks were significant trading
participants, particularly arising from inter-dealer trading, which is not
treated as a permissible source of “customer” demand under the rule.
343
Banks, as a result, will not be able to hold certain assets as “inventory,”
which will reduce liquidity in the markets for those assets and make it harder
for banks to share risk with other banks when permissible customer-driven
trading results in banks’ taking on large blocks of equities. As a result,
banks may incur higher costs to hedge or shed those risks, or face more difficulties
in managing risks. Further, the reduction in liquidity caused by the ban on
inter-dealer trading will likely reduce the depth of those markets and the
ability of issuers to raise capital in those markets.
344
Another potential cost of the rule is similar to one noted above for the Basel
III rules: migration of trading activity to non- or less-regulated “shadow”
banks, which could pose systemic risks, offsetting (and possibly exceeding) the
benefits of risk reduction within the banking system.
In sum, as with the foregoing case studies, the OCC’s CBA/FR
did not include a quantification of the benefits and only quantified a
subset—and likely a small portion—of the costs of the Volcker Rule. The result
was that the OCC confidently categorized the rule as “major” for purposes of
the CRA,
345
because that categorization only requires bounding the rule’s costs, but did
not reach any conclusion about the rule’s net costs and benefits.
Could the agencies go beyond conceptual CBA and conduct a
reliable, precise, quantified CBA/FR? The short answer is no. There is simply
no historical data on which anyone could base a reliable estimate of the
benefits of preventing banks from engaging in proprietary trading or investing
in hedge and private equity funds. Any effort to quantify those benefits will run
straight up against the difficulties described in the case studies above. While
Basel III capital rules address the “liability” side of a bank’s balance sheet,
and the Volcker Rule addresses its “asset” side, both rules have as a core
intended benefit the reduction in the frequency and magnitude of systemic
financial crises. Thus, as with Basel III, any complete quantified CBA/FR of
the Volcker Rule would require the same components discussed above for Basel
III to estimate the costs and frequency of financial crises (macroeconomic
modeling, subjective data selection, prediction of policy responses).
The difficulties with the Volcker Rule are compounded beyond
Basel III, however, for two reasons. First, the rule has additional, separate
benefits, such as the mitigation and reduction of conflicts of interest, which
(as with the mutual fund governance rules) can only be quantified by relying on
causal inferences with low-powered tools about complex institutional
arrangements. Second, and perhaps more important, it remains unclear how, if at
all, the Volcker Rule will in fact reduce the risk or cost of financial crises.
The Rule’s proponents (including Volcker himself) strongly believe that it
will, by decreasing the role of speculation within banks and perhaps by
limiting the ability of banks to attract and retain individuals with a
risk-taking temperament.
346
But those
judgments do not rest on historical data, nor is there any mechanical relationship
between an activity (proprietary trading) and failure, as with capital levels.
Ironically, then, the primary category of benefits (reduced systemic crisis
risk from less speculation by banks) is inherently speculative, as with any
novel structural rule or activity ban of a similar kind.
Quantifying the aggregate costs of the rule would be equally
difficult. While the OCC quantified a subset of costs, it did not quantify the
costs that are likely to be largest—especially the costs of lower liquidity. As
the OCC noted, it is possible to quantify those costs: there are research
papers estimating the cost of reduced liquidity for specific categories of
assets.
347
But, as the OCC also noted, any estimates produced by relating predicted
reductions in liquidity to this sparse research literature would be
“difficult.”
348
Among other things, a full set of cost estimates would require predicting the
impact of the rule on liquidity across a range of financial markets (including
anticipating entry by institutions not subject to the rule—institutions that
could be expected to take advantage of any competitive opportunities opened up
by the exit of banks subject to the rule). Those estimates would then have to
be linked to estimates of the impact on the cost of capital from any expected reduction
in the liquidity of one channel for capital raising, again taking into account
possible substitution effects from other channels. Then, finally, the effects
on output of any estimated capital cost increase would have to be quantified,
using a macroeconomic model.
As with Basel III, the result
would be complex, difficult, constrained by limited data, highly contestable,
and sensitive to modeling assumptions.
E. “Gold
Standard” Examples of CBA/FR
Perhaps other significant regulations—beyond those explored
in the case studies presented above—are more susceptible to quantified CBA/FR.
Taking a cue from the adversarial legal system, in which neutral judges rely on
advocates to advance the best evidence in favor of a cause, this section
reviews two regulations that CBA/FR proponents hold up as examples of “gold
standard” quantified CBA/FR
349
—the SEC’s cross-border swaps rules
and the FSA’s mortgage market reforms—on the theory that they should provide
the best evidence that quantified CBA/FR is capable of being done in a
reliable, precise way. These rules are also high-profile and indisputably
significant, and are of interest for evaluating CBA/FR law because the agencies
did conduct and publish CBA/FR in response to CBA/FR law: the SEC was
responding to the D.C. Circuit decisions reviewed above, and the FSA was
complying with a U.K. statute requiring CBA/FR, precisely the kind of mandate
that CBA/FR advocates hope to bring to the U.S.
Does either of those rules demonstrate that quantified CBA/FR
is feasible and desirable? Far from it—they instead show how easily CBA/FR can
camouflage the effects of rulemaking, rather than discipline it. Both case
studies show that even motivated and relatively expert members of the
public—specifically, the Center for Capital Market Regulation, composed of
leading financial industry participants and staffed by technically trained
lawyers and economists—can apparently misread the contents and achievements of
a lengthy and technical cost-benefit analysis. The case study of the FSA’s
mortgage reforms also illustrates that even the most creative and sustained
effort to quantify the costs and benefits of a fairly narrow but important financial
regulation remained fragile, imprecise, and incapable of significantly
constraining regulatory judgment, by the admission of the staff carrying out
the analysis.
1. The
SEC’s Cross-Border Rules on Swaps
One of the few examples of CBA/FR of U.S. financial
regulatory rules praised by CBA/FR proponents was conducted by the SEC, in its
proposed rules on cross-border swaps under the Dodd-Frank Act (the Cross-Border
Swap Release).
350
Those rules are designed to fill a
regulatory gap
351
relating to
over-the-counter (OTC) derivatives markets, which exploded over the past two
decades and exacerbated the 2008 financial crisis, causing the insolvency of
one of the world’s largest insurance companies (AIG) and triggering a bailout
through an unprecedented series of actions by the U.S. Treasury and the Federal
Reserve Board.
352
The Dodd-Frank Act authorizes the SEC and the CFTC
353
to register and regulate entities active in the OTC swap markets,
354
and to establish rules for clearing and trade execution, recordkeeping, real-time
reporting, and disclosure. Pursuant to this authority, the SEC (in conjunction
with the CFTC) has issued two releases defining terms
355
and proposed or adopted ten sets of rules on domestic swap activities.
356
The Dodd-Frank Act was clear that swap regulation should also cover
cross-border activity that could affect the U.S. markets.
357
To that end, the SEC proposed a rule in May 2013 to address cross-border swaps
comprehensively, issuing one large release collecting, discussing, and
analyzing all of the swap-related
rules
as they would
apply to cross-border activities. That release contained roughly 200 pages
labeled “economic analysis,” a third of the total release—including both
conceptual and limited elements of quantified CBA/FR—and cross-referenced lengthy
CBA/FR in previously issued releases.
358
By comparison to CBA/FR in most prior SEC releases, the length of the CBA/FR is
indeed impressive, which is part of why CBA/FR advocates praised it.
359
The SEC’s CBA/FR was also praised because it focused on full, quantified
CBA/FR, “estimating the
quantitative
impact of
each key aspect
of the proposed
rule, rather than simply assess[
ing
] firm-specific
compliance costs.”
360
However, a careful (if exhausting) review of the CBA/FR in
the Cross-Border Swap Release shows that it is comprehensive only in its
qualitative
economic analysis of the
proposed rules and contains little quantified information, other than for a
subset of compliance costs. As noted in passing towards the beginning of the
CBA/FR, “Many of the resulting costs and benefits are difficult to quantify
with any degree of certainty, especially as the practices of market
participants are expected to evolve and adapt to changes in technology and
market developments.”
361
The SEC
divides its CBA/FR into “assessment” costs—the costs of determining if a given
entity is subject to swap regulation, a subset of compliance costs—and “programmatic”
costs and benefits due to subjecting swaps to regulation.
362
The primary programmatic benefits the SEC identified were promoting competition
by increasing market access and transparency, reducing search costs, and
increasing price efficiency.
363
The primary
programmatic costs the SEC identified were reduced liquidity and depth in the
swap markets due to market participants’ withdrawing because transparency
requirements will reveal valuable information, and a potentially increased incentive
to “race to the bottom” as participants relocate cross-border operations to
jurisdictions with less regulation.
364
Almost no information relating to “programmatic” costs and
benefits is quantified. No models of competition, liquidity, or prices under
the rules are presented. Instead, the SEC repeatedly said that it lacks data
and/or an inferential basis for quantifying those costs and benefits. Exceptions
include, for example, a quantification of the costs of building a compliant
swap execution facility from scratch and maintaining it thereafter or modifying
an existing trading platform into compliance and maintaining it.
365
But these exceptions prove only the general absence of quantification, as they
relate to a subset of the costs of a subset of the rules proposed in the
release—a subset of a subset of a subset of what a
full
quantified
CBA/FR would include.
This description is not meant to criticize the absence of
quantification. The SEC’s decision not to quantify is fully justified, given
the state of available information and research methods. The Dodd-Frank Act
effectively required the creation of entirely new OTC swaps markets. Private
actors will be reacting to these novel regulations in ways that cannot be
reliably predicted. The realization of the rules’ major potential
benefit—increased competition—depends upon latent demand for products
(transparently cleared swaps). Private actors had only limited incentives to
provide these products under prior rules and
the value of the
products will be altered by other new aspects of the rules, such as segregation
and capital requirements
. The realization of the rules’ major potential
cost—reduced liquidity and depth relative to prior markets—will also be a
function of latent demand. The size of the cost will also turn on the
importance of proprietary information that may be revealed in more transparent
markets. Another major potential cost—an increased incentive for participants
to relocate to other jurisdictions—depends on political and policy outcomes in
other countries, as well as the ability of international regulatory
coordination to cope with or blunt those incentives.
Although justified in this respect, the SEC’s CBA/FR
nevertheless must be fairly viewed as conceptual, not quantified. Rather than
showing quantification is possible and desirable, as a matter of policy or law,
the Cross-Border Swap Release shows just the opposite. Yet CBA/FR advocates have
singled out the Cross-Border Swap Release for accomplishing something it did
not accomplish.
366
How could
that be? Perhaps the praise was false, a mere rhetorical pretense in service of
the political goal of promoting CBA/FR.
But a more charitable possibility exists: perhaps CBA/FR
advocates did not see through the camouflage of the SEC’s release. As noted,
the CBA/FR is 200 pages long and incorporates lengthier CBA/FR sections in
other related releases. It is turgid, vague, and full of jargon. Discussions of
less important assessment costs are longer than discussions of more important
programmatic costs and benefits. Specific quantified amounts appear regularly,
367
so someone skimming the analysis might surmise that it was filled with
quantitative analysis, while in fact the vast majority of the amounts relate to
assessment costs or a small subset of programmatic costs, not to programmatic
benefits or the most important programmatic costs.
368
The release contains lengthy discussions of qualitative costs and benefits of a
de
minimis
exemption from coverage by the rules,
while nowhere setting forth a detailed conceptual outline of how one might (in
theory) measure the costs and benefits of being covered by the rules. Important
points relevant to the limited quantification in the release are buried in
footnotes,
369
while whole pages are taken up with text such as this:
Segregation requirements would limit the potential
losses for security-based swap customers if a registered security-based swap
dealer fails. The extent to which assets are in fact protected by proposed Rule
18a-4(a)-(d) would depend on how effective they are in practice in allowing
assets to be readily returned to customers. In the cross-border context, the
effectiveness of the segregation requirement with respect to foreign
security-based swap dealers in practice may depend on many factors, including
the type and objective of the insolvency or liquidation proceeding and how the
U.S. Bankruptcy Code, SIPA, banking regulations, and applicable foreign insolvency
laws are interpreted by the U.S. bankruptcy court, SIPC, Federal Deposit
Insurance Corporation, and relevant foreign authorities. In the Capital,
Margin, and Segregation Proposing Release, we stated that it would be difficult
to measure the benefits of the segregation requirements proposed by the
Commission under Section 3E of the Exchange Act; however, we believe that Rule
15c3-3, the existing segregation rule for broker-dealers, would provide a
reasonable template for crafting the segregation requirements for security-based
swap dealers. The ensuing increased confidence of market participants when
transacting in
security-based swaps, as
compared to the OTC derivatives market as it exists today, should increase the
desire to trade security-based swaps and generally benefit market participants.
370
Perhaps someone finds this and similar paragraphs
illuminating. I do not. Did including it in a 200-page section labeled
“economic analysis” in a 650-page release inform the public about the costs and
benefits of requiring dealers in cross-border swaps to segregate customer
assets? In what way is it “economic” analysis, as distinct from the more
general form of analysis that has long been included in adopting releases? The
paragraph would look out of place in an economics journal. Even if these 210
words were boiled down to a more succinct, social-scientific style,
371
would a law requiring such a statement discipline the SEC, improve the public’s
ability to comment on the proposals, or correct the SEC’s potential cognitive
biases? I cannot see how.
Again, I do not intend to criticize the authors of the
Cross-Border Swap Release; to the contrary, I commend them. They accomplished
an important goal—eliciting praise from a group of critics of the SEC’s CBA
practices—and likely helped set up the SEC to defend itself against any court
challenges to its rules. The staff accomplished here what any rational actor at
a regulatory agency would want to accomplish given the court decisions reviewed
in Part II above—decisions that have created a strong incentive for regulators
to generate precisely the kind of qualitative, lengthy, and largely opaque
“gold standard” CBA/FR included in the Cross-Border Swap Release.
2. The
FSA’s Mortgage Market Reforms
A second example held up as model CBA/FR is the set of
mortgage market rules passed by the FSA in 2011. The FSA was abolished in 2010
(effective in 2013) for its failures to foresee, prevent, and mitigate the 2008
crisis.
372
Among its pre-crisis failures was allowing significant amounts of mortgage
loans to be made to borrowers who could not repay the loans other than by
refinancing or reselling their homes into what optimists hoped would be an
ever-rising market.
373
Reforms adopted in 2011 require
lenders to assess affordability of homes before lending to buyers, to include
the possibility of interest rate increases in making those affordability
assessments, and to evaluate interest-only mortgages without assuming (as
opposed to demonstrating) the possibility of a refinancing.
374
a. The
FSA’s CBA/FR
Since 2000, UK law has required the FSA to publish a CBA/FR
of its regulations and guidance,
375
such as the mortgage reforms. That 131-page CBA/FR was attached as an annex to
the reform proposal (a “consultation paper” in European legal jargon).
376
In it, the FSA summarized the
benefit of the main reform (mandatory affordability analysis) as protecting
some borrowers “from mortgage impairment,” and its cost as “prevent[
ing
] [other borrowers] from taking out the mortgage they
want.”
377
In an effort to quantify and compare those primary benefits
and costs, the FSA used a multistep process. First, it applied a multivariate
logistic model to a large (
=730,000)
sample of loans from 2005 to 2010 to estimate the probability of loan
“impairment.”
378
It then used ordinary-least-squares regression of the probability of impairment
on factors it selected as contributing to impairment to quantify the
contribution each factor made to impairment risk.
379
It used “judgment” to choose factors relevant to loan underwriting to identify
a cut-off where impairment risk increased “markedly,”
380
on the theory that this was where the new affordability requirement would have
affected sample loans.
381
With those models, the FSA concluded that the rules would
have prevented roughly 200,000 loans from entering default (“unaffordable”
loans), and constrained approximately 530,000 borrowers to take out smaller or
delayed loans than they could have taken out and repaid without the rules.
382
The FSA then assumed the rules would prevent similar future defaults, which the
FSA assumed would create solely social costs and so counted solely as benefits
of the rules.
383
The FSA further assumed the rules would generate social costs but no benefits
if they prevented or delayed borrowers who could have afforded larger or
earlier loans from obtaining consumption benefits.
384
To quantify a comparison between these direct costs and
benefits of the new rules on borrowers, the FSA needed a common metric. Because
the FSA had no data on actual demand for loans in a hypothetical world without
information asymmetries (a market failure addressed by the rules),
385
it estimated effects not on welfare but on psychological “well-being,” for
which it had proxy data, derived from a U.K. government household panel survey
with data from 1991 to 2008.
386
By
regressing self-reported well-being scores on “housing-related events” in a
fixed-effects regression with other controls from the survey, the FSA generated
parameters
387
for changes in well-being for events that were (by assumption) related to
unaffordable loans (for example, payment problems) or affordable loans (for
example, becoming a home owner rather than a renter, moving into a larger
home). The FSA found that effects on well-being were “much greater” for payment
problems and defaults than for foregone improvements in housing,
388
such that the net effects on all affected borrowers were positive overall,
despite being expected to stop more affordable loans than unaffordable loans.
389
While this procedure allowed for a comparison of direct effects
of the rule, by design it did not
monetize
the effects for use in a full, quantified CBA. To do that, self-reported
well-being figures needed to be converted to pounds, to compare to other costs
and benefits. Nevertheless, the FSA exploited the happenstance that the effects
on
well-being
of loans’ falling into arrears were similar
in size to the effects of a person’s becoming unemployed, a condition more
easily monetized by reference to income data.
390
The bottom line was an average benefit of
350
per borrower over the period 2005 to 2010.
391
Added to this was an additional benefit of ten pounds per borrower in the form
of fees and repossession costs that the rules would have prevented.
392
Finally, the FSA estimated compliance costs for the new rules
at between 47 and 170 million pounds per year, for an average of
109 million per year, based on a combination of its
own survey of lenders, input from a consulting group (
Oxera
that conducted its own surveys, and internal FSA data.
393
Using the FSA’s discount rate of 3.5%,
394
one can derive a present value of compliance costs of between
1.3 and
4.9
billion. The FSA did not explain how it was able to relate the per-borrower
benefits it estimated from its main analyses to the per-year compliance costs
it estimated. However, it did present a per-borrower compliance cost (
120 per borrower), which can be related to its aggregate
average compliance cost estimate (
109 million
per year), to derive a per-year benefit from the earlier analyses of
300 million per year. Using the FSA’s 3.5% discount
rate, that annual amount has a present value of nine billion pounds. The
bottom line implicit in the FSA’s analysis, then, is a total benefit (net of
compliance costs) of six billion pounds.
Separately, the FSA used a macroeconomic (“
NiGEM
”)
395
model to estimate
effects of the rules on output. With many assumptions,
396
the model predicted six categories of sequential monetary impacts.
397
The long-run effects in the sixth category—increased output from increased
business investment—more than outweighed categories (such as reduced home
lending, home prices, and household consumption) that would reduce output in
the short run. The net effect was estimated at over
300
million more per year of output.
398
Using the FSA’s discount rate of 3.5%, the present value of this increase would
be nine billion pounds,
399
as much as
the total direct benefits. Yet elsewhere, without explanation or detail, the
CBA/FR stated it had not included output in its bottom-line summary of costs
and benefits because “the margin of error inherent in the estimation of the
macroeconomic impacts means that in reality this impact could either be
positive or negative.”
400
b. Assessing
the FSA’s CBA/FR
Any assessment of the FSA’s CBA/FR should begin by
acknowledging it is better as an academic exercise—more complex, detailed, and
creative—than anything yet produced by any U.S. financial regulatory agency. It
relies on academic working papers, several different datasets, and multiple
modeling techniques, and tackles a host of difficult estimation problems. It
actually attempts to quantify the
benefits
of a financial regulation—something that the rest of Part III shows
is
rarely done. If CBA/FR has a role to play in the United
States, the FSA’s CBA/FR is a useful example of a path forward, just as CBA/FR
advocates suggest by calling it the “gold standard.”
However, it should also be recognized that the FSA’s job here
was by many measures easier than that faced in other regulatory contexts. The
mortgage reforms were important and will have complex effects, but their
importance and complexity pale beside those of more general regulations such as
Basel III or the Volcker Rule. The mortgage reforms impose relatively light
mandates on the process and terms of one class of consumer financial product—an
important class, to be sure—but one that is considerably simpler than, for example,
swaps or even common stock issued by a variety of public companies with a
variety of governance arrangements and disclosure practices. A home mortgage is
a loan, with clear and definite terms, and a limited set of straightforward
purposes. Other important transactions have similar characteristics—consumer
loans, credit card loans, student loans—and regulations of those markets are
also likely to be more tractable for CBA/FR than the more complex regulations
reviewed here.
401
Despite being in a simpler regulatory context, a review of
the FSA’s CBA/FR of its mortgage reforms nevertheless shows how fragile and
unreliable the analysis remains, and how susceptible such CBA/FR is to being
used as camouflage, rather than as discipline—particularly as it gets more
complex and ambitious (as it will have to do to approach the goals that its
advocates have for it). Below is a short list of weaknesses in the FSA’s CBA/FR
that illustrate both its shortcomings and how it could just as easily mislead
as inform the public.
First, the FSA is clear in its exposition that it used
judgment in a number of crucial places. Examples include: (1) it created its
own loan impairment model, where its staff effectively chose their own
underwriting criteria, rather than relying on industry models, due to data
limitations; (2) it chose where the new rules would begin to bind on lending
decisions, using visual inspection of a figure rather than more quantitative
methods; and (3) it chose how to “weight” the well-being results given the
multiple comparisons it had with its data. Another important judgment the FSA
made was to ignore the output of its macroeconomic modeling, as noted above,
despite the fact that the net benefits on output of the rules were comparable
to the direct benefits to borrowers. Each of these decisions, while defensible,
required judgment.
Second, the FSA’s entire well-being analysis, which is its
core method for estimating the effects of the rules, was usable only because of
the happenstance that its output could be related to unemployment data. If the
net effect on well-being had been significantly larger or smaller, this method
would have been unavailable, and the FSA would have had to use another method
to monetize the well-being effects, something that is—as the FSA noted—“notoriously
problematic.”
402
This difficulty calls into question
the viability of this “gold standard” CBA as a model for the future.
Third, the FSA made a number of assumptions that affected its
CBA: (a) it assumed that loans would not be made if they were reduced by thirty
percent in size (an arbitrary figure) due to the new rules, but would be made
otherwise;
403
(b) it assumed that delayed loans would never be made;
404
(c) it assumed that repossession had no effects on well-being distinct from
default, because it had too few observations in its well-being dataset to
estimate a different effect;
405
(d) by using
a fixed effects model to generate causal inferences about loan rules and
well-being, it assumed that unobserved variation in individual respondents does
not co-vary with home-related events;
406
(e) it assumed that data from 2006 to 2011—a period of concededly low and
falling interest rates—predicts future home market conditions;
407
(f) it implicitly assumed that its modeling of the effects of Basel III were
correct, but as discussed in Part III.C above, that is a fragile assumption;
(g) it estimated compliance costs from a small survey (
=15, response rate 60%) of firms that would be subject to the new
rules, resulting in potentially biased data;
408
and (h) it assumed that the social cost of transfers represented by
repossessions and
resales
of repossessed homes (as
opposed to the transaction costs of those events, which it did estimate) was
zero.
409
Each of these assumptions is defensible as a matter of regulatory discretion,
as each simplified the analysis or coped with data limits. Together, however,
they demonstrate the lack of reliability or precision in the overall analysis.
Two other strong assumptions are nowhere discussed or
explained in detail: that all “unaffordable” loans would produce only social
losses, and that all “affordable” loans would produce only social gains. Both
assumptions seem dubious. Some loans that turn out to be unaffordable represent
gambles by borrowers that turn out badly, but which, ex ante, even on a fully
informed basis, the borrowers would take again. The new rules will likely
prevent those gambles, and while one can make good arguments in favor of
preventing such gambling, at least some normative approaches to welfare
analysis would treat preventing informed consumers from making knowing gambles
as a welfare harm. Some loans on which borrowers never default are nevertheless
the product of avoidable misunderstandings by borrowers, and others are the
product of deception and fraud by lenders: the fact that a borrower chooses not
to default on such a loan does not imply that the borrower would take it out
again, were the borrower adequately evaluated and warned about the loan’s
potential risks. Indeed, the FSA’s own data showed that many non-defaulting
borrowers experienced high levels of stress and difficulty in making payments,
suggesting that they may regret their loans. The new rules will likely reduce
some of those loans, but none of the associated increase in
well-being
was counted in the FSA’s analysis. Nowhere does the FSA identify these possibilities
in a clear manner, and the technical language in which it presents its
well-being analysis may prevent many readers from even understanding the
assumptions that have been made, much less appreciate what effect they have on
the bottom line.
Finally, despite the relative merits of the substance, the
FSA’s presentation is not a model of clarity or candor in other respects. The
assumptions listed in the two paragraphs above are not collected in one place
in the FSA’s paper, but are mentioned in scattered locations, or are not
explicitly noted at all. The sensitivity of the bottom-line results of the
CBA/FR to important assumptions is not made clear.
410
For example, the FSA does show that parts of its analysis are sensitive to
assumptions
about future levels of lending activity. It
does so by breaking its historical data into two sub-periods: the “boom” period
of the 2000s, when the new rules would have affected between 1.7% and 10.5% of
borrowers, and the “subdued” period after the collapse, when they would have
affected no more than 0.4% of borrowers.
411
Similarly, the FSA shows that in the subdued period, seven percent of borrowers
who would have been affected by the reforms faced actual impairment in its
historical data, while thirty percent would have faced impairments in the boom
period.
412
The FSA does not, however, translate this sensitivity into bottom-line effects
on benefits (gross or net). It does not present sensitivities to most of the assumptions
discussed in the prior two paragraphs, and because it does not translate
per-borrower benefits from its well-being analysis into present values, it does
not allow readers to compare those benefits with the possible range of macroeconomic
effects of the rules.
In sum, it is not clear that this “gold standard” CBA/FR,
while distinctly more ambitious and interesting than other examples of CBA/FR,
was a net benefit to an assessment of the mortgage rules. The FSA’s analysis is
thought-provoking
and may represent a step on a path
toward regulatory capacity to use CBA/FR to generate outputs that can help the
public assess the value of regulations such as the mortgage rules.
Nevertheless, the bottom line of the FSA’s CBA/FR depends on assumptions and
limited data to such an extent that, with equally plausible assumptions or
different data, it could have come out with a different sign or order of
magnitude attached to it. The FSA does include a number of disclaimers precisely
to this effect—writing that “certain data, for example on relevant households’
expenditure, are not available . . . [such that] this CBA has been unusually
difficult to prepare [and led to a] wide margin of uncertainty around its
results.”
413
Elsewhere, the FSA notes that the analysis “is inherently highly uncertain,”
with the result that “[
t]o
a significant extent . . .
the decision on whether to proceed with the proposed rules has to be based on
social and political judgments.”
414
And further: “It is extremely difficult to identify exactly how the responsible
lending requirements will change borrowing in the market or the likely scale of
this. It requires some
judgemental
assumptions on the
basis of imperfect evidence.”
415
None of this
would be apparent to anyone reading U.S. white papers advocating CBA/FR legal
reform.
416
Therefore, the FSA’s CBA of its mortgage rules came with some unquantifiable
cost in increasing misunderstandings of what CBA/FR is capable of, while failing
to improve the public’s ability to evaluate the merits of the rules or achieving
any other obvious benefit. It is an example of why quantified CBA/FR should not
be mandated, rather than an example of why it should be.
F. Summary
of Case Studies
The substantive rules reviewed in the foregoing case studies
are summarized in Table 4.
Table 4.
summary
of case studies
As reflected in Table 4, the case studies range across
representative regulatory instruments
417
disclosure
(SOX 404),
governance
(mutual fund rules),
capital
regulation
(Basel III), and
activity
limits
(Volcker Rule). The cross-border swaps rules cover a large number of
regulatory instruments, including disclosure and capital requirements, but also
rules requiring
segregation
risk management
margin limits
, and
fair
dealing
. The mortgage reforms represent a final, important category of financial
regulation—consumer protection, in the form of required
process
and constraints on
contract
. The rules’ benefits range across public goods pursued by financial
regulation: more competition, fewer systemic crises and harmful conflicts of
interest, and reduced levels of asymmetric information.
418
Table 5.
challenges
for possible or actual efforts at
guesstimated
cba
fr
in case
studies
Table 5 summarizes the conclusions of the case studies on the
feasibility of quantitative CBA/FR. As can be seen, it shows that any
substantial financial regulatory rules will face one or more of five serious
challenges: (1) data limitations, (2) causal inference challenges, (3) the need
to incorporate judgmental macroeconomic models, (4) the need to incorporate
even more judgmental policy/political models, and (5) the need to make
contestable, judgmental assumptions or modeling choices that have large effects
on the outputs of the analysis. Not every challenge is as acute for every kind
of rule—political/policy modeling is probably not a first-order component of an
analysis of an anti-fraud or governance rule, for example. But all rules face
data challenges and are highly sensitive to assumptions; all face causal
inference challenges more severe in kind than the ones faced in many
non-financial contexts (as discussed more in Part IV); and most require the analyst
to embed (explicitly or not) a macroeconomic model of the same judgmental
nature as that used in setting monetary policy.
The central conclusion of the case studies is that
quantitative CBA/FR is not currently feasible with any degree of precision and
reliability for representative types of financial regulation. Anything
presented as quantified CBA/FR is in fact judgmental in nature, not an actual
alternative to judgment but rather its equivalent in numerical form—“judgment
in disguise.” Such quantitative CBA/FR as has been done is better understood as
“guesstimated,” and has been presented without clear disclaimers and
sensitivity analyses. As a result, it is more likely to mislead and camouflage
than inform or discipline. The only kind of CBA that is currently feasible for
representative types of financial regulation is conceptual CBA, augmented by
limited elements of quantified evidence that will be more illustrative than
disciplinary.
IV. what are the implications of these case studies?
The case studies in Part III suggest that the capacity of
anyone—including financial regulatory agencies, OIRA, academic researchers,
CBA/FR proponents, litigators, and courts—to conduct quantified CBA/FR with any
real precision or confidence does not exist for important, representative types
of financial regulation. This Part discusses the reasons for and implications
of this conclusion.
A. Why
Is Quantified CBA/FR So Unreliable?
A straightforward implication of the case studies is that
efforts by the financial agencies at quantified CBA/FR will for the foreseeable
future produce only
guesstimation
Back-of-the-envelope guesses at ranges of magnitudes are currently feasible,
but precise and reliable estimates are not. Too many variables are in play for
any given rule, and too many contestable assumptions are required, for anyone
producing or consuming guesstimated CBA/FR to have any confidence in any
specific estimate of costs or benefits, even if expressed in ranges or bounds.
419
While guesstimated CBA/FR can draw on social scientific disciplines, such as
financial economics, and while the agencies themselves may reasonably attempt
quantified CBA/FR on occasion as a way of helping analysts better understand
the implications of a given regulation, quantified CBA/FR will not be
replicable, reliable, or predictive.
CBA/FR should be understood not as science but as
number-laden guesswork, and should be treated as such by the public,
regulators, and courts. While
guesstimation
can be a
legitimate part of decision making, as one input into a judgmental choice, it
should not “guide” policy except in the loosest sense. Basing policy on
specific quantitative outputs would simply be a poor exercise of judgment.
This conclusion—that quantitative CBA is not a good basis for
setting policy—may contrast with practice in other regulatory domains, where
quantitative CBA appears to be used in setting policy.
420
Possibly the conclusions generated by these case studies might be generalizable
to some non-financial domains. But it is worth considering whether there are
features of CBA/FR that make it more difficult to perform effectively than CBA
in other domains, at least when considering “typical” financial and
non-financial regulations. While this topic warrants considerably more analysis
than is provided in this Article, here are three tentative explanations for why
CBA/FR is so hard, with the recognition that some of what follows may also
characterize some non-financial domains, at least in part.
421
1. Finance
Is Central to the Economy
Part of the explanation for how far we are from reliable and
precise quantified CBA/FR estimates is that finance is at the heart of the
economy. Any change in regulation with a material impact on finance will have a
material impact on the economy, and large and complex effects on welfare.
Recall from Part III.E.2 that the FSA’s mortgage reforms—relatively simple
consumer protection regulations on the surface—were conceptually identified as
having multiple, complex effects on the
macroeconomy
422
They would cut home lending, lower home prices, reduce consumer spending,
increase consumer saving, reduce consumer borrowing, and increase business
lending and investment. The FSA used one of a large family of materially
different but respectable macroeconomic models to derive a positive net effect
of $9 billion, which it then claimed it was ignoring as too unreliable. Many
rules would have more complex effects.
Macroeconomic models that include finance are still highly
contested. They are the stuff of newspaper op-eds and blogs as much as
consensus models in academic journals.
423
The ripple effects of financial regulation are too large and complex, relative
to its direct effects, to allow for reliable predictions of net effects. As
noted in Part I.D, this reason explains why even CBA proponents concede that
monetary policy should remain unregulated by CBA laws. What advocates have not
grasped, but Part III shows, is that important financial regulation is always
likely to interact with the economy—perhaps not to the same extent as
quantitative easing, but with enough impact to generate large (and uncertain)
effects on economic growth.
By contrast, consider the Department of Transportation’s
proposed rule to increase rear visibility in motor vehicles.
424
While there were uncertainties associated with estimating the rule’s
benefits—owing to the question of whether to value children differently than
adults—and the costs—owing to the possibility that compliance costs might fall
over time and to the appropriate discount rate to use in estimating future
costs—estimating neither costs nor benefits required a macroeconomic model.
425
Indeed, it is hard to imagine a financial regulation important enough to
warrant significant CBA/FR costs that would be as simple to model as this rule.
Yet this rule is typical of many non-financial regulations, which generate
direct compliance costs and result in straightforward improvements in safety,
with few knock-on systemic effects.
2. Finance
Is Social and Political
A second reason why quantitative CBA/FR is hard is that the
main units of variation and change in finance are not things, or even
individuals, but
groups
of
people—groups with not only economic but also social and political relations. Finance
is about firms, corporations—groups of people coming together to form and fund
a business—and financial markets—groups of people routinely trading
intangibles. These features of finance can be contrasted with some
non-financial domains, where objects of regulation are inanimate (for example,
chemicals, rear-facing car cameras) and regulations are designed to achieve
relatively simple ends (for example, changing the frequency and intensity of
the use of identified chemicals, or requiring installation of cameras). While a
chemical can interact with the environment in ways that are challenging to model
and predict, those interactions are generally simpler than interactions of
groups of humans. Every human possesses agency and interacts with others in
non-linear, unpredictable ways. As stated by one theoretical physicist,
“Computational approaches [to modeling] have been very useful in physics because
the knowledge of microscopic laws constrains theoretical modeling in extremely
controlled ways. This is almost never possible for socioeconomic systems.”
426
Chemicals can also be subjected easily to randomly controlled
experiments, but experiments are more difficult for humans and are frequently
not feasible for groups. Because finance affects the economy, modeling policy
also becomes necessary to quantify effects of financial regulation; finance is
more routinely and powerfully political than chemistry. Part of evaluating the
costs of a crisis, as Part III showed, requires predicting how governments will
respond. No similar efforts are required for most typical non-financial
regulations.
427
3. Finance
Is Non-Stationary
A third reason that may help explain why quantified CBA/FR is
hard is that underlying regularities that enable quantification are commonly
“non-stationary” in finance—more likely to change over time than in other
domains. The proverbial “rocket science,” for example, uses relatively simple
models of inert objects moving through space, with key inputs—such as the
gravitational constant and gravitational acceleration
428
—that
do not change.
429
By contrast,
most relationships in finance change through time, often rapidly. Consider the
striking decline from 1978 to 1999 in the dividend payout ratio or the steady
fall since 1930 in the ratio of directly to institutionally invested stocks in
U.S. retail portfolios, both changes with large implications for the costs and
benefits of many financial regulations.
430
One reason for the greater degree of non-
stationarity
in finance is that finance is non-physical, such that technology shocks have
larger and more unpredictable effects on optimal financial choices. This point
is reflected in the case studies in Part III: new technologies of derivatives
and securitization were significant causes of the last crisis,
431
which gave rise to several of the rules reviewed. While technological progress
affects all regulatory domains, physics, chemistry, and biology are more
central to non-financial regulation than to financial regulation, and
regularities uncovered in those disciplines have proven more durable than those
found in finance. As summarized by the same physicist quoted above:
Nature has been there since ever, but it has taken
centuries to develop a reasonable understanding of little parts of it. Many of
the
things which are traded nowadays in financial markets
did not exist few decades ago, not to speak of internet communities. In
addition, we face a situation in which the density and range of interactions
are steadily increasing, thus making theoretical concepts based on effective
non-interacting theories inadequate.
432
No doubt there are other explanations
for why quantitative CBA/FR is so unreliable; some have to do with historical unwillingness
of the financial agencies to invest sufficiently in the task. No doubt, too,
there are areas of non-financial regulation in which science is weak, and CBA
there, too, cannot be reliably used as a strong guide for regulation. But the
problems in financial regulation are real and likely to persist for the
foreseeable future.
B. New
CBA/FR Mandates Should Be Passed Only If CBA/FR Satisfies CBA
A second implication of the case studies in Part III is that
new legal mandates for CBA/FR such as those reviewed in Part II are a bad idea,
at least until CBA/FR can be shown to pass its own test—that is, to be likely
to result in benefits that outweigh its costs. It is hard to understand how any
CBA advocate could argue to the contrary. Instead, CBA/FR should be conducted
only to the extent and in the manner the expert agencies choose, since they are
in the best position to decide whether CBA/FR will be, in a given instance,
likely to pass its own test. This conclusion is particularly true when it comes
to quantified CBA, because of how unreliable quantified CBA/FR remains. CBA/FR
law’s purpose—to discipline agencies and reduce agency costs—will not be furthered
by forcing analyses that amount to no more than
guesstimation
and camouflage—again, “judgment in disguise.”
Conceptually, what would the benefits of CBA/FR be, given the
conclusion of Part III? If CBA/FR were precise and reliable, it might
generate the benefits of disciplining agencies, informing the public through
increased transparency, and counteracting cognitive biases faced by the
agencies. But CBA/FR’s benefits have been low, and are likely to remain low,
for the reasons sketched in Part IV.A above: CBA/FR is by definition about
finance—and finance is at the heart of the economy; is social and political;
and is composed of non-stationary relationships that exhibit secular change.
These features undermine the ability of science to precisely and reliably
estimate the effects of financial regulations, even retrospectively. Whenever
agencies face such sensitive and speculative forecasting abilities, quantified
CBA is not capable of disciplining regulatory analysis, and it will generate
low benefits.
The analysis is even worse for CBA/FR mandates when one
focuses not only on the abstract benefits they might create but also on the
marginal
benefits they might create—over the baseline of the status quo.
Other constraints—the general goals of the agencies, the screening and
socialization of the agency staff, and the political oversight of the agencies
by Congress, through confirmations, budgets, hearings, and public criticism of
the sort reviewed in Part II—will prevent new regulation or deregulation that
is so extreme in generating costs without offsetting benefits that it could not
be justified by the current art of guesstimated CBA. Within the range of
plausible regulatory action set by those other constraints, the financial
agencies retain too much discretion to select inputs and make assumptions in
CBA/FR, meaning that numbers that emerge in any effort at quantification are
unlikely to demonstrate whether a proposed change is net beneficial. Worse, the
goal of disciplining agencies may be undermined if the result is to encourage
agencies to use CBA/FR as camouflage—to hide discretionary judgments under
impressive numbers.
As discussed more in Part IV.D below, CBA/FR remains a useful
conceptual framework, quantified CBA/FR is a worthy long-term research goal,
and
attempts
to quantify may advance
the research needed to achieve reliable, precise estimates, making it a
worthwhile project for agencies to pursue, in parallel with their other
activities.
433
But the current benefits of CBA/FR remain low, because its real effects remain
far off in time; like any regulatory benefit, the benefits of these real
effects should be discounted to present value. Moreover, CBA/FR will produce
costs—resources consumed, regulatory delay, diffusion of regulatory focus, and
potential decreases in regulatory transparency—particularly if regulatory
agencies and any courts involved in reviewing agency action do not have good
incentives to be honest about the limits and uncertainties of the results.
Empowering courts to review even
conceptual
CBA/FR policy analysis is likely to be a bad idea.
Judicial review is not likely to generate any significant improvement in CBA/FR
itself, as agencies will likely respond to the threat of such review by hiding,
not exposing, the weaknesses in their analyses. Nothing produced by the back-and-forth
between the SEC and the D.C. Circuit over the mutual fund rules reviewed in
Parts II and III meaningfully advanced public understanding of the qualitative
costs and benefits of requiring more independent fund boards; the compliance
costs on which the
Chamber of Commerce
court focused were minor even by the lights of the Chamber of Commerce itself.
434
The SEC’s cross-border swap CBA, reviewed in Part III.E, provides a clear
picture of how little the threat of such review will accomplish, relative to
what conceptual CBA voluntarily presented by an agency might do.
Mandating an open interagency process for CBA—such as
requiring a financial agency to publish not only its CBA but also the views of
OIRA on its CBA—will also worsen outcomes.
435
The result will be a bigger record that will continue to be largely ignored by
the public but used by litigators to pick at particular agency judgments as
arbitrary and capricious under the APA. The benefits such a mandate might
achieve can already be achieved if the financial agency sees the process as
valuable, as evidenced by the voluntary cooperation between the CFTC and OIRA
during the Dodd-Frank Act rollout.
436
The cases reviewed in Part II show how aggressive some D.C. Circuit panels have
been in using such review to overturn agency actions, particularly when an
agency’s commissioners have been divided in making any regulatory change. Trebling
the number of pages or components of CBA available for judicial
second-guessing, and adding the possibility of interagency disagreement to the
mix, will incite more interventions, with no clear benefit to anyone other than
litigators.
437
More extensive judicial review will have other pernicious
consequences. Not only will agencies rationally use CBA/FR as camouflage, but
they can also be expected to go to Congress to lobby for the establishment of
rules through detailed congressional mandates, which will likely receive
greater deference from courts than rules adopted pursuant to congressional
delegations of discretion to achieve general goals.
438
Both the litigation and the shift towards congressional mandates will produce a
general slowdown, not just of regulation, but also of deregulation and
regulatory reform, and will likely increase partisan polarization in and
deterioration of public opinion of the very courts charged with that review.
The CBA of CBA just sketched is preliminary and incomplete.
Completing a CBA of CBA would require evidence: quantitative studies of the
degree to which CBA results in better regulations and more transparency in the
regulatory process, as well as quantified estimates of the costs—delay,
confusion, camouflage, partisanship—that CBA can introduce. Until evidence is
developed to illuminate when CBA/FR passes its own test, we must rely on
judgment, just as agencies must when they regulate. As currently informed by
the poor results of judicially reviewed CBA/FR (discussed in Part II), it is
hard to see how laws that give courts a greater role in second-guessing the
choice of when to conduct CBA/FR, or the details of CBA/FR when it is used,
could be judged a good idea.
439
C. Existing
CBA/FR Laws Are Little Better in Practice
A final implication of Part III is that existing
interpretations of the APA and the financial agencies’ governing statutes
should be restored to their state prior to
Chamber
of Commerce
, to reduce the influence of concentrated interests through litigation
and of politically partisan but unaccountable judges on regulatory outcomes. As
shown in Part II, the D.C. Circuit’s new interpretations of the APA have
permitted (some) panels to overturn regulatory changes on the ground that a
court would conduct its guesstimated CBA differently than an agency’s
guesstimated CBA/FR. As shown in Part III, the state of CBA/FR is such that one
can reasonably argue that all guesstimated CBA/FR of major financial
regulations inevitably will contain multiple arbitrary assumptions and
judgments simply in order to allow for rough guesstimates to be made. A legal
system that simultaneously requires arbitrary judgments by agencies, and then
allows them to be overturned by a court for being arbitrary, depending on which
panel of the D.C. Circuit is randomly (that is, arbitrarily) chosen, is
self-evidently indefensible.
440
Even if one agrees with a given court that a given rule
represents bad policy (as I do with respect to the fund governance rules
reviewed in Part III.B), better means exist for those affected by such rules to
protect their interests, such as through the legislative process or by
developing regulatory proposals to await a new set of regulators—who, after
all, are more frequently replaced by politically accountable Presidents than
are the judges on the D.C. Circuit. In sum, the current, erratically applied
law of CBA/FR raises agency costs as between citizens and their political
agents, rather than lowering them as CBA/FR is supposed to accomplish.
Often, the current state of the law on CBA/FR of financial
regulation is perceived in simple partisan terms—Republican judges will strike
down regulations adopted by regulators appointed by a Democratic President—and
this is viewed as good by Republicans (and financial institutions) and bad by
Democrats (and individual investors and bank customers). But in a few years the
same unfortunate dynamic may reverse, with Democratic judges striking down
deregulatory changes adopted by regulators appointed by a Republican President.
Regardless of the current state of partisan power sharing, or of one’s political
inclinations, it should require more theory and evidence than CBA/FR proponents
have developed to leave financial regulation wrapped in the unlovely arms of
litigators and the partisan lottery that is the D.C. Circuit.
441
To remedy the situation, two recommendations made by Kraus
and
Raso
for the SEC
442
should be extended to all financial agencies. First, an exemption from the
“sunshine” laws
443
should be
added to permit closed-door, pre-decisional discussions of CBA/FR among
financial agency commissioners, between commissioners and the economic staffs
of the agencies, among the agencies, and between the staffs of the agencies and
the staffs of OIRA and the OFR. Until CBA/FR is considerably more developed,
such deliberations are best conducted in a setting that encourages candor and
creativity, rather than defensive camouflage and obfuscation in anticipation of
litigation or requests under the Freedom of Information Act.
444
Such a reform would likely increase the willingness of agencies to comply with
existing requirements under the CBA Executive Orders
445
that they submit CBA of their annual regulatory agendas to OIRA, requirements
that have long been given short shrift by the financial agencies.
446
Second, a “safe harbor” for CBA/FR should be added to the APA
and the financial agencies’ governing statutes. The safe harbor can be modeled
on the CRA,
447
which courts have interpreted as barring judicial review of agency compliance
with the statute, including agency determinations of whether a rule is “major.”
As Kraus and
Raso
put it, “private litigants must not
be allowed to throw [CBA/FR] back at the agency as ‘party admissions against
interest,’ undermining the validity of the very rules that the analysis
informed.”
448
Anyone genuinely interested in fostering CBA/FR should recognize that, with the
current, politicized D.C. Circuit only likely to become more polarized after
the elimination of the filibuster, the absence of such a safe harbor may well
lead agencies to be overly cautious, long-winded, and opaque in their
CBA/FR—lawyerly virtues, not economic ones.
D. CBA/FR
Remains a Potentially Valuable Component of Policy Analysis
A naïve response to the case studies in Part III would be to
jettison CBA/FR altogether. If CBA cannot generate reliable, precise estimates
of costs and benefits, one might conclude that it has no value, even as a discretionary
component for policymaking. If CBA/FR cannot produce reliable quantification,
then it has only costs and
no
benefits. This response would be a mistake for four reasons. First, it is
possible that some financial regulations are susceptible of quantified CBA/FR.
There may be some relatively simple financial regulations in which the costs
and benefits will be more straightforward to estimate reliably, particularly if
the regulations are implemented in a careful way and combined with a
retrospective CBA/FR. The case studies in Part III are only a sampling of
rules.
Second, conceptual CBA/FR remains the best available
overarching framework for organizing and communicating the pros and cons of a
proposed regulation. Conceptual CBA/FR is a commonsense way to begin the
analysis necessary to evaluate a proposed rule by comparing it to the status
quo and plausible alternatives. Indeed, it is hard to imagine conducting any
sort of policy analysis without at least engaging in tacit conceptual CBA/FR.
Organizing analysis in a conceptual CBA framework will provide some benefit for
public understanding, even if the benefit is modest, and even if the negative effects
of guesstimated camouflage can easily overwhelm that benefit.
Third, CBA may have effects other than the conventional set
outlined in Part I.C (discipline, transparency, and camouflage). CBA
guidelines, such as those in the OMB Guidance,
449
also serve a brainstorming function, as a checklist to prompt analysts to be
more creative in regulatory design and evaluation. Precisely because conceptual
CBA is not an entrenched and exclusive piece of any one agency’s historical
lore, evaluating regulatory proposals within a CBA framework can open up new
channels of thought and nudge regulators beyond a baseless enthusiasm for tried
but perhaps less helpful models of regulation. Conceptual CBA involves a common
language and mode of thought that could facilitate interagency dialogue by
floating above any one statutory mandate or set of agency-specific regulatory
goals. Such dialogue can improve thinking about CBA-related problems (for
example, how to phase in or randomize regulation so as to generate useful information
while meeting legitimate expectations about equal treatment under the law).
450
Thinking through conceptual CBA for a rule can lead to novel insights about how
the rule is (or is not) similar to rules issued by other agencies, or how it
might generate unintended consequences.
Fourth and most broadly, and with the greatest potential
value, conceptual CBA/FR can facilitate improvements in quantified CBA/FR.
Quantified CBA/FR, after all, would be highly valuable if it could generate
precise and reliable estimates of the social costs and benefits of a regulatory
change. Anything that promotes the long-term research agenda needed for
reliable, precise quantitative CBA/FR has high potential value. To pursue that
agenda, it would be useful for financial agencies to frame the questions that
they face in evaluating regulations in terms of conceptual CBA, so as to stimulate
and guide research. Research in economics, sociology, psychology, and other
relevant fields proceeds along paths that are not random, but shaped by
incentives, social cues, and psychological rewards. If agencies ask pointed
research questions in their rulemaking proposals, they will encourage private
researchers to answer those questions. Private actors with an interest in the
answers may fund such research; tenure can be granted in part on the ground
that an academic has answered a socially valuable question; and grant proposals
are more likely to be funded if they relate to research topics that have direct
potential value to regulatory agencies.
For conceptual CBA to be useful in this way, however, careful
attention must be paid to institutional details, where the devil always lurks.
Conceptual CBA/FR will not be useful in stimulating thought or guiding research
if it consists of a simple, abstract list of the benefits and costs of a
category of regulations. For example, it is correct in most instances for the
SEC to include in the category of qualitative benefits “investor protection”
and “investor confidence,” but it would be useless to leave things at that.
How, precisely, does a rule improve confidence—through which channels? How does
improved confidence constitute a social benefit—how does it affect the cost of
capital? Nor will conceptual CBA/FR be useful if it consists of lengthy and
opaque boilerplate circumlocutions designed to deflect or confuse judicial
review rather than actually communicate to researchers or those who fund,
evaluate, or publicize research.
A review of CBA conducted by the financial regulatory
agencies demonstrates that fleshing out the benefits of financial regulation is
a largely incomplete conceptual task, one that I hope the case studies in
Part III will help advance. Similarly, indirect or systemic costs of
regulation remain undeveloped. CBA/FR proponents have a strong point when they
mock past CBA/FR efforts as exercises in “paperclip counting.”
451
Those who are unhappy with the financial agencies are striving to promote
quantified CBA through law in part because they rightly worry that regulatory
practices that focus only on easily quantified subsets of costs in isolation
will achieve little good.
The question, then, is how to encourage financial regulators
to engage in meaningful, detailed conceptual CBA for its own sake—which should
enhance public understanding and may also assist regulators themselves—but also
because more and better conceptual CBA should stimulate research on quantitative
CBA by making more apparent the key quantities to be estimated, and so by
stimulating academics to think harder about research designs that would permit
that quantification. How can lawmakers or law affirmatively encourage the use
of conceptual CBA to stimulate thought and innovation? While a detailed set of
proposals is beyond the scope of this Article,
452
suffice it to say here that the challenge is primarily managerial, not
methodological, a challenge not susceptible to simple legal commands or
conventional judicial review. The challenge is not going to be met by
specifying in meta-regulations methods to be used to conduct CBA/FR, but by
using law and the lawmaking process to encourage expert agencies to better
manage their resources and rulemaking processes in the short run—with the
long-run goal of facilitating reliable, precise, quantified CBA/FR.
Conclusion
This Article has attempted to fill a significant gap in
writing about CBA. It has shown how CBA/FR analysis would be conducted if—as
advocated by some members of Congress, the D.C. Circuit, and legal academia—the
law extended the current requirements that executive agencies engage in CBA to
financial agencies, and required those agencies to produce as part of their rulemaking
quantified CBA that could be subject to review under the requirements of the
agencies’ authorizing statutes and the APA. Detailed case studies of six rules
reveal that precise, reliable, quantified CBA remains unfeasible. Quantified
CBA of such rules can be no more than “guesstimated,” and is not a true
alternative to expert judgment—it is simply judgment in (numerical) disguise.
As a result, for the near future, at least, judicial review of quantified CBA
of financial regulation is not likely to generate benefits that exceed its
costs. Until CBA/FR passes CBA’s own test, no new legal mandates should be
adopted to require such review and more serious attention should be given to
how to improve the capacities of the agencies to improve the reliability and
precision of CBA in practice.
Throughout, I use the awkward acronym “CBA/FR” to flag that the analysis focuses on CBA of fina…
Throughout, I use the awkward acronym “CBA/FR” to flag that the analysis focuses on CBA of financial regulation, and that my conclusions may but do not necessarily carry over to CBA in other regulatory domains Part IV.A,
infra
, discusses potential differences between financial and other regulation.
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub
L. No. 111-203, 124 Stat. 1376 (201…
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub
L. No. 111-203, 124 Stat. 1376 (2010) [hereinafter Dodd-Frank Act].
A trade group recently sued to enjoin the most prominent rule under the Dodd-Frank Act, the Volcker Rule, in part on grounds that the agencies ignored economic effects of one small part of the rule on small banks. Matthew Goldstein & Peter
Eavis
Banks’ Suit Tests Limits of Resisting Volcker Rule
N.Y. Times:
DealBook
(Dec. 24, 2013, 8:13 PM),
[http://perma.cc/Y78M-CKY7]. For the plaintiff’s motion for an emergency stay in the case, see Emergency Motion of Petitioners for Stay of Agency Action Pending Review, Am. Bankers
Ass’n
v. Fed. Reserve, No. 13-1310 (D.C. Cir.
Dec. 24, 2013).
On the current state of the law of CBA/FR, see
infra
Part II.A; for a discussion of the Volcker Rule and the trade group’s lawsuit, see
infra
Part III.D.
See
Regulatory Tracker
Davis Polk & Wardwell LLP
, http://www
davispolk.com/dodd-frank/regulatory-t…
See
Regulatory Tracker
Davis Polk & Wardwell LLP
davispolk.com/dodd-frank/regulatory-tracker
[http://perma.cc/G7PQ-5LHZ]
See, eg.
Comm. on Capital
Mkts
. Regulation
A Balanced Approach to Cost-Benefit Analysis Reform 3…
See, eg.
Comm. on Capital
Mkts
. Regulation
A Balanced Approach to Cost-Benefit Analysis Reform 3, 9
(2013) [hereinafter
CCMR Report
] (citing the Dodd-Frank Act as the reason for Congress to pass a law requiring CBA by independent agencies and noting that “the SEC and the CFTC still often fall short of conducting meaningful cost-benefit analysis of new regulations”);
see also
Hester Peirce,
Economic Analysis by Federal Financial Regulators
, 9
J.L. Econ.
Pol’y
569 (2013).
See, for example, the Independent Agency Regulatory Analysis Act of 2013, S 1173, 113th Cong., des…
See, for example, the Independent Agency Regulatory Analysis Act of 2013, S 1173, 113th Cong., described
infra
Part II. For other bills, see
infra
note
144
CCMR Report,
supra
note 4, at 4 (using legislative history to argue that the National Securities M…
CCMR Report,
supra
note 4, at 4 (using legislative history to argue that the National Securities Markets Improvement Act of 1996, Pub L. No. 104-290, 110 Stat. 3416 (codified as amended in scattered sections of 15 U.S.C.) requires the SEC to conduct CBA based on the statutory requirement that the SEC consider “efficiency” as one of a number of factors in rulemaking);
Paul Rose & Christopher Walker
Ctr. for Capital
Mkts
. Competitiveness,
The Importance of Cost-Benefit Analysis in Financial Regulation
24-33 (2013) [hereinafter
CCMC Report
]. Critics also point to an efflorescence of decisions by the D.C. Circuit striking down SEC regulations as “arbitrary and capricious” under the Administrative Procedure Act (APA), 5 U.S.C. §§ 500-596 (1946), because of the agency’s failure to “consider” certain costs as part of its “efficiency” analysis; these cases are discussed in Part II below. Critics also note that the Commodity Exchange Act, Pub. L. No. 74-675, 49 Stat. 1491 (1936) (codified as amended at 7 U.S.C. §§ 1-27f) requires the CFTC to “consider the costs and benefits” of its regulatory actions.
Id.
§ 19(a)(1).
The Consumer Financial Protection Bureau is required to consider the “potential benefits and costs” as part of its rulemaking authority.
Dodd-Frank Act § 1022.
Bus
Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
I discuss this case in more detail in Part …
Bus
Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
I discuss this case in more detail in Part II below.
See infra
notes
114
125
and accompanying text.
The decision was written by Judge Douglas Ginsburg, joined by Chief Judge David
Sentelle
and Judge Janice Brown,
each appointed by a Republican President. Commentators have extensively criticized this decision,
see
infra
note
114
, but it remains a binding precedent. For completeness, I note that the U.S. Chamber of Commerce, a party to the case, paid two professors who wrote a report defending the decision.
See
CCMC
Report
supra
note 6, at ii (discussing “financial and administrative support” for the report).
Nat’l
Ass’n
of Mfrs v. SEC, 956 F. Supp. 2d.
43 (D.D.C. 2013),
aff’d
in part
, 748 F.3d 18 (D.C. Ci…
Nat’l
Ass’n
of Mfrs v. SEC, 956 F. Supp. 2d.
43 (D.D.C. 2013),
aff’d
in part
, 748 F.3d 18 (D.C. Cir. 2014). The trial court decision was by Judge Robert L. Wilkins, who was subsequently nominated to the D.C. Circuit by President
Obama,
only to have his nomination filibustered by Senate Republicans. Todd
Ruger
Senate Blocks Robert Wilkins’ Nomination to D.C. Circuit
Legal
Times: BLT
(Nov. 18, 2013, 6:44 PM),
[http://perma.cc/75P8-PYM6]. This occurrence helped prompt the Senate to abolish filibusters of lower court appointments. Jeremy W. Peters,
In Landmark Vote, Senate Limits Use of the Filibuster
N.Y. Times
, Nov. 21, 2013,
[http://perma.cc/68ME-L8VL]. Judge Wilkins was confirmed to the D.C. Circuit under the Senate’s new rules. Pete
Kasperowicz
Senate Confirms Third Judicial Nominee
The Hill
(Jan. 13, 2014, 6:22 PM),
[http://perma.cc/6GA5-84ZW]. Earlier, a panel of the D.C. Circuit upheld a decision of the Office of Thrift Supervision against a CBA-based challenge, Stilwell v. Office of Thrift Supervision, 569 F.3d 514 (2009), and another Obama-appointed judge upheld a decision of the CFTC against a CBA-based challenge in 2012, despite the CFTC’s not having quantified the benefits or certain costs of the rule, Inv. Co. Inst. v. Commodity Futures Trading Comm., 891 F. Supp. 2d 162 (2012).
For a different but consistent critique of judicial review of agency decisions under conditions of…
For a different but consistent critique of judicial review of agency decisions under conditions of uncertainty, see Adrian
Vermeule
Rationally Arbitrary Decisions (in Administrative Law)
(Harvard Law Sch, Working Paper No. 13-24, 2013),
[http://perma.cc/5AY8-WN7L] (arguing that courts should defer to agencies when agencies must act under conditions of uncertainty, even when the action is arbitrary).
10
In a related paper, I make further recommendations on how law and legal institutions can promote g…
In a related paper, I make further recommendations on how law and legal institutions can promote good CBA/FR as policy analysis, without risking the negative consequences of judicially enforced quantification
See
John C. Coates IV,
Towards Better Cost-Benefit Analysis: An Essay on Regulatory Management
, 78
Law & Contemp. Probs.
forthcoming
2015),
[http://perma.cc/W5KF-44KT].
11
For overviews outside the financial regulatory context, see
Matthew D Adler & Eric Posner, New Fou…
For overviews outside the financial regulatory context, see
Matthew D Adler & Eric Posner, New Foundations of Cost-Benefit Analysis
(2006);
Cass R.
Sunstein
, The Cost-Benefit State: The Future Of Regulatory Protection
(2002) [hereinafter
Sunstein
, The Cost-Benefit State]
; and
Cass R.
Sunstein
, Risk and Reason
(2003).
12
Supporters and critics of CBA alike tend to elide distinctions between different meanings of “co…
Supporters and critics of CBA alike tend to elide distinctions between different meanings of “cost-benefit analysis” Supporters—who, ironically, often defend CBA as promoting transparency—elide these distinctions to make CBA look appealing to the broadest possible audience, including skeptics and optimists about quantification, advocates of regulation and deregulation, regulators and the regulated, and intended regulatory beneficiaries and taxpayers. Critics of CBA elide the distinctions because they see efforts to promote CBA as policy as a step on a slippery slope to CBA law. Of late, others have taken a more nuanced position, supporting CBA/FR as policy without supporting CBA/FR law.
See, e.g.
, Bruce Kraus & Connor
Raso
Rational Boundaries for SEC Cost-Benefit Analysis
30
Yale J. on Reg.
289
(2013).
13
Lawyers negotiating contracts know the difference, too For example, they do not view a clause requ…
Lawyers negotiating contracts know the difference, too For example, they do not view a clause requiring a party to act reasonably or the like as innocuous: it is a “get” by the counterparty and a “give” by the party subject to the requirement.
14
Part IV,
infra
, develops this point in further detail
Part IV,
infra
, develops this point in further detail
15
See
Edward Sherwin,
The Cost-Benefit Analysis of Financial Regulation: Lessons from the SEC’s St…
See
Edward Sherwin,
The Cost-Benefit Analysis of Financial Regulation: Lessons from the SEC’s Stalled Mutual Fund Reform Effort
12 Stan J.L. Bus. & Fin.
1, 47 (2006) (arguing that “[
t]he
SEC’s failure to express the costs and benefits of its proposed rulemakings in numerical terms represents a significant shortcoming in its analysis”);
see also
U.S. Gov’t Accountability Office, Dodd-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination 17-18
(Nov. 2011) (“Without monetized or quantified benefits and costs, or an understanding of the reasons they cannot be monetized or quantified, it is difficult for businesses and consumers to determine if the most cost-beneficial regulatory alternative was selected . . . .”).
16
For a discussion of these Executive Orders, see
infra
text accompanying note
79
For a discussion of these Executive Orders, see
infra
text accompanying note
79
17
Robert W Hahn et al.,
Assessing Regulatory Impact Analyses: The Failure of Agencies To Comply with…
Robert W Hahn et al.,
Assessing Regulatory Impact Analyses: The Failure of Agencies To Comply with Executive Order 12,866
23
Harv
J.L. & Pub.
Pol’y
859, 861, 864 n.22 (1999-2000) (citing Exec. Order No. 12,866 § 6(a)(3)(C)(ii), 3 C.F.R. § 638, 645 (1993)). The authors acknowledge that the agencies were required to quantify costs and benefits only to “the extent feasible,”
id.
at
864 (citing Exec. Order No. 12,866, 3 C.F.R. § 645), and that “[
]t
is arguably not always possible or desirable to monetize all benefits and costs,”
id.
at
864 n.18 (citing Exec.
Order No. 12,866, 3 C.F.R. § 638-39;
Office of Mgmt. & Budget, Economic Analysis of Federal Regulations Under Executive Order 12,866
(Jan. 11, 1996)).
More recently, supporters of proposed legislative CBA mandates, including former commissioners of some of the independent agencies, have argued in favor of the bill on the ground that “not one of the 21 major rules issued by independent agencies in 2012 was based on a
complete, quantified
” CBA. Letter from Nancy Nord et al. to Thomas R. Carper, Chair of the Senate Homeland Sec. and Gov’t Affairs Comm., and Thomas A. Coburn, Ranking Member of the Senate Homeland Sec. and Gov’t Affairs Comm. 2 (June 18, 2013) (emphasis added),
serve
?File
_id=8eb0dbd9-5631-4878-bfb2-e040407cf0ba [http://perma.cc/BB9B-HER8].
18
412 F3d 133, 144 (D.C. Cir. 2005).
412 F3d 133, 144 (D.C. Cir. 2005).
19
Robert W Hahn,
The Economic Analysis of Regulation: A Response to the Critics
, 71
U. Chi. L. Rev.
Robert W Hahn,
The Economic Analysis of Regulation: A Response to the Critics
, 71
U. Chi. L. Rev.
1021, 1049-50 (2004) (rebutting critiques of CBA by noting that it “does not require that costs and benefits be expressed in the same units or that agencies monetize benefits that may not be quantifiable” and arguing that CBA should “be careful to reflect those uncertainties and account for qualitative factors”); Cass R.
Sunstein
Nonquantifiable
(May 1, 2013) (unpublished manuscript),
[http://perma.cc/H6N8-KZTT].
20
Office of Management and Budget guidelines are not entirely consistent on whether CBA entails quan…
Office of Management and Budget guidelines are not entirely consistent on whether CBA entails quantification On the one hand, they emphasize that CBA should contain, in addition to quantification, the specification of baselines, alternatives, and a
qualitative
description of how a rule will produce benefits and what side effects it may have,
Circular A-4: Regulatory Analysis
Off. Mgmt. & Budget
2 (2003) [hereinafter
OMB Guidance
],
[http://perma.cc/TZ3F-S8UU], and they explicitly provide that
where full monetization of all costs and benefits is not feasible, agencies should relate what can be quantified to what cannot be, so as to specify how large
unquantified
benefits could be or how small
unquantified
costs could be before a rule would “yield zero net benefits,”
id.
On the other hand,
the guidelines contain statements suggesting that CBA entails full quantification; for example, the guidelines
state that
“[a] distinctive feature of [CBA] is that both benefits and costs are expressed in monetary units, which allows you to evaluate different regulatory options with a variety of attributes using a common measure.”
Id.
at 6.
21
Letter from Nancy Nord et al to Thomas R. Carper and Thomas A. Coburn
supra
note 17
Letter from Nancy Nord et al to Thomas R. Carper and Thomas A. Coburn
supra
note 17
22
Kenneth J Arrow et al.,
Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Sa…
Kenneth J Arrow et al.,
Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Safety Regulation
272
Science
221, 222 (1996). Neither Arrow et al. nor Hahn et al.,
supra
note
17
, provide evidence or cite to research supporting their views that quantification “should be possible” in “most” instances as applied to executive agencies.
Sunstein
likewise asserts without evidence that quantification will be impossible only in “rare” instances: “In the most extreme (and admittedly rare) cases, agencies may be operating under circumstances of
ignorance
, in which they cannot specify either outcomes or probabilities.”
Sunstein
supra
note 19, at 7.
23
For discussions, see, for example,
Frank Ackerman & Lisa
Heinzerling
, Priceless: On Knowing The Pr…
For discussions, see, for example,
Frank Ackerman & Lisa
Heinzerling
, Priceless: On Knowing The Price of Everything and the Value of Nothing
(2004);
David S Brookshire et al.,
Valuing Public Goods: A Comparison of Survey and Hedonic Approaches
, 72
Am. Econ. Rev
. 165 (1982)
David S. Bullock & Nicholas Minot,
On Measuring the Value of a Nonmarket Good Using Market Data
, 88
Am. J. Agric. Econ.
961 (2006);
and
Karl-
Göran
Mäler
A Method of Estimating Social Benefits from Pollution Control
73
Swedish J. Econ
121 (1971).
24
See
infra
Part III for further discussion of the relevant non-market goods affected by financial r…
See
infra
Part III for further discussion of the relevant non-market goods affected by financial regulation
25
Consultative Document: Assessment Methodologies for Identifying Non-Bank Non-Insurer Global System…
Consultative Document: Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions
Fin Stability Bd. & Int’l Org. Sec.
Comm’ns
3 (Jan. 8, 2014),
[http://perma.cc/LS8E-TAHJ] (identifying three transmission mechanisms for systemic risk: (1) direct exposure to failed institutions; (2) forced asset liquidations by failed institutions that disrupt trading or funding in key markets; and (3) disruption of a critical service or function without substitutes);
see also
Stephen L.
Schwarcz
Systemic Risk
97 Geo.
L.J. 193
(2008) (identifying relationships between markets and institutions and noting how risk can spread through interconnected financial systems).
26
OMB Guidance,
supra
note 20, at 2
OMB Guidance,
supra
note 20, at 2
27
5 US.C. § 706(2)(A) (2012).
5 US.C. § 706(2)(A) (2012).
28
Eg.
, OMB Guidance,
supra
note 20.
Eg.
, OMB Guidance,
supra
note 20.
29
Eg.
, Eric Posner & E. Glen
Weyl
Benefit-Cost Analysis for Financial Regulation
, 103
Am
. Econ. Rev…
Eg.
, Eric Posner & E. Glen
Weyl
Benefit-Cost Analysis for Financial Regulation
, 103
Am
. Econ. Rev.: Papers & Proc.
393, 397 (2013) (arguing that CBA “should be applied to the introduction of new [derivatives] products into markets by private participants”). This approach is close to the one currently used in regulation of mutual funds in both the United States and the European Union, which generally forbid innovation in the design of collective investments without prior regulatory approval; as a result, proponents are generally required to demonstrate that the benefits of the design will outweigh its risks to investors.
See
John C. Coates IV,
Reforming the Taxation and Regulation of Mutual Funds: A Comparative Legal and Economic Analysis
, 1
J. Legal Analysis
591 (2009).
30
5 US.C. § 553 (2012).
5 US.C. § 553 (2012).
31
See, eg.
, Matthew D. Adler & Eric A. Posner,
Introduction,
Cost
-Benefit Analysis: Legal, Economic,…
See, eg.
, Matthew D. Adler & Eric A. Posner,
Introduction,
Cost
-Benefit Analysis: Legal, Economic, and Philosophical Perspectives
, 29
J. Legal Stud.
837, 841 (2000) (“Much has been written about whether the cost-benefit analysis executive orders have actually influenced the behavior of agencies. Knowledgeable scholars in this area seem to doubt that the executive orders have had much influence.”).
32
No published study examines empirically whether CBA produces benefits that outweigh its costs—wh…
No published study examines empirically whether CBA produces benefits that outweigh its costs—whether CBA in practice passes its own test Closest are studies assessing whether ex ante quantitative CBA by executive agencies produced CBA that was consistent with retrospective estimates.
E.g
.,
Robert W. Hahn et al.,
Do Federal Regulations Reduce Mortality
? 19 (2000) (finding that nine of twenty-four rules passed a cost-benefit test); Winston Harrington et al.,
On the Accuracy of Regulatory Cost Estimates
, 19
J.
Pol’y
Analysis & Mgmt
. 297, 314 (2000) (finding that for fourteen of twenty-eight Occupational Safety and Health Administration or EPA rules, total costs were overestimated, while for only three were they underestimated, and overestimates were often due to difficulties in determining the baseline and incomplete compliance). These studies do not provide reliable evidence about whether CBA would pass its own test, because they do not model the counterfactual of interest: how does regulation under CBA compare to regulation without it? For that analysis, one would need to match rules subject to CBA with those not subject to CBA, and study which did better at achieving net benefits. One method may be to exploit the fact that “economically significant rules” (ESRs) are subject to more stringent CBA under OMB Guidance,
supra
note 20, than other rules, so one could compare outcomes for rules just above and below the ESR threshold. Any objection that this question is simply too hard to study should lead to a similar conclusion as the one reached by this Article—in other words, that CBA/FR itself is unreliable.
33
Eg
., Matthew D. Adler & Eric A. Posner,
Rethinking Cost-Benefit Analysis
, 109
Yale L.J.
165, 239 (…
Eg
., Matthew D. Adler & Eric A. Posner,
Rethinking Cost-Benefit Analysis
, 109
Yale L.J.
165, 239 (1999) (tentatively recommending CBA over “
unidimensional
” or “
nonaggregative
” decision procedure alternatives).
34
Eg.
, Cass R.
Sunstein
The Arithmetic of Arsenic
, 90
Geo.
L.J
. 2255, 2289-90 (2002) (defending CBA…
Eg.
, Cass R.
Sunstein
The Arithmetic of Arsenic
, 90
Geo.
L.J
. 2255, 2289-90 (2002) (defending CBA on the ground that, although the bottom-line quantification of the arsenic rule was so uncertain that no conclusion could be reached from it, it was successful because it allowed the government to be “transparent” about why the rule’s net benefits were uncertain).
Transparency is often presented as an obviously good thing.
Id
.; Adler & Posner,
supra
note 35, at 239 (asserting the “inherent transparency of CBA itself” and noting that oversight bodies such as OMB can prevent agencies from misusing CBA or applying it in a way that decreases transparency).
But see
Troy A.
Paredes
Blinded by the Light: Information Overload and Its Consequences for Securities Regulation
81
Wash. U. L.Q.
417, 444-45 (2003) (arguing that information overload can lead to disclosures that are not meaningful or effective).
35
Eg
., Cass R.
Sunstein
Cost-Benefit Default Principles
, 99
Mich.
L. Rev.
1651, 1662, 1709 (2001) (…
Eg
., Cass R.
Sunstein
Cost-Benefit Default Principles
, 99
Mich.
L. Rev.
1651, 1662, 1709 (2001) (stating that “
the case for cost-benefit analysis is strengthened by the fact that interest groups are often able to use . . . cognitive problems strategically, thus fending off regulation that is desirable or pressing for regulation when the argument on its behalf is fragile
”;
and
noting the risk that, if permitted to adopt rules that do not pass a CBA test, agencies “
will conceal an effort to placate powerful private groups not having a strong claim to governmental assistance
”)
W. Kip
Viscusi
Risk Equity
, 29
J. Legal Stud.
843 (2000) (agencies sometimes adopt rules that benefit private interests)
36
Adler & Posner,
supra
note 35, at 245 (“CBA is a useful decision procedure and it should be rout…
Adler & Posner,
supra
note 35, at 245 (“CBA is a useful decision procedure and it should be routinely used by agencies CBA is superior to rival method[s] . . . [and] allows agencies to take into account all relevant influences on overall well-being . . . and . . . to weigh the advantages and disadvantages in a clear and systematic way . .
. .
”).
37
Compare
Sunstein
supra
note 37, at 1662 (arguing that unless people “are asked to seek a full a…
Compare
Sunstein
supra
note 37, at 1662 (arguing that unless people “are asked to seek a full accounting, they are likely to focus on small parts of problems” and explaining that CBA “is a way of producing [a] full accounting” and is a “natural corrective” for “systematic errors” and “misperceptions of facts” caused by the use of “rules of thumbs, or heuristics”),
with
Richard A Posner,
Cost-Benefit Analysis: Definition, Justification, and Comment on Conference Papers
, 29
J. Legal Stud.
1153, 1161-62 (2000) (critiquing the justification of CBA as a corrective for cognitive biases),
and
Joshua D. Wright & Douglas H. Ginsburg,
Behavioral Law and Economics: Its Origins, Fatal Flaws, and Implications for Liberty
, 106
Nw.
U. L. Rev.
1033 (2012) (critiquing
Sunstein’s
research and attempts to account for cognitive biases in policymaking).
38
Despite being generally in favor of CBA, Adler and Posner acknowledge this point, but they do not …
Despite being generally in favor of CBA, Adler and Posner acknowledge this point, but they do not develop it as a theoretical reason to resist legalizing CBA Adler & Posner,
supra
note 35, at 172 (“Agencies sometimes appear to use CBA to rationalize decisions made on other grounds.”).
39
Paredes
supra
note 36, at 420 (“[
T]he
specter of information overload casts doubt on the long-hel…
Paredes
supra
note 36, at 420 (“[
T]he
specter of information overload casts doubt on the long-held belief and policy choice that more disclosure is better than less”).
Paredes
was a Republican Commissioner of the SEC until 2013, and as Commissioner,
Paredes
was a strong proponent of CBA.
See
Troy A.
Paredes
, Remarks at AICPA Council Spring Meeting (May 17, 2012),
.VEMV6ecdVEA
(“[The SEC] must engage in rigorous [CBA] when fashioning . . . securities law . . . . I have expressed these views several times before in advocating for rigorous [CBA] at the SEC.”);
see also
Alex
Edmans
et al.,
The Real Costs of Disclosure
2 (Nat’l Bureau of Econ. Research, Working Paper No. 19420, 2013) (arguing that “even if the actual act of disclosure is costless, high-disclosure policy can still be costly due to differential verifiability of some kinds of information”).
40
Duncan Kennedy,
Cost-Benefit Analysis of Entitlement Problems: A Critique
, 33
Stan L. Rev.
387, 44…
Duncan Kennedy,
Cost-Benefit Analysis of Entitlement Problems: A Critique
, 33
Stan L. Rev.
387, 443 (1981) (“[CBA] is arbitrary. It provides yet another medium for the introduction of political preferences through what seem merely necessary ‘practical’ assumptions of any
analysis.
. . . The focus on particular problems legitimates arbitrary assumptions and masks their political content.”)
Amy
Sinden
Cass
Sunstein’s
Cost-Benefit Lite: Economics for Liberals
, 29
Colum. J.
Envtl
. L.
191, 194 (2011) (book review) (“The danger of CBA . . . lies in its false promise of determinacy, its pretense of objectivity and scientific
accuracy.
. . . [
T]his
false promise . . . renders CBA . . . vulnerable to manipulation and . . . destructive to democratic decision-making, as . . .
Sunstein’s
analysis of the arsenic CBA amply demonstrates.”).
41
Eg.
, Adler & Posner,
supra
note 35, at 169 & n.5 (citing
Ajit
K.
Dasgupta
& D.W. Pearce, Cost-Bene…
Eg.
, Adler & Posner,
supra
note 35, at 169 & n.5 (citing
Ajit
K.
Dasgupta
& D.W. Pearce, Cost-Benefit Analysis: Theory and Practice
12-13 (1972)).
42
Flood Control Act of 1936, 33 US.C. § 701a (2012);
see also
Sherwin,
supra
note 15, at 6 (citing
J…
Flood Control Act of 1936, 33 US.C. § 701a (2012);
see also
Sherwin,
supra
note 15, at 6 (citing
James T.
Campen
, Benefit, Cost, and Beyond: The Political Economy of Benefit-Cost Analysis 16
(1986)). Sherwin correctly notes but does not discuss an earlier statute, the River and Harbor Act of 1902,
ch.
1079, § 3, 32 Stat. 331, 372. That statute directed the organization and authorized the funding of a board of engineers reporting to the Chief of Engineers of the United States Army. The board was directed “so far as in the opinion of the Chief of Engineers may be necessary” to review reports for proposed river and harbor improvements and submit recommendations and “have in view the amount and character of commerce existing or reasonably prospective which will be benefited by the improvement, and the relation of the ultimate cost of such work . . . to the public commercial interests involved, and the public necessity for the work.”
33 U.S.C. § 541 (2012).
The board was instructed to do the same for past projects upon request by relevant congressional committees.
Id.
43
Theodore M Porter,
Trust in Numbers: The Pursuit of Objectivity in Science and Public Life
148-90 …
Theodore M Porter,
Trust in Numbers: The Pursuit of Objectivity in Science and Public Life
148-90 (1995).
44
Id
at 153.
Id
at 153.
45
Id
Id
46
Id
at 155.
Id
at 155.
47
Id
Id
48
Id
at 157.
Id
at 157.
49
Id
at 160.
Id
at 160.
50
Id
at 161.
Id
at 161.
51
Id
Id
52
Id
at 149.
Id
at 149.
53
Adler & Posner,
supra
note 35, at 194 (noting “an argument [they] believe has currency among eco…
Adler & Posner,
supra
note 35, at 194 (noting “an argument [they] believe has currency among economists although it is rarely defended in print . . is that CBA is desirable because there are no superior alternatives that provide determinate, or relatively determinate, prescriptions”).
54
Isaac
Alfon
& Peter Andrews,
Cost-Benefit Analysis in Financial Regulation: How To Do It and How I…
Isaac
Alfon
& Peter Andrews,
Cost-Benefit Analysis in Financial Regulation: How To Do It and How It Adds Value
Fin Services Authority,
Sept. 1999, at 11
[http://perma.cc/XY93-BFA3].
55
Sinden
supra
note 42, at 226-27
Sinden
supra
note 42, at 226-27
56
See
Risk Versus Risk: Tradeoffs in Protecting Health and the Environment
(John D Graham & Jonathan…
See
Risk Versus Risk: Tradeoffs in Protecting Health and the Environment
(John D Graham & Jonathan
Baert
Weiner eds
.,
1995).
57
Henry M Levin, Cost-Effectiveness: A Primer 17-18
(1983).
Henry M Levin, Cost-Effectiveness: A Primer 17-18
(1983).
58
An example is the Bank Holding Company Act of 1956, which bans banks from being owned by or affili…
An example is the Bank Holding Company Act of 1956, which bans banks from being owned by or affiliating with companies engaged in non-financial activities
Bank Holding Company Act of 1956 § 4, 12 U.S.C. § 1843 (2010).
The Federal Reserve Board and other banking agency regulations interpreting this statute do not engage in CBA when they evaluate whether an activity is prohibited by the statute.
59
Despite the repeal in the Gramm-Leach-
Blilely
Act, Pub
L. No. 106-102, 113 Stat. 1338 (1999) (codi…
Despite the repeal in the Gramm-Leach-
Blilely
Act, Pub
L. No. 106-102, 113 Stat. 1338 (1999) (codified in scattered sections of 12 U.S.C.), of the Glass-
Steagall
Act of 1933, 48 Stat. 162, banks and companies that control banks are still banned from most non-financial activities and investments under the Bank Holding Company Act of 1956. The Volcker Rule is similar, as discussed
infra
Part III.D, in that it bans banks from specified activities.
60
OMB Guidance,
supra
7note 71erm
ing
the ban and has signaled a desire to address the issue in the c…
OMB Guidance,
supra
7note 71erm
ing
the ban and has signaled a desire to address the issue in the coming
legisrting
oil produced
domestically.siona
note 20 (suggesting the use of “judgment” or “professional judgment” fourteen times, including the use of formal Delphi methods for eliciting expert seat-of-the-pants estimates). On Delphi methods, see
M. Granger Morgan & Max
Henrion
, Uncertainty: A Guide to Dealing with Uncertainty in Quantitative Risk and Policy Analysis
164-68 (1990). For a trenchant attack on CBA generally, arguing in favor of the use of “intelligent deliberation” as the alternative, see Henry S. Richardson,
The Stupidity of the Cost-Benefit Standard
29
J. Legal Stud.
971 (2000).
61
The expertise of the financial agencies includes vastly more firepower than is available to OIRA, …
The expertise of the financial agencies includes vastly more firepower than is available to OIRA, which has a total staff of roughly fifty
Office of Information and Regulatory Affairs (OIRA) Q & A’s
Off.
Mgmt. & Budget
(Nov. 2009),
[http://perma.cc/AA96-TFKU].
The Federal Reserve Board alone has 220 Ph.D. economists on staff.
See
Ryan Grim,
Priceless: How the Federal Reserve Bought the Economics Profession
Huffington Post,
Oct. 23, 2009,
/2009/09/07/priceless-how-the-federal_n_278805.html [http://perma.cc/M9AN-FZRL]. The SEC has more than fifty economists.
See Economists
Sec. & Exch. Commission
(Oct. 7, 2014),
[http://perma.cc/NT98-GHUU]. For a discussion of the careers of SEC Commissioners and staff, see John C. Coates IV,
Private vs. Political Choice of Securities Regulation: A Political Cost/Benefit Analysis
41
Va. J. Int’l L
531 (2001).
62
Eg.
Cybersecurity
Roundtable
Sec. & Exch.
Comm’n
(May 14, 2014),
Eg.
Cybersecurity
Roundtable
Sec. & Exch.
Comm’n
(May 14, 2014),
] (example of consultation by SEC with experts); Office of Econ.
Analysis,
Economic Analysis of the Short Sale Price Restrictions Under the Regulation SHO Pilot
Sec. & Exchange Commission
(Feb. 6, 2007),
[http://perma.cc/23G6-S9YC] (example of regulatory experiment); Office of Econ. Analysis,
Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting Requirements
Sec. & Exchange Commission (2009) [
hereinafter Office of Econ.
Analysis,
Study of the Sarbanes-Oxley Act
] (example of study including survey data).
63
See Final Report of the National Commission on the Causes of the Financial and Economic Crisis in …
See Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States
Fin Crisis Inquiry Commission
27-82 (Jan. 2011),
[http://perma.cc/43W2-7WAU].
64
See
Philip E
Tetlock
, Expert Political Judgment: How Good Is It? How Can We Know?
(2005) (
noting
t…
See
Philip E
Tetlock
, Expert Political Judgment: How Good Is It? How Can We Know?
(2005) (
noting
that expert political opinion is often wrong);
Tom Stark, Fed. Reserve Bank of
Phila
.,
Realistic Evaluation of Real-Time Forecasts in the Survey of Professional Forecasters
2 (May 28, 2010) (unpublished paper),
[http://perma.cc/W4GG-J84W] (concluding that expert economic forecasts beat “no change” forecasts and simple direct and indirect
autoregression
models, but performance of forecasts fell sharply for predictions more than three months in the future)
65
See infra
note 73
See infra
note 73
66
More specifically, the Rule calls for the Fed to set the federal funds rate (traditionally its pri…
More specifically, the Rule calls for the Fed to set the federal funds rate (traditionally its principal instrument for setting monetary policy) at one plus 15 times the inflation rate plus 0.5 times the “output gap,” defined as the percentage deviation of actual GDP from “potential” GDP.
See
John B. Taylor,
Discretion Versus Policy Rules in Practice
, 39
Carnegie-Rochester Conf. Series on Pub.
Pol’y
195, 202 (1993).
“Potential” GDP is an estimate of “the trend growth in the productive capacity of the economy . . . an estimate of the level of GDP attainable when the economy is operating at a high rate of resource use . . . [that is, an estimate of] maximum
sustainable
output—the level of real GDP in a given year that is consistent with a stable rate of inflation.”
CBO’s Method for Estimating Potential Output: An Update
Cong. Budget Off.
(Aug. 2001),
[http://perma.cc/L68J-SMQV].
Although models of potential GDP vary, the CBO publishes estimates that are widely used, based on the “Solow growth model,” a simple projection of GDP based on two supply-side factors: “labor input (hours worked) and accumulation of physical capital (additions to the nation’s stock of plant and equipment).”
Id.
at 3.
67
See
Taylor,
supra
note
66
, at 207-08 For prior theoretical work, see Finn E.
Kydland
& Edward C. P…
See
Taylor,
supra
note
66
, at 207-08 For prior theoretical work, see Finn E.
Kydland
& Edward C. Prescott,
Rules Rather than Discretion: The Inconsistency of Optimal Plans
, 85
J. Pol. Econ
473 (1977).
68
In fact, Taylor has argued that the Federal Reserve has repeatedly deviated from his rule John B. …
In fact, Taylor has argued that the Federal Reserve has repeatedly deviated from his rule John B. Taylor,
Getting Back on Track: Macroeconomic Policy Lessons from the Financial Crisis
, 92
Fed. Res. Bank of St. Louis Rev
. 165-76 (May/June 2010) [hereinafter Taylor,
Getting Back on Track
]; John B. Taylor,
A Historical Analysis of Monetary Policy Rules
in
Monetary Policy Rules
319 (John B. Taylor ed., 1999) [hereinafter Taylor,
A Historical Analysis
]. On the other hand, recently departed Federal Reserve Chairman Ben Bernanke, Federal Reserve Board members, and staff economists have argued the contrary—and, moreover, have claimed that Taylor’s 1993 formulation of his rule differs from his 1999 formulation. Ben Bernanke, Chairman, Fed. Reserve, Monetary Policy and the Housing Bubble, Speech at the Annual Meeting of the American Economic Association (Jan. 3, 2010),
[http://perma.cc/KT3L-6SVD]; Laurence Meyer,
Dueling Taylor Rules
Macroeconomic Advisors: Monetary
Pol
Insights,
Aug. 20, 2009; Glenn
Rudebusch
The Fed’s Monetary Policy Response to the Current Crisis
, 2009-17
Fed. Res. Bank of S.F. Econ.
Letter
(May 22, 2009).
69
Alex
Nikolsko-Rzhevskyy
& David H
Papell
, Taylor’s Rule Versus Taylor Rules 1 (Sept. 15, 2012) (…
Alex
Nikolsko-Rzhevskyy
& David H
Papell
, Taylor’s Rule Versus Taylor Rules 1 (Sept. 15, 2012) (unpublished paper),
[http://perma.cc/7U7U-Q552] (referring to the period under Greenspan from 1987 to 1992).
70
Compare
Kydland
& Prescott,
supra
note
67
, at 487 (advocating that Congress select a “simple and…
Compare
Kydland
& Prescott,
supra
note
67
, at 487 (advocating that Congress select a “simple and easily understood” monetary policy rule and have it take effect prospectively after a two-year delay—without explaining how such a law could be made binding on a future Congress),
with
Ricardo Reis,
Central Bank Design
27
J Econ.
Persp
17, 18 (2013) (stating that central banks’ objectives have usually been “vague”);
id.
at
19 (stating that “some discretion” may better allow a central bank to achieve even clearly stated objectives);
id.
at
25-26 (stating that central banks “always have some discretion”),
and
John B. Taylor,
A Steadier Course for Monetary Policy
, Testimony Before the Joint Economic Committee on “The Fed at 100: Can Monetary Policy Close the Growth Gap and Promote a Sound Dollar?” 3-4 (Apr. 18, 2013),
[http://perma.cc/8KB2-B5WA] (calling for a “return to a more rules-based policy” and a “gradual exit” from what he criticizes as unfortunate policy decisions, and not for a sudden or strict “rule” to set policy; declaring that, under his proposal, “while discretion would be constrained, it would not be eliminated”).
71
See infra
notes 146-148 and accompanying text Even those who advocate greater Fed transparency—a…
See infra
notes 146-148 and accompanying text Even those who advocate greater Fed transparency—as reflected in the various bills known colloquially as “Audit the Fed” laws—would not subject the Fed’s monetary policy choices to either ex ante CBA requirements or ex post review by courts or another agency.
See, e.g.
, Federal Reserve Transparency Act of 2013, S. 209, 113th Cong. (2013) (proposing to repeal exemption from audit by the Comptroller General of the Federal Reserve, contained in 31 U.S.C. § 714, for various transactions, deliberations, and communications relating to, among other things, monetary policy).
72
Sewall Chan,
From Tea Party Advocates, Anger at the Federal Reserve
, NY.
Times,
Oct. 10, 2010,
htt…
Sewall Chan,
From Tea Party Advocates, Anger at the Federal Reserve
, NY.
Times,
Oct. 10, 2010,
0/11/us/politics/11fed.html [http://perma.cc/74TA-GNYU] (describing Republican politicians’ criticisms of the Fed based on Fed policy decisions during the economic crisis).
73
On the overall goals pursued by the Fed, see
What Is the Purpose of the Federal Reserve System
B…
On the overall goals pursued by the Fed, see
What Is the Purpose of the Federal Reserve System
Board Governors Fed Res. Sys
.,
[http://perma.cc/TW9Z-ANYL] (outlining the Fed’s legal responsibilities and goals, including an effective payment system and a stable financial system). The Fed’s statutory mandate relating to monetary policy is narrower, consisting of seeking to maintain the “long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
12 U.S.C. § 225a (2012).
I am informed by close observers of Congress that the Office of Legislative Council—which provides confidential drafting advice to members of Congress and their staffs—routinely suggests exemptions for monetary policy from bills imposing procedural or other requirements on regulatory action, based on a strong norm of preserving the Fed’s independence in overseeing monetary policy.
74
See
Roger E Backhouse, The Puzzle of Modern Economics: Science or Ideology?
117-37 (2010) (describ…
See
Roger E Backhouse, The Puzzle of Modern Economics: Science or Ideology?
117-37 (2010) (describing historical and ongoing debates within economics over whether and how to construct macroeconomic models, and detailing continuing disputes over the ability of such models to adequately forecast economic behavior).
75
The APA defines a “rule” as any “statement of general or particular applicability and future…
The APA defines a “rule” as any “statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy”
5 U.S.C. § 551 (2012).
If the pending bills did not exempt monetary policy, then any “statement” by the Federal Reserve Board meant to “implement . . . policy” would arguably require CBA/FR under the APA.
Id.
76
OMB Guidance,
supra
note 20, at 2 (“You will find that you cannot conduct a good regulatory anal…
OMB Guidance,
supra
note 20, at 2 (“You will find that you cannot conduct a good regulatory analysis according to a formula Conducting high-quality analysis requires competent professional judgment.”).
77
See
Taylor,
Getting Back on Track
supra
note 70; Taylor,
A Historical Analysis
supra
note 70
See
Taylor,
Getting Back on Track
supra
note 70; Taylor,
A Historical Analysis
supra
note 70
78
Independent regulatory agencies are listed in the Paperwork Reduction Act of 1980
44 U.S.C. § 350…
Independent regulatory agencies are listed in the Paperwork Reduction Act of 1980
44 U.S.C. § 3502(5) (2012).
Not all financial regulations are issued by independent agencies; the Department of Labor, which is an executive agency, promulgates regulations relevant to pension funds, for example, and is governed by the executive orders listed
infra
note 81.
79
Exec Order No. 12,291, 46 Fed.
Reg. 13,193 (Feb. 17, 1981) (requiring, inter alia, CBA for new reg…
Exec Order No. 12,291, 46 Fed.
Reg. 13,193 (Feb. 17, 1981) (requiring, inter alia, CBA for new regulations),
superseded by
Exec.
Order No. 12,866, 58 Fed.
Reg. 51,735 (Sept. 30, 1993) (modestly amending prior CBA requirements, imposing heightened requirements for “significant regulatory action” and further requirements for actions likely to have an economic impact of $100 million per year (hereinafter, an “economically significant rulemaking”)),
amended by
Exec.
Order No. 13,258, 67 Fed.
Reg. 9385 (Feb. 26, 2002) (eliminating the role of the Vice President in the CBA process),
supplemented by
Exec.
Order No. 13,563, 76 Fed.
Reg. 3821 (Jan. 18, 2011).
Under these orders, executive agencies are required to conduct quantified CBA to the extent feasible, to submit significant rules to OIRA in advance, to provide CBAs to OIRA, to wait until OIRA reviews the CBAs before publishing rules for public comment, and to publish CBAs with rules.
Id.
Independent agencies are required only to provide OMB with an annual agenda of significant regulatory actions for the upcoming year, including, “to the extent feasible and permitted by law,” a summary CBA.
Id.
Sherwin reports having reviewed these agendas for the SEC in the period leading up to 2006, and he found they did not generally include summary CBA. Sherwin,
supra
note 15, at 12. These executive orders were joined by the Unfunded Mandates Reform Act requirement that executive agencies, but not independent agencies, include written CBAs for each economically significant rulemaking.
Unfunded Mandates Reform Act of 1995, Pub.
L. No. 104-4, 109 Stat. 48 (codified as amended in scattered sections of 2 U.S.C.).
80
Eg.
Monetary Policy and the State of the Economy: Hearing Before the H. Comm. on Fin.
Servs
113…
Eg.
Monetary Policy and the State of the Economy: Hearing Before the H. Comm. on Fin.
Servs
113th Cong. 8 (2013) (statement of Federal Reserve Chairman Ben Bernanke that Federal Open Market Committee purchases of financial assets are conducted “within a [CBA] framework”);
SEC Office of the Inspector
Gen.,Compliance
Handbook
38-39 (1999) (stating that SEC rule proposals should contain CBAs). This handbook reflected OMB’s best practices guidance issued in 1996,
see
Gov’t Accountability Office,
GAO-12-151
Dodd-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination
n.14 (2011);
see also
Budget Hearing—Securities and Exchange Commission: Hearing Before the Fin.
Servs
and
Gen. Gov’t
Subcomm
of
the H. Comm. on Appropriations
, 112th Cong. (2011) (statement of SEC Chairman Mary Schapiro), Federal News Service, Inc., transcript at 26-27;
SEC Office of the Inspector General, Office of Audits, SEC OIG 499, Follow-Up Review of Cost-Benefit Analyses in Selected Dodd-Frank Rulemakings 6
(2012) (“SEC Chairman Arthur Levitt stated that there was an expectation that the SEC would perform cost-benefit analyses as part of the rulemaking process.”).
See generally
Barry D. Friedman, Regulation in the Reagan-Bush Era: The Eruption of Presidential Influence
78 (1995); Richard H.
Pildes
& Cass R.
Sunstein
Reinventing the Regulatory State
, 62
U. Chi. L. Rev.
1, 11-18 (1995); Peter L. Strauss,
The Place of Agencies in Government: Separation of Powers & the Fourth Branch
, 84
Colum. L. Rev.
573, 591-93 (1984).
81
Financial Services Act, 2012, amending inter alia sections 138I (Financial Conduct Authority) and …
Financial Services Act, 2012, amending inter alia sections 138I (Financial Conduct Authority) and 138J (Prudential Regulation Authority) of the Financial Services and Markets Act 2000 In striking contrast to the recent U.S. experience, the FSA and its successors’ rulemakings and CBA (while subject to judicial review) have not been subjected to numerous court decisions striking down rules for inadequate CBA. The only example of a court decision that even refers to CBA by the Financial Services Authority (FSA) is
R (on the application of the British Bankers Association) v. FSA et al.
, [2011] EWHC (Admin) 999 (Eng.), which rejected a challenge by a banking trade group to the handling of complaints about “Payment Protection Insurance” by the FSA and the Financial Ombudsman Service, which handles consumer financial complaints.
82
Pub L. No. 104-13, 109 Stat. 163 (1995) (codified at 44 U.S.C. §§ 3501-3520).
Pub L. No. 104-13, 109 Stat. 163 (1995) (codified at 44 U.S.C. §§ 3501-3520).
83
Pub
L. No. 96-354, 94 Stat. 1164 (1980) (codified at 5 U.S.C. §§ 601-612).
The RFA was one basis f…
Pub
L. No. 96-354, 94 Stat. 1164 (1980) (codified at 5 U.S.C. §§ 601-612).
The RFA was one basis for the recent suit against the Volcker Rule by the American Bar Association.
See
infra
note 341.
84
Technically, the reports are submitted to the head of the GAO, the Comptroller General Contract wi…
Technically, the reports are submitted to the head of the GAO, the Comptroller General Contract with America Advancement Act of 1996, Pub. L. No. 104-121, 110 Stat. 847 (1996) (codified as amended in 5 U.S.C. §§ 801 et seq.). This statute exempts monetary policy by the Federal Reserve Board and the Federal Open Market Committee.
5 U.S.C. § 807.
85
5 US.C. § 804.
Under the statute, major rules do not go into effect for sixty days, and Congress h…
5 US.C. § 804.
Under the statute, major rules do not go into effect for sixty days, and Congress has the power to veto “major rules” by joint resolution passed within that period, subject to presidential veto of the joint resolution.
5 U.S.C. §§ 801-802.
Courts have interpreted this statute to preclude judicial review of agency compliance with the statute, including agency determinations of whether a rule is “major.”
See, e.g.
, Via Christi
Reg’l
Med. Ctr., Inc. v. Leavitt,
509 F.3d 1259, 1271 n.11 (10th Cir. 2007) (“The Congressional Review Act specifically precludes judicial review of an agency’s compliance with its terms.”);
Operation of the Missouri River Sys.
Litig
.,
363 F. Supp. 2d 1145, 1173 (D. Minn. 2004) (agency’s determination under CRA that a rule is not a “major rule” is not subject to judicial review);
see also
Montanans for Multiple Use v.
Barbouletos
568 F.3d 225 (D.C. Cir. 2009);
Tex.
Sav
. &
Cmty
Bankers
Ass’n
v. Fed.
Hous
. Fin.
Bd.,
201 F.3d 551 (5th Cir. 2000).
86
Eg.
GAO-03-933R
Report
nder 5 U.S.C. § 801(a)(2)(A) on a Major Rule
U.S. Gov’t Accountability O
Eg.
GAO-03-933R
Report
nder 5 U.S.C. § 801(a)(2)(A) on a Major Rule
U.S. Gov’t Accountability O
ff.
(June 25, 2003),
[http://perma.cc/CEG8-WVRH] (reviewing the rule proposed by the SEC for the implementation of section 404 of the Sarbanes-Oxley Act, discussed more
infra
Part III.A);
GAO-14-147R,
Report
nder 5 U.S.C. § 801(a)(2)(A) on a Major Rule
U.S. Gov’t Accountability Off.
(Oct. 30, 2013)
[http://perma.cc/VXV7-A35V] (reviewing the rule proposed by the Office of the Comptroller of the Currency (OCC) and the Federal Reserve to implement Basel III, discussed more
infra
Part III.C); Off.
Info. & Regulatory Affairs,
2012 Report to Congress on the Benefits and Costs of Federal Regulations and Unfunded Mandates on State, Local, and Tribal Entities
Off.
Mgmt. Budget
app. C
[http://perma.cc/2N6B-NKL7] (assessing CBA of “major rules” issued by independent agencies in the prior fiscal year).
87
Chamber of Commerce v SEC, 412 F.3d 133 (D.C. Cir. 2005).
Chamber of Commerce v SEC, 412 F.3d 133 (D.C. Cir. 2005).
88
412 F3d at 142 (citing 15 U.S.C. § 80a-2(c) (2012)).
412 F3d at 142 (citing 15 U.S.C. § 80a-2(c) (2012)).
89
National Securities Markets Improvement Act, Pub
L. No. 104-290, § 106, 110 Stat. 3416, 3425 (199…
National Securities Markets Improvement Act, Pub
L. No. 104-290, § 106, 110 Stat. 3416, 3425 (1996) (codified at 15 U.S.C. § 80a-2).
Identical requirements were added to the other federal securities laws.
Id.
90
412 F3d at 144.
412 F3d at 144.
91
Id
Id
92
Id
at 143.
Id
at 143.
93
Id
at 144.
The third failing did not raise CBA issues, and arose under the APA directly: the SEC h…
Id
at 144.
The third failing did not raise CBA issues, and arose under the APA directly: the SEC had not formally considered a disclosure alternative to its proposals, in which funds would prominently disclose whether they had independent chairs. Here, the court pointed to the fact that two dissenting Commissioners had suggested the alternative, along with a number of commentators, and that the SEC’s only stated reasons for not considering it were that it had no obligation to consider every alternative raised, that it did consider other alternatives, and that Congress in the ICA itself had not relied on disclosure to police conflicts of interest in funds. To this, the court noted, “[
T]hat
the Congress required more than disclosure with respect to some matters governed by the ICA does not mean it deemed disclosure insufficient with respect to all such matters.”
Id.
at 144-46.
94
Id
at 137 (citing Investment Company Governance, 69 Fed. Reg. 46,387 n.81) (stating that “[
w]e
hav…
Id
at 137 (citing Investment Company Governance, 69 Fed. Reg. 46,387 n.81) (stating that “[
w]e
have no reliable basis for estimating those costs”).
95
Id
at 144 (“The Commission did violate the APA by failing adequately to consider the costs mutua…
Id
at 144 (“The Commission did violate the APA by failing adequately to consider the costs mutual funds would incur in order to comply with the conditions.”);
accord id.
at
136.
96
The only precedent cited by the court in its critique of the SEC’s CBA was
Public Citizen v Federa…
The only precedent cited by the court in its critique of the SEC’s CBA was
Public Citizen v Federal Motor Carrier Safety Administration
, 374 F.3d 1209 (D.C. Cir. 2004). In that case, an executive (not independent) agency that was specifically required by statute to “consider the costs and benefits” of its regulation was held to have violated a distinct statutory requirement to “
deal[
] with . . . fatigue-related issues pertaining to . . . vehicle safety,” which the court there interpreted as requiring the agency to collect and analyze data on the costs and benefits of a specific possible regulation.
Id.
at 1211-12 (citing 49 U.S.C. §§ 31502, 31506, 31136 (2012));
see also id.
at
1221 (“This directive, in our view, required the agency, at a minimum, to collect and analyze data on the costs and benefits.”). No specific directive of that kind was at issue in
Chamber of Commerce
, only the open-ended directive for the SEC to consider the effects of its rules on “efficiency, competition, and capital formation.”
412 F.3d at 140 (citing 15 U.S.C. § 80a-2(c) (2012)).
97
See, eg.
Mas-
Collel
et al.,
supra
note 32, at 127, 152-53 (discussing “efficiency” without re…
See, eg.
Mas-
Collel
et al.,
supra
note 32, at 127, 152-53 (discussing “efficiency” without reference to quantitative data).
98
See
Bowman Transp, Inc. v. Ark.-Best Freight Sys
.,
Inc., 419 U.S. 281, 285-86 (1974). After
Chambe…
See
Bowman Transp, Inc. v. Ark.-Best Freight Sys
.,
Inc., 419 U.S. 281, 285-86 (1974). After
Chamber of Commerce
, the D.C. Circuit has held that courts should be “particularly deferential in matters implicating predictive judgments,” Rural Cellular
Ass’n
v. FCC, 588 F.3d 1095, 1105 (D.C. Cir. 2009), which led another panel of the D.C. Circuit to hold that the APA “imposes no general obligation on agencies to produce empirical evidence” when it is not in the agency’s record.
Stilwell v. Office of Thrift Supervision, 569 F.3d 514, 519 (D.C. Cir. 2009).
99
Nat’l Wildlife
Fed’n
v EPA, 286 F.3d 554, 563 (D.C. Cir. 2002).
This fact has led another panel of…
Nat’l Wildlife
Fed’n
v EPA, 286 F.3d 554, 563 (D.C. Cir. 2002).
This fact has led another panel of the D.C. Circuit, after
Chamber of Commerce
, to announce sweepingly that courts should “review . . . cost-benefit analysis deferentially.”
Nat’l
Ass’n
of Home Builders v. EPA, 682 F.3d 1032, 1040 (D.C. Cir. 2012).
100
OMB Guidance,
supra
note 20 The OMB does not specify that an agency engaging in quantification “…
OMB Guidance,
supra
note 20 The OMB does not specify that an agency engaging in quantification “to the extent feasible” must quantify costs on a conditional basis.
101
647 F3d 1144 (D.C. Cir. 2011).
647 F3d 1144 (D.C. Cir. 2011).
102
For the total number of major rules, see
Office of Info
& Regulatory Affairs, Office of Mgmt. & Bu…
For the total number of major rules, see
Office of Info
& Regulatory Affairs, Office of Mgmt. & Budget, Exec.
Office of the President, 2012 Report to Congress on the Benefits and Costs of Federal Regulations and Unfunded Mandates on State, Local, and Tribal Entities
app. c (2012).
103
Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).
Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).
104
Fin
Planning Ass’n v. SEC, 482 F.3d 481 (D.C. Cir. 2007).
Fin
Planning Ass’n v. SEC, 482 F.3d 481 (D.C. Cir. 2007).
105
PAZ Sec., Inc. v. SEC, 494 F.3d 1059 (D.C. Cir. 2007).
PAZ Sec., Inc. v. SEC, 494 F.3d 1059 (D.C. Cir. 2007).
106
Am
Equity Inv. Life Ins. Co. v. SEC, 613 F.3d 166 (D.C. Cir. 2010).
Am
Equity Inv. Life Ins. Co. v. SEC, 613 F.3d 166 (D.C. Cir. 2010).
107
Chamber of Commerce v SEC, 443 F.3d 890 (2006) (holding that the SEC’s re-proposal of the mutual…
Chamber of Commerce v SEC, 443 F.3d 890 (2006) (holding that the SEC’s re-proposal of the mutual fund governance rules violated the APA because the SEC relied on materials not in the public record and had not reopened the rule for public comment).
Some commentators have suggested that the SEC’s rapid re-adoption of its rule with the cost estimates called for by the D.C. Circuit in
Chamber of Commerce I
shows that it was less than diligent in failing to provide the cost estimates in the first release.
E.g.
CCMC Report
supra
note 6, at 30; Sherwin,
supra
note 15, at 164. This criticism is unfair, because it fails to explain why the SEC should have understood that it had an obligation to provide that cost information in its first release; at the time of that release, neither the APA nor NSMIA nor court precedents would have made it apparent that the cost considerations—referred to by the Chamber of Commerce’s own report as “relatively minor,” CCMC
Report,
supra
note 6, at 30—would be an independently important component of the SEC’s regulatory analysis, or were otherwise required to be set forth in the release. It is even more deceptive to imply that the SEC was able in its second release to do something it had said it could not do in its first release, as the CCMC report suggests,
id.
noting
that “the court’s incredulity about the SEC’s position that the agency could not determine these costs proved true”), because the SEC’s position was not that it could not estimate conditional cost estimates, but only that these conditional cost estimates could not be translated into an actual aggregate compliance estimate—which it never provided, even in its second release.
108
Nat’l
Ass’n
of Mfrs v. SEC, 748 F.3d 359 (D.C. Cir. 2014).
Nat’l
Ass’n
of Mfrs v. SEC, 748 F.3d 359 (D.C. Cir. 2014).
109
Inv Co. Inst. v. CFTC, 891 F. Supp. 2d 162, 215 (D.D.C. 2012) (“While the CFTC did not calculate…
Inv Co. Inst. v. CFTC, 891 F. Supp. 2d 162, 215 (D.D.C. 2012) (“While the CFTC did not calculate the costs of the Final Rule down to the dollar-and-cent, it reasonably considered the costs and benefits of the Final Rule, and decided that the benefits outweigh the costs.”).
110
Stilwell v Office of Thrift Supervision, 569 F.3d 514 (D.C. Cir. 2009).
Stilwell v Office of Thrift Supervision, 569 F.3d 514 (D.C. Cir. 2009).
111
See
cases cited
supra
notes 103-112
See
cases cited
supra
notes 103-112
112
956 F Supp. 2d 43, 53 (D.D.C. 2013) (“All of those cases involved rules or regulations that were…
956 F Supp. 2d 43, 53 (D.D.C. 2013) (“All of those cases involved rules or regulations that were proposed and adopted by the SEC of its own accord, with the Commission having independently perceived a problem within its purview and having exercised its own judgment to craft a rule or regulation aimed at that problem.”).
113
See
Brandice
Canes-
Wrone
Bureaucratic Decisions and the Composition of the Lower Courts
, 47
Am
J.…
See
Brandice
Canes-
Wrone
Bureaucratic Decisions and the Composition of the Lower Courts
, 47
Am
J. Pol. Sci.
205, 205 (2003) (using a dataset of Army Corps of Engineers decisions from 1988 to 1996 to conclude that “judicial ideology significantly affects bureaucratic decision making,” consistent with the idea that agencies may seek to shelter decisions from court review by obtaining Congressional mandates);
Yehonatan
Givati
Strategic Statutory Interpretation by Administrative Agencies
, 12
Am.
L. & Econ.
Rev.
95 (2010) (finding that, in a theoretical model, stricter judicial review of agency action can result in “safer” statutory interpretations by the agency, due to the relative shift in utility of safe and aggressive interpretations); M. Elizabeth Magill,
Agency Choice of Policymaking Form
, 71
U. Chi. L. Rev.
1383, 1437-42 (2004) (noting that agencies can and do choose among rulemaking, enforcement, and informal guidance for various reasons and that judicial review is affected by and affects these choices); Matthew C. Stephenson,
The Strategic Substitution Effect: Textual Plausibility, Procedural Formality, and Judicial Review of Agency Statutory Interpretations
, 120
Harv
. L. Rev
. 528 (2006) (concluding that procedural formality substitutes for textual interpretation of statutes that authorize agency actions); Emerson H. Tiller,
Controlling Policy by Controlling Process: Judicial Influence on Regulatory Decision Making
, 14
J.L. Econ.
& Org.
114 (1998) (presenting a model of judicial review of agency decision making, in which “process review” under the APA for arbitrariness forces agencies to expend resources to reduce the risk of judicial reversal); Emerson H. Tiller & Pablo T. Spiller,
Strategic Instruments: Legal Structure and Political Games in Administrative Law
, 15
J.L. Econ.
& Org
. 349 (1999) (finding that agencies choose among “instruments of decision making” so as to increase costs of court review).
For an account of executive agency efforts to avoid CBA review by OIRA, see Jennifer
Nou
Agency Self-Insulation Under Presidential Review
126
Harv
. L. Rev
. 1755 (2013).
114
The decision provoked unusual agreement among legal commentators—all negative
See
Robert B.
Ahdieh
The decision provoked unusual agreement among legal commentators—all negative
See
Robert B.
Ahdieh
Reanalyzing Cost-Benefit Analysis: Toward a Framework of Function(s) and Form(s)
, 88
N.Y.U. L. Rev.
1983 (2013); James D. Cox & Benjamin J.C.
Baucom
The Emperor Has No Clothes: Confronting the D.C. Circuit’s Usurpation of SEC Rulemaking Authority
, 90
Tex. L. Rev.
1811 (2012); Jill E.
Fisch
The Long Road Back:
Business Roundtable
and the Future of SEC Rulemaking
, 36
Seattle U. L. Rev.
695 (2013); Grant M. Hayden & Matthew T.
Bodie
The Bizarre Law & Economics of
Business Roundtable v. SEC, 38
J. Corp. L.
101 (2012); Kraus &
Raso
supra
note 12; Michael E. Murphy,
The SEC and the District of Columbia Circuit: The Emergency of a Distinct Standard of Judicial Review
, 7
Va.
L. & Bus.
Rev.
125 (2012); Comment,
D.C. Circuit Finds SEC Proxy Access Rule Arbitrary and Capricious for Inadequate Economic Analysis
, 125
Harv
. L. Rev.
1088 (2012); Anthony W.
Mongone
, Note, Business Roundtable
: A New Level of Judicial Scrutiny and Its Implications in a Post-Dodd-Frank World
, 2012
Colum. Bus. L. Rev.
746; Stephanie Lyn Parker, Note,
The Folly of Rule 14a-11:
Business Roundtable v. SEC
and the Commission’s Next Step
, 61
Am
. U. L. Rev.
715 (2012); J. Robert Brown, Jr.,
Shareholder Access and Uneconomic Economic Analysis:
Business Roundtable v. SEC
Univ. of Denver Sturm College of Law Legal Research Paper Series, Working Paper No. 11-14, 2011),
/shareholder-access-and-uneconomic-economic-analysis-business.html [http://perma.cc/PD72-8K83]; Dennis Kelleher, Stephen Hall &
Katelynn
Bradley,
Setting the Record Straight on Cost-Benefit Analysis and Financial Reform at the SEC
Better Markets, Inc.
59-68 (2012),
%20Straight.pdf [http://perma.cc/X4L8-SUK5]. The only substantial defense of the decision is in the CCMC report, CCMC
Report
supra
note 6, which, as noted above, was funded by a party to the case, the U.S. Chamber of Commerce.
Id.
at ii.
115
Indeed, the circumstances were so limited that prominent corporate law scholars labeled the rule …
Indeed, the circumstances were so limited that prominent corporate law scholars labeled the rule “insignificant” Marcel
Kahan
& Edward Rock,
The Insignificance of Proxy Access
, 97
Va. L. Rev.
1347 (2011). The CCMR report’s characterization of the proxy access rule as “more substantive,”
CCMR Report
supra
note 4, at 7, than the CFTC registration and reporting requirements upheld in
Investment Company Institute v. CFTC
, 891 F. Supp. 2d 162 (2012), is mysterious. Proxy access would not have changed “substantive” corporate governance but only added disclosure and process requirements for proxy solicitation; it would have been, in effect, a cross-subsidy of large, long-term shareholders’ disclosure obligations, but would not have altered voting rights or the relative authority of boards or shareholders to make decisions for corporations.
116
Bus
Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
Bus
Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
117
Id
at 1148
Id
at 1148
118
Id
The court also asserted the SEC had been arbitrary by using “inconsistent” estimates of the…
Id
The court also asserted the SEC had been arbitrary by using “inconsistent” estimates of the frequency with which the rule would be used.
Id.
at 1153.
To support this, the court claimed that the SEC had “predicted nominating shareholders would realize ‘direct cost savings’ from not having to print or mail their own proxy materials,” that the SEC had cited comment letters in support of this fact, and that one letter reported the rule would be frequently used, suggesting that the SEC believed that the cost savings would be large.
Id.
at 1153-54 (noting that the SEC “then cited comment letters predicting the number of elections contested under [the rule] would be quite high” and that “[
o]ne
of the comments reported . . . that . . . ‘hundreds’ of . . . companies . . . expected a shareholder . . . to nominate a director using the rule” (citing Letter from Kenneth L. Altman, President, The Altman
Grp
., Inc., to Elizabeth M. Murphy, Secretary, Sec. & Exch.
Comm’n
(Jan. 19, 2010),
.sec.gov/comments/s7-10-09/s71009-605.pdf [http://perma.cc/QTJ4-TADN]
)). The court’s opinion on this point is egregiously misleading: it falsely claims the SEC relied on the Altman comment as a basis for the SEC’s views on costs, and it then falsely claims that the SEC’s supposed view on costs contradicted other statements in the SEC’s release. In fact, the SEC did not cite
any
public comments to support its beliefs about direct cost savings, which were qualitative, a matter of common sense, and did not need such support.
See
Facilitating Shareholder Director Nominations, Exchange Act Release No. 33-9136, 75 Fed.
Reg. 56,668 (Sept. 16, 2010).
To the contrary, the SEC specifically rejected the claim that the rule would be frequently used, as claimed in the Altman letter cited by the court.
Id.
at 270.
Nowhere does the SEC cite the Altman letter to support its conclusions.
Id.
119
Bus
Roundtable
, 647 F.3d at 1149-50.
Bus
Roundtable
, 647 F.3d at 1149-50.
120
Id
at 1153.
Id
at 1153.
121
Jess
Bravin
Why DC. Circuit, at Center of Nominee Fight, Is So Important
Wall St. J.,
Nov. 20, 2…
Jess
Bravin
Why DC. Circuit, at Center of Nominee Fight, Is So Important
Wall St. J.,
Nov. 20, 2013,
/SB10001424052702304607104579210383151449004 [http://perma.cc/C5V-Q7UH].
122
Bus
Roundtable
, 647 F.3d at 1151.
Bus
Roundtable
, 647 F.3d at 1151.
123
Chamber of Commerce v SEC, 412 F.3d 133, 143 (D.C. Cir. 2005) (emphasis added).
Chamber of Commerce v SEC, 412 F.3d 133, 143 (D.C. Cir. 2005) (emphasis added).
124
Stilwell v Office of Thrift Supervision, 569 F.3d 514, 519 (D.C. Cir. 2009) (emphasis added).
Noth…
Stilwell v Office of Thrift Supervision, 569 F.3d 514, 519 (D.C. Cir. 2009) (emphasis added).
Nothing in the text of the securities laws would change this; the word “efficiency” does not by any reasonable reading imply a burden to generate evidence that does not exist, and the court in
Business Roundtable
did not examine the legislative history of the requirement that the SEC consider “efficiency.”
See
Murphy,
supra
note 116, at 128-30
Mongone
supra
note 116, at 746-56.
125
On the partisan nature of the Court’s decisions on CBA, see the discussion in the text accompany…
On the partisan nature of the Court’s decisions on CBA, see the discussion in the text accompanying notes 7 and 8;
see also
Cass R
Sunstein
& Adrian
Vermeule
Libertarian Administrative Law
, 81
U. Chi. L. Rev.
(forthcoming 2015) (manuscript at 56) (on file with author) (noting the libertarian ideology of judges on the D.C. Circuit who have been most active in striking down agency decisions on CBA grounds, and that while this ideology does not perfectly track party affiliation, it “correlates powerfully” with it). While the D.C. Circuit now has seven active judges who were nominated by Democratic presidents and four active judges who were nominated by Republican presidents, it also has five senior judges who were nominated by Republican presidents and one senior judge who was nominated by a Democratic president. These senior judges are entitled to (and do) carry up to a full caseload. Because panels are composed of three judges, there remains a strong possibility of partisan or ideological panels reviewing independent agency decisions.
126
Gen Accounting Office
U.S. Gov’t Accountability Office
, GAO/GGD-98-30,
Unfunded Mandates: Reform …
Gen Accounting Office
U.S. Gov’t Accountability Office
, GAO/GGD-98-30,
Unfunded Mandates: Reform Act Has Had Little Effect on Agencies’ Rulemaking Actions
30 (1998),
[http://perma.cc/5QFV-5864].
127
Sherwin,
supra
note 15, at 27-28 (citing HR. 4818, 108th Cong. (2004); H.R. R
ep
. N
. 108-472, at 8…
Sherwin,
supra
note 15, at 27-28 (citing HR. 4818, 108th Cong. (2004); H.R. R
ep
. N
. 108-472, at 841 (2004); S. 2908, 108th Cong. (2004) (introduced by Sen. Judd Gregg (R-NH)); Consolidated Appropriations Act of 2005, Pub. L. No. 108-447, 118 Stat. 2809 (2004)).
128
Full Committee Hearing on Sarbanes-Oxley 404: Will the SEC’s and PCAOB’s New Standards Lower C…
Full Committee Hearing on Sarbanes-Oxley 404: Will the SEC’s and PCAOB’s New Standards Lower Compliance Costs for Small Companies
?:
Hearing Before the H Comm. on Small Bus.
, 110th Cong. 97 (2007) (statement of Hal Scott, Professor, Harvard Law Sch.) (“That estimate was, we now know, off by a factor of over 48.”)
accord
CCMR
Report
supra
note 4. As noted in Part III.A,
infra
, this criticism was mistaken, but has been repeated by the Committee on Capital Markets Regulation in its 2013 report promoting CBA.
Id.
at 9.
129
A Balancing Act: Cost, Compliance, and Competitiveness After Sarbanes-Oxley: Hearing Before the
Su…
A Balancing Act: Cost, Compliance, and Competitiveness After Sarbanes-Oxley: Hearing Before the
Subcomm
on
Regulatory Affairs of the H. Comm. on Government Reform
, 109th Cong. 2 (2006) (statement of Rep. Patrick T. McHenry, Chairman, H.
Subcomm
. on Regulatory Affairs) (repeating criticism).
130
Daniel M Gallagher,
Comm’r
, Sec. & Exch.
Comm’n
, Remarks Before the Corporate Directors Forum, (Ja…
Daniel M Gallagher,
Comm’r
, Sec. & Exch.
Comm’n
, Remarks Before the Corporate Directors Forum, (Jan. 29, 2013),
/1365171492142#
.VADgc7xdXkZ
[http://perma.cc/TV7S-8QW5] (“One example relates to compliance with Section 404 of Sarbanes Oxley, which the Commission estimated would cost on average roughly $91,000 a year to implement.”).
131
Memorandum from Dan M
Berkovitz
, Gen. Counsel, U.S. Commodities Futures Trading
Comm’n
, & Jim Mose…
Memorandum from Dan M
Berkovitz
, Gen. Counsel, U.S. Commodities Futures Trading
Comm’n
, & Jim Moser, Acting Chief Economist, U.S. Commodities Futures Trading
Comm’n
, to Rulemaking Teams (Sept. 29, 2010),
/@aboutcftc/documents/file/oig_investigation_041511.pdf [http://perma.cc/M235-EUT2].
132
Id
at Exhibit 1, 2-3 (“[
S]
ection
15 does not require the [CFTC] to quantify the costs and benefits…
Id
at Exhibit 1, 2-3 (“[
S]
ection
15 does not require the [CFTC] to quantify the costs and benefits of an action. However, the [CFTC] cannot consider the costs and benefits . . . unless they are presented either quantitatively or qualitatively.”). A follow-up memo, in May 2011, required rulemaking teams to “incorporate the principles of Executive Order 13563 . . . to the extent . . . reasonably feasible” in final rulemakings. Memorandum from Dan M.
Berkovitz
, Gen. Counsel, U.S. Commodities Futures Trading
Comm’n
, & Andrei
Kirilenko
, Chief Economist, U.S. Commodity Futures Trading
Comm’n
, to Rulemaking Teams 1
May 13
, 2011
/file/oig_investigation_061311.pdf [http://perma.cc/M3SR-VYNW]. In May 2012, the CFTC and OIRA entered into a memorandum of understanding permitting OIRA staff to provide “technical assistance” to CFTC staff during implementation of the Dodd-Frank Act, “particularly with respect” to CBA/FR.
Memorandum of Understanding
between
Office of Info.
& Regulatory Affairs and U.S. Commodity Futures Trading
Comm’n
(2012),
.whitehouse.gov/sites/default/files/omb/inforeg/regpol/oira_cftc_mou_2012.pdf
133
Wall Street Reform: Oversight of Financial Stability and Consumer and Investor Protections: Hearin…
Wall Street Reform: Oversight of Financial Stability and Consumer and Investor Protections: Hearing Before the S Comm. on Banking, Housing, and Urban Affairs
, 113th Cong. 21 (2013) (statement of Sen. Crapo).
134
Office of the Inspector Gen, Sec. & Exch.
Comm’n
, Report No. 499, Follow-Up Review of Cost-Benefit…
Office of the Inspector Gen, Sec. & Exch.
Comm’n
, Report No. 499, Follow-Up Review of Cost-Benefit Analyses in Selected SEC Dodd-Frank Act Rulemakings 1
(2012);
Office of the Inspector Gen., U.S. Commodity Futures Trading
Comm’n
, A Review of Cost-Benefit Analyses Performed by the Commodity Futures Trading Commission in Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank Act,
at
(2011).
135
Pub L. No. 112-10, § 1573(a), 125 Stat. 38, 138-39 (2011) (codified at 12 U.S.C. § 5496(b)).
Pub L. No. 112-10, § 1573(a), 125 Stat. 38, 138-39 (2011) (codified at 12 U.S.C. § 5496(b)).
136
US. Gov’t Accountability Office,
GAO-12-151,
Dodd
-Frank Act Regulations: Implementation Could Bene…
US. Gov’t Accountability Office,
GAO-12-151,
Dodd
-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination 14 (2011).
137
Id
at 16-17.
In 2012, the GAO released another report advocating CBA/FR, reiterating its view that…
Id
at 16-17.
In 2012, the GAO released another report advocating CBA/FR, reiterating its view that financial regulators should “more fully incorporate OMB’s guidance into their rulemaking policies.”
U.S. Gov’t Accountability Office,
GAO-13-101,
Dodd-Frank Act: Agencies’ Efforts To Analyze and Coordinate Their Rules
(2012) (text on “highlights” page).
138
US. Gov’t Accountability Office
supra
note 138, at 17.
US. Gov’t Accountability Office
supra
note 138, at 17.
139
See
CCMC
Report
supra
note 6, at 9-10
CCMR Report
supra
note 4, at 7-10 Neither the GAO nor oth…
See
CCMC
Report
supra
note 6, at 9-10
CCMR Report
supra
note 4, at 7-10 Neither the GAO nor other CBA proponents have set out examples of how the SEC should conduct CBA/FR, limiting themselves to simply counting what share of rulemakings contained CBA/FR of any kind, and what share contained at least some quantification, without regard to whether the quantification is precise, reliable, or comprehensive as to either costs or benefits. The CCMR report holds up one SEC rulemaking as the “gold-standard” of CBA/FR,
CCMR Report
supra
note 4, at 13-15, as discussed
infra
at text accompanying notes 344-361.
140
Eg.
Who Is Too Big To Fail? GAO’s Assessment of the Financial Stability Oversight Council and t…
Eg.
Who Is Too Big To Fail? GAO’s Assessment of the Financial Stability Oversight Council and the Office of Financial Research
Hearing Before the
Subcomm
on
Oversight and Investigations of the H. Comm. on Fin.
Serv
., 113th Cong. 26 (2013) (question from Rep. Wagner to witness from Financial Stability Oversight Council about a “GAO report that talked about [needing] a [CBA]”).
141
Memorandum from the Div of Risk, Strategy and Fin.
Innovation and the Office of the Gen. Counsel, …
Memorandum from the Div of Risk, Strategy and Fin.
Innovation and the Office of the Gen. Counsel, U.S. Sec. & Exch.
Comm’n
, to the Staff of the Rulemaking Div. and Offices, U.S. Sec. & Exch.
Comm’n
, on Current Guidance on Economic Analysis in SEC Rulemakings 1
(2012),
[http://perma.cc/RDN3-NU64].
142
Id
at 3.
Id
at 3.
143
Id
at 4-15.
See
sources cited
supra
notes 20 and 81 (citing CBA Executives Orders and OMB Guidance…
Id
at 4-15.
See
sources cited
supra
notes 20 and 81 (citing CBA Executives Orders and OMB Guidance).
144
S 1173, 113th Cong. (2013). The Senators were Senators Collins (R-ME), Portman (R-OH), and Warner…
S 1173, 113th Cong. (2013). The Senators were Senators Collins (R-ME), Portman (R-OH), and Warner (D-VA). A similar bill was introduced in 2012. S. 3468, 112th Cong. (2012). Other bills promoting CBA have been introduced in this and prior years.
E.g
., Unfunded Mandates Information and Transparency Act of 2014, H.R. 899, 113th Cong. (2014); Regulatory Sunset and Review Act of 2013, H.R. 309, 113th Cong. (2013); Startup Act 3.0, S. 310, 113th Cong. (2013); SEC Regulatory Accountability Act, H.R. 1062, 113th Cong. (2013); Startup Act 3.0, H.R. 714, 113th Cong. (2013); Congressional Office of Regulatory Analysis Creation and Sunset and Review Act of 2011, H.R. 214, 112th Cong. (2011);
Regulatory Improvement Act of 1999, S. 746, 106th Cong. (1999); Regulatory Improvement Act of 1998, S. 981, 105th Cong. (1997); Comprehensive Regulatory Reform Act of 1995, S. 343, 104th Cong. (1995); Regulatory Reform and Relief Act, H.R. 926, 104th Cong. (1995).
To date, a small number of former commissioners of independent agencies have backed the bill.
E.g
., Letter to the Chair and Ranking Member of the Senate Homeland Sec. and Gov’t Affairs Comm., June 18, 2013,
.cfm/files/serve
?File
_id=6f3f466c-e744-4d99-892a-91f6e6348ebf [http://perma.cc/9V34-W5X9].
145
S 1173, § 3(a)(6). The independent financial regulatory agencies include, among others, the Burea…
S 1173, § 3(a)(6). The independent financial regulatory agencies include, among others, the Bureau of Consumer Financial Protection (CFPB), Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corporation (FDIC), Federal Reserve System, Federal Housing Finance Agency (FHFA), Federal Trade Commission (FTC),
Office
of the Comptroller of the Currency (OCC), Office of Financial Research (OFR), and Securities Exchange Commission (SEC). S. 1173, § 2(4) (incorporating 44 U.S.C. § 3502(5) (2012)). The newly created CFPB and OFR were added to the list in the Dodd-Frank Act, § 1100D, and the OCC was added to the list in § 315 of that Act. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.
L. No. 111-203, 124 Stat. 1524 (codified in scattered sections).
146
S 1173, § 2(5) (incorporating the definition of “rule” under 5 U.S.C. § 551 (2012), which d…
S 1173, § 2(5) (incorporating the definition of “rule” under 5 U.S.C. § 551 (2012), which defines a “rule” as any “statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy”).
147
Id
§ 3(b).
Id
§ 3(b).
148
Id
§ 3(c)(3)(B).
Id
§ 3(c)(3)(B).
149
Id
§ 4(b).
Id
§ 4(b).
150
See
Alan B Morrison,
The Administrative Procedure Act: A Living and Responsive Law
, 72
Va. L. Rev
.…
See
Alan B Morrison,
The Administrative Procedure Act: A Living and Responsive Law
, 72
Va. L. Rev
. 253, 256 (1986) (“[
R]
ulemakings
are often more controversial than adjudications [under the APA], whose very processes are hidden from outsiders.”).
151
See
CCMR Report,
supra
note 4, at 1 (stating that CBA/FR should “[
f]
ocus
on economically significa…
See
CCMR Report,
supra
note 4, at 1 (stating that CBA/FR should “[
f]
ocus
on economically significant rules”)
152
It is worth noting that no similar efforts can be found in the more prominent publications advocat…
It is worth noting that no similar efforts can be found in the more prominent publications advocating CBA/FR of financial regulation
E.g.
CCMC Report
supra
note 6; CCMR
Report
supra
note 4. The closest proponents come is to point to selected CBA/FR as “gold standard” CBA/FR, but CBA/FR advocates do not review that CBA in any detail, and as discussed in Part III.E below, these “gold standards” are no more compelling in their guesstimated CBA/FR components than the examples reviewed here. This gap between what the CBA/FR proponents promise can be done and what they can demonstrate has been done is troubling.
153
This section draws extensively on John C Coates IV &
Suraj
Srinivasan
SOX After Ten Years: A Mult…
This section draws extensively on John C Coates IV &
Suraj
Srinivasan
SOX After Ten Years: A Multidisciplinary Review,
29
Acct. Horizons
(forthcoming 2015),
[http://perma.cc/6SVZ-ELZW].
154
For a review and evaluation of the core elements of SOX, see John C Coates IV,
The Goals and Promi…
For a review and evaluation of the core elements of SOX, see John C Coates IV,
The Goals and Promise of the Sarbanes-Oxley Act
, 21
J. Econ.
Persp
91 (2007).
155
Such systems consist of methods by companies that monitor use of the company’s assets and produc…
Such systems consist of methods by companies that monitor use of the company’s assets and produce accurate financial reports, including (for example) computer programs designed to detect inconsistencies between customer orders and accounting records, rules for which corporate agents can authorize certain expenditures and transactions, internal audits, and verification procedures
See
Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting, Exchange Act Release Nos. 33-8810, 34-55929, 72 Fed.
Reg. 35,324 (June 27, 2007).
156
Sarbanes-Oxley Act of 2002 § 3(a), 107 Pub
L. No. 204, 116 Stat. 745, 749 (codified at 15 U.S.C. 7…
Sarbanes-Oxley Act of 2002 § 3(a), 107 Pub
L. No. 204, 116 Stat. 745, 749 (codified at 15 U.S.C. 7202 (2012)).
157
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure…
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, 68 Fed Reg 36,636 (June 18, 2003) (codified at 17 C.F.R. pts. 210, 228, 229, 240, 249, 270, 274).
For brevity, I refer to the SEC’s “rule” in this section, although in fact the release modified a number of separate SEC rules. The effect of the SEC’s rules in practice would turn out to be heavily influenced by rules separately adopted by the PCAOB.
158
See
supra
notes 77-78, 87-88, 95-98 and accompanying text
See
supra
notes 77-78, 87-88, 95-98 and accompanying text
159
This was required by the National Securities Markets Improvement Act of 1996, Pub
L. No. 104-290, …
This was required by the National Securities Markets Improvement Act of 1996, Pub
L. No. 104-290, 110 Stat. 3416, 3424-25 (codified in scattered sections of 15 U.S.C.), which amended three of the SEC’s governing statutes—the Securities Act of 1933, the Exchange Act of 1934, and the Investment Company Act of 1940—to require the SEC to consider whether any rulemaking done “pursuant to” those statutes would “promote efficiency, competition, and capital formation.”
15 U.S.C. §§ 77b(b), 78c(f), 80a-2(c) (2012).
160
See
supra
notes 81-82
See
supra
notes 81-82
161
68 Fed
Reg. 36,636, 36,656-57 (June 18, 2003).
68 Fed
Reg. 36,636, 36,656-57 (June 18, 2003).
162
Id
at 36,657.
Id
at 36,657.
163
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure…
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Exchange Act Release Nos 33-8238, 34-47986, Investment Company Act Release No. IC-26068 at pt.
V(
B) & n.174 (Aug. 14, 2003),
[http://perma.cc/XZN4-GMZ5] (“The estimate does not include the costs of the auditor’s attestation report, which many commenters have suggested might be substantial.”).
164
Full Committee Hearing on Sarbanes-Oxley Section 404: Will the SEC’s and PCAOB’s New Standards…
Full Committee Hearing on Sarbanes-Oxley Section 404: Will the SEC’s and PCAOB’s New Standards Lower Compliance Costs for Small Companies
?:
Hearing Before the H Comm. on Small Bus.
, 110th Cong. 97 (2007) (statement of Hal S. Scott, Dir., Comm. on Capital
Mkts
. Regulation) (“[The SEC’s] estimate was, we now know, off by a factor of over 48.”). Presumably, this claim is based on comparing the SEC’s cost estimate with the results of a survey (
=274) conducted by the Financial Executives International (FEI) and Financial Executives Research Foundation (FERF). That survey found the average cost of SOX 404 reported in 2004 was $4.4 million (4,400,000 / 91,000 = 48.4). FEI is a trade group, and the FERF is a related organization that performs research on topics of interest to chief finance officers of large companies and other members. The FEI/FERF study is formally titled
Financial Executives International and Financial Executives Research Foundation
Special Survey on Sarbanes-Oxley Section 404 Implementation
(2005) [hereinafter
FEI/FERF Survey
].
165
Criticisms of the SEC’s cost estimate are misplaced for two other reasons The FEI/FERF survey,
see…
Criticisms of the SEC’s cost estimate are misplaced for two other reasons The FEI/FERF survey,
see supra
note 166, was of large firms (average revenues of $6 billion, as compared to overall average revenues for all public firms in
Compustat
in 2004 of $2 billion, and median revenues for such firms of $96 million). Since compliance costs generally, and control system costs in particular, increase at a decreasing rate in relation to firm size, $4.4 million would have been too high as an average for all covered firms even in 2004. In addition, the FEI/FERF estimate was based on data that was gathered from companies during their first year under the rule. The costs of any new rule will fall over time, with learning, as has been the case with SOX 404. Further, the agency ultimately charged with supervising section 404(b) work by audit firms, the PCAOB, modified the requirements applicable under that section in 2007, further dramatically reducing the costs of the rule. The upshot is that the best current estimate of section 404 costs is closer to $400,000 than to $4.4 million—still higher than the SEC’s estimate of section 404(a) costs, but reasonably close, once one acknowledges that the $91,000 estimate was for a part and not all of section 404’s costs.
166
See
Coates &
Srinivasan
supra
note 155, at 25
See
Coates &
Srinivasan
supra
note 155, at 25
167
See
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclo…
See
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports,
supra
note 165, at pt
V(
B).
168
See
supra
note 166
See
supra
note 166
169
See
infra
text accompanying notes 182-203
See
infra
text accompanying notes 182-203
170
See
Amendments to Rules Regarding Management’s Report on Internal Control Over Financial Reporti…
See
Amendments to Rules Regarding Management’s Report on Internal Control Over Financial Reporting, 72 Fed Reg. 35,310 (June 27, 2007) (codified at 17 C.F.R. pts. 210, 228, 229, 240); Internal Control Over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers and Newly Public Companies, 71 Fed.
Reg. 76,580 (Dec. 21, 2006) (codified at 17 C.F.R. pts. 210, 228, 229, 240, 249).
171
Section 3(e) of Executive Order 12,866,
supra
note 81, defines the “regulatory action” covered…
Section 3(e) of Executive Order 12,866,
supra
note 81, defines the “regulatory action” covered by the order to include “any substantive action by an agency . . that promulgates or is expected to lead to the promulgation of a final rule or regulation,” without regard to whether the final rule adds new restrictions on private activity or exempts private activity covered by a prior regulation. Exec. Order 12,866,
58 Fed.
Reg. 51,735 (Sept. 30, 1993).
172
See
CCMC Report,
supra
note 6
CCMR Report
supra
note 4
See
CCMC Report,
supra
note 6
CCMR Report
supra
note 4
173
Throughout this section, I use “fraud” in a loose sense, and mean it to encompass deceptive, m…
Throughout this section, I use “fraud” in a loose sense, and mean it to encompass deceptive, manipulative, or misleading accounting and other financial disclosures that could be prevented or corrected in a cost-effective manner, regardless of whether proof of specific intent to deceive, reasonable reliance, or other elements of the tort or crime of fraud exists, and regardless of whether the accounting technically complies with generally accepted accounting principles
174
See
Coates &
Srinivasan
supra
note 155
See
Coates &
Srinivasan
supra
note 155
175
Id
at 46.
Interestingly, the U.S. crime victimization survey does not ask questions that would be …
Id
at 46.
Interestingly, the U.S. crime victimization survey does not ask questions that would be likely to elicit data on fraud incidence, instead focusing on violent crime, sexual assaults, and stalking.
See
Census Bureau,
OMB No. 1121-0111, National Crime Victimization Survey: NCVS-1 Basic Screen Questionnaire
U.S. Dep’t Commerce,
[http://perma.cc/Q8BM-N3WU]; Census Bureau,
OMB No. 1121-0302, Supplemental Victimization Survey
U.S. Dep’t Commerce
(2006),
[http://perma.cc/RJ8H-XYUN]. Identity theft and cyber crimes are types of fraud surveyed by the Bureau of Justice Statistics,
see
Erika Harrell & Lynn Langton
, Bureau of Justice Statistics, U.S. Dep’t Justice,
Victims of Identity Theft, 2012,
Dec. 2013),
[http://perma.cc/DDX4-HWPU];
Bureau of Justice Statistics
Cybercrime
U.S. Dep’t Justice,
?ty
=tp&tid=41 [http://perma.cc/9LWR-VJTY], but no general survey of fraud is conducted by the Bureau of Justice Statistics.
176
See
Jonathan S Feinstein,
Detection Controlled Estimation
, 33
J.L. & Econ.
233
, 233-34 (1990).
See
Jonathan S Feinstein,
Detection Controlled Estimation
, 33
J.L. & Econ.
233
, 233-34 (1990).
177
Eg.
Vikramaditya
S.
Khanna
et al.,
CEO Connectedness and Corporate Frauds
J. Fin.
forthcoming
2…
Eg.
Vikramaditya
S.
Khanna
et al.,
CEO Connectedness and Corporate Frauds
J. Fin.
forthcoming
2015),
[http://perma.cc/S3YL-ZKBM]; Si Li, Corporate Financial Fraud: An Application of Detection Controlled Estimation (Sch. of Bus. and Econ.,
Wilfrid
Laurier Univ., Working Paper, July 2013),
[http://perma.cc/WB8G-ZRNZ]; Tracy
Yue
Wang, Corporate Securities Fraud: An Economic Analysis (Carlson Sch. of Mgmt., Univ. of Minn., Working Paper, Apr. 2006),
[http://perma.cc/AW9P-33SF]. Such models have their weaknesses, as they rely in an ad hoc fashion on different instruments that are assumed to be exogenous, when none truly are exogenous; they are, however, the best that researchers have yet devised.
178
IJ. Alexander
Dyck
et al.,
How Pervasive Is Corporate Fraud?
4 (
Rotman
Sch. of Mgmt. Working Paper…
IJ. Alexander
Dyck
et al.,
How Pervasive Is Corporate Fraud?
4 (
Rotman
Sch. of Mgmt. Working Paper No. 222608, Feb. 2013),
[http://perma.cc/D7H6-G47F]. They validate this measure with a survey of fraud observed by business school students at former employers.
Id.
at 21-23.
179
For related research, using different and less theoretically grounded empirical methods, see Anast…
For related research, using different and less theoretically grounded empirical methods, see Anastasia K
Zakolyukina
Measuring Intentional GAAP Violations: A Structural Approach
(Univ. of Chicago Booth Sch. of Bus
.,
Working Paper No. 13-45, Apr. 25, 2014),
[http://perma.cc/X4QR-4JSC] which estimates undetected intended earnings manipulation from a sample of 1400 CEOs after SOX. She finds the probability of detection is six percent and that intended earnings manipulation generates a loss of twenty-four percent to a firm’s CEO wealth when detected. The inference she draws is that seventy-three percent of her sample has incentives to manipulate earnings, and that the value-weighted bias in stock prices is 2.82%.
Id.
at 3.
A survey-based study is provided in Ilia
Dichev
et al.,
Earnings Quality: Evidence from the Field
, 56
J. Acct. & Econ
1, 30 (2013), in which respondents suggest around twenty percent of firms exploit GAAP to misrepresent reported performance in their financial statements.
180
Assume, for example, a fraudster obtains $1 from a victim and spends it on food Is the social loss…
Assume, for example, a fraudster obtains $1 from a victim and spends it on food Is the social loss $0 or $1? If the criminal’s utility is ignored and the fraud has no effect besides the transfer of $1, the social loss is $1. If the criminal’s utility is counted equally with the victim’s, and neither attaches unusual utility to the dollar, the social loss is $0.
181
For example, David A Anderson,
The Aggregate Burden of Crime
, 42 J.L. &
Econ.
611, 629 tbl.7 (1999
For example, David A Anderson,
The Aggregate Burden of Crime
, 42 J.L. &
Econ.
611, 629 tbl.7 (1999
),
estimates that such gains, if counted, roughly double the costs of crime.
182
OMB Guidance,
supra
note 20
OMB Guidance,
supra
note 20
183
Id
Id
184
In the context of crime, compare Philip J Cook,
Crime Statistics: Costs of Crime
in
Encyclopedi…
In the context of crime, compare Philip J Cook,
Crime Statistics: Costs of Crime
in
Encyclopedia of Crime and Justice 373
(Sanford H.
Kadish
et al. eds
.,
1983) (criminals’ utility should count) with
Mark A. Cohen, The Costs of Crime and Justice
(2005) (criminals’ utility should not count), and
The Cost of Crime: Understanding the Financial and Human Impact of Criminal Activity: Hearing Before the S. Comm. on the Judiciary
, 109th Cong. 7 (2006) (statement of Jens Ludwig, Professor, Georgetown Public Policy Institute) (same).
185
Fraud is criminalized in part because it causes large externalities: direct remediable civil damag…
Fraud is criminalized in part because it causes large externalities: direct remediable civil damages are not thought to be large enough to provide sufficient incentive for private actors to enforce optimally S.
Shavell
The Judgment Proof Problem
, 6
Int’l Rev. L. & Econ
45 (1986) (tort-
feasors
may be “judgment proof” against large civil sanctions).
But criminal sanctions are reserved for a small subset of frauds—those in which clear evidence is available ex post for frauds caused by individuals with specific intent—and the nature of fraud is such that this type of evidence is often unavailable. Section 24 of the Securities Act of 1933 imposes criminal liability for “willful” violations. Securities Act of 1933,
ch.
38, § 24, 48 Stat. 74 (codified at 15 U.S.C. § 77x (2012));
see also
Securities Exchange Act of 1934, 15 U.S.C. § 78a (2012).
186
Baruch Lev,
Corporate Earnings: Facts and Fiction
, 17
J Econ.
Persp
27, 42-44 (2003).
Anderson,
s…
Baruch Lev,
Corporate Earnings: Facts and Fiction
, 17
J Econ.
Persp
27, 42-44 (2003).
Anderson,
supra
note 183, at 616-17, 629, presents a similar list of indirect effects of crime generally. He estimates the indirect costs—what he categorizes as “crime-induced production,” opportunity costs, and risks to life and health—as roughly double the value of victim-to-criminal property transfers, and when he counts the costs incurred by criminals, the total costs of crime are more than double the value of those transfers.
Id.
at 629 tbl.7.
In other words, the external effects of crime generally greatly exceed their direct effects.
187
Reduced quality of financial information provided by one firm will in the first instance lower exp…
Reduced quality of financial information provided by one firm will in the first instance lower expectations of the quality of information provided by other firms, heighten expected fraud-related losses generally, and reduce confidence in public securities markets and in markets more generally Market-wide liquidity deteriorated following Enron and related scandals, and improved after SOX’s adoption.
Pankaj
K. Jain et al.,
The Sarbanes-Oxley Act of 2002 and Market Liquidity
, 43
Fin
Rev.
361 (2008).
Mariassunta
Giannetti
and Tracy
Yue
Wang show that revelation of corporate frauds in a state caused equity holdings of households in that state to fall, increasing the cost of capital for non-fraudulent firms.
Mariassunta
Giannetti
& Tracy
Yue
Wang,
Corporate Scandals and Household Stock Market Participation
(Eur. Corp. Governance Inst., Finance Working Paper No. 405/2014, 2014),
[http://perma.cc/73LY-VSWS]. For a more general study of the effect of trust on finance, see Luigi
Guiso
et al.,
Trusting the Stock Market
63
J. Fin.
2557 (2008).
See also
Emilia
Bonaccorsi
di Patti,
Weak Institutions and Credit Availability: The Impact of Crime on Bank Loans
(Bank of It., Occasional Paper No. 52, 2009),
[http://perma.cc/84L3-UWXL] (demonstrating that crime, including fraud, increases borrowing costs and increases capital constraints by the public generally).
188
Misallocation is caused by fraudulent signals of the value of firms or whole industries, as in the…
Misallocation is caused by fraudulent signals of the value of firms or whole industries, as in the telecom and Internet bubbles For a review of studies showing that corporate finance decisions are driven by capital market prices, including prices that deviate from fundamental values (that is, mispricing), see Malcolm Baker,
Capital Market-Driven Corporate Finance
, 1
Ann. Rev.
Fin.
Econ
181 (2009).
See also
Malcolm Baker et al.,
When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms
Q. J. Econ.
969 (2003) (modeling and presenting evidence that bubbles affect corporate investment).
Simi
Kedia
and Thomas
Philippon
model investment decisions of firms during periods of fraud and find empirical support for their prediction that fraud and earnings management distort hiring and investment decisions of firms, leading to over-investment and excessive hiring during periods of suspicious accounting; this over-investment and excessive hiring, in turn, lead to misallocation of resources in the economy. Simi
Kedia
& Thomas
Philippon
The Economics of Fraudulent Accounting
, 22
Rev.
Fin
. Stud.
2169 (2009).
189
One can view costly acquisitions by fraudulent companies of other companies as an example of the p…
One can view costly acquisitions by fraudulent companies of other companies as an example of the prior category (misallocated resources), but it is important enough to warrant estimating separately Such acquisitions are often followed by mismanagement or outright theft, contributing to otherwise avoidable bankruptcies. While bankruptcy can reorganize firms, resulting in transfers among investors, they also use up real resources. For a model of merger and acquisition activity driven by mispricing, see Andrei
Shleifer
& Robert W.
Vishny
Stock Market Driven Acquisitions
, 70
J. Fin. Econ.
295 (2003).
For estimates of the costs of bankruptcy, see, for example, Arturo
Bris
et al.,
The Costs of Bankruptcy: Chapter 7 Liquidation Versus Chapter 11 Reorganization
, 61
J. Fin.
1253 (2006), which estimates that the range of firm assets resulting from formal bankruptcy is between two and twenty percent.
190
Such costs include bonding and monitoring by investors to avoid fraud, such as for audit firms, in…
Such costs include bonding and monitoring by investors to avoid fraud, such as for audit firms, independent directors, appraisers, analysts, regulatory and enforcement agencies, and prisons Audit fees were rising prior to SOX, due to market-driven demand for increased scrutiny of financial statements following the scandals that led to SOX.
Sharad
Asthana
et al.,
The Effect of Enron, Andersen, and Sarbanes-Oxley on the US Market for Audit Services
, 22
Acct. Res. J.
4 (2009). Likewise, separate from SOX, the New York Stock Exchange and the
Nasdaq
adopted tighter corporate governance requirements in response to Enron et al., which tightened the criteria for and likely increased the costs of recruiting independent directors.
See
Coates,
supra
note 156, at 111.
191
These third parties include those dependent on the victims of the initial fraud (eg., family, busi…
These third parties include those dependent on the victims of the initial fraud (eg., family, business partners, creditors, and communities). For studies showing spillover effects of restatements, see Coates &
Srinivasan
supra
note 155, at 51 n.21.
192
While SOX 404 would have had no effect on
Madoff’s
scheme, since he kept his brokerage private and…
While SOX 404 would have had no effect on
Madoff’s
scheme, since he kept his brokerage private and outside the scope of SOX, the findings are suggestive of what might be discovered if the prospect of quantifying such harms to fraud victims more generally were undertaken For the number of investors affected, see Trustee’s Ninth Interim Report for the Period Ending March 31, 2013, exhibit A at 4-5, Sec. Investor Prot. Corp. v. Bernard L.
Madoff
Inv. Sec. (
In re
Bernard L.
Madoff
), No. 08-01789 (
Bankr
. S.D.N.Y. Apr. 30, 2013). For charities harmed by the
Madoff
scandal, see Anthony Weiss & Gabrielle
Birkner
Charities, Day Schools Hard Hit by
Madoff
Scandal
Jewish Daily Forward
(Dec. 17, 2008),
[http://perma.cc/AZ7D-CPRA].
193
See
Trustee’s Ninth Interim Report,
supra
note 194,
exhibit
A at 2
See
Trustee’s Ninth Interim Report,
supra
note 194,
exhibit
A at 2
194
Audrey Freshman,
Financial Disaster as a Risk Factor for Posttraumatic Stress Disorder: Internet S…
Audrey Freshman,
Financial Disaster as a Risk Factor for Posttraumatic Stress Disorder: Internet Survey of Trauma in Victims of the
Madoff
Ponzi
Scheme
, 37
Health & Soc Work
39, 44-47 (2012).
195
Carol Graham et al, The Bigger They Are,
the
Harder They Fall: An Estimate of the Costs of the Cri…
Carol Graham et al, The Bigger They Are,
the
Harder They Fall: An Estimate of the Costs of the Crisis in Corporate Governance (The Brookings Inst., Working Paper, 2002),
[http://perma.cc/MK3C-MWDY]
. Another attempt to assess the size of externalities (without quantifying them for society overall) uses brokerage data of a sample of retail investors across the United States and shows that, upon the revelation of fraud in a company in a particular state, all households in the state, not just the ones owning stocks of fraud firms, reduce their equity holdings.
Giannetti
& Wang,
supra
note 189.
196
This is the model described in David
Reifschneider
et al,
Aggregate Disturbances, Monetary Policy,…
This is the model described in David
Reifschneider
et al,
Aggregate Disturbances, Monetary Policy, and the
Macroeconomy
: The FRB/US Perspective
, 85
Fed. Res. Bull.
1 (1999
),
sometimes referred to as the “FRB/US” (pronounced “
ferbus
”) model.
See
Div. of Research & Statistics,
Fed. Reserve Bd.
A Guide to FRB/US: A Macroeconomic Model of the United States
(Flint
Brayton
& Peter Tinsley eds
.,
Oct. 1996),
.gov/pubs/feds/1996/199642/199642pap.pdf [http://perma.cc/H6LF-TC2Q].
197
Graham et al,
supra
note 197, at 5.
Graham et al,
supra
note 197, at 5.
198
Id
at 6.
Id
at 6.
199
The sensitivity of estimates of social harms to assumptions in similar macroeconomic models is dis…
The sensitivity of estimates of social harms to assumptions in similar macroeconomic models is discussed more in connection with the Basel III rules in Part IIIC,
infra
200
For overviews, see John J Donohue III,
Assessing the Relative Benefits of Incarceration
Overall C…
For overviews, see John J Donohue III,
Assessing the Relative Benefits of Incarceration
Overall Changes and the Benefits on the Margin
in
Do Prisons Make Us Safer? The Benefits and Costs of The Prison Boom 269, 270-341
(Steven Raphael & Michael A. Stoll eds
.,
2009); and Jens Ludwig,
The Costs of Crime
, 9
Criminology & Pub.
Pol’y
307, 307-11 (2010).
201
See
John P
Hoehn
et al.,
A Hedonic Model of Interregional Wages, Rents and Amenity Values
, 27
J. R…
See
John P
Hoehn
et al.,
A Hedonic Model of Interregional Wages, Rents and Amenity Values
, 27
J. Regional Sci
. 605 (1987); Richard
Thaler
A Note on the Value of Crime Control: Evidence from the Property Market
, 5
J.
Urb
. Econ
137 (1978).
202
See
Mark A Cohen et al.,
Willingness-to-Pay for Crime Control Programs
42
Criminology
89
(2004); …
See
Mark A Cohen et al.,
Willingness-to-Pay for Crime Control Programs
42
Criminology
89
(2004); Daniel S.
Nagin
et al.,
Public Preferences for Rehabilitation Versus Incarceration of Juvenile Offenders: Evidence from a Contingent Valuation Survey
, 5
Criminology & Pub.
Pol’y
627 (2006).
203
See
Anderson,
supra
note 183, at 616-29
See
Anderson,
supra
note 183, at 616-29
204
See
Simon Moore & Jonathan P Shepherd,
The Cost of Fear: Shadow Pricing the Intangible Costs of Cr…
See
Simon Moore & Jonathan P Shepherd,
The Cost of Fear: Shadow Pricing the Intangible Costs of Crime
, 38
Applied Econ.
293 (2006).
205
These methods are probably best used in combination, as described in Donohue,
supra
note 202, at 3…
These methods are probably best used in combination, as described in Donohue,
supra
note 202, at 321 (“Instead of trying to resolve these normative questions, this chapter illustrates their importance by presenting various estimates of the cost of crime based on different assumptions The effort to highlight the underlying assumptions and methodologies will enable readers to implement their own normative choices in conducting cost-benefit analyses of incarceration.”).
206
Peter A Diamond & Jerry A.
Hausman
Contingent Valuation: Is Some Number Better than No Number
8…
Peter A Diamond & Jerry A.
Hausman
Contingent Valuation: Is Some Number Better than No Number
J. Econ.
Persp
45, 63 (1994) (concluding that “survey responses [in contingent valuation surveys] are not satisfactory bases for policy” because they are internally inconsistent, unreliable and biased by such factors as the “warm glow” from answering questions in particular ways);
see also
John
Bronsteen
et al.,
Well-Being Analysis vs. Cost-Benefit Analysis
, 62
Duke L.J
. 1603 (2013) (advocating use of hedonic surveys as more reliable than willingness-to-pay surveys, which are conventionally used in CBA in the non-financial regulatory context).
207
See
Coates &
Srinivasan
supra
note 155, at 17
See
Coates &
Srinivasan
supra
note 155, at 17
208
See, eg.
, Ehud
Kamar
et al.,
Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-C…
See, eg.
, Ehud
Kamar
et al.,
Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis
, 25
J.L. Econ. & Org.
107 (2009) (studying whether SOX drove firms out of the public capital market)
; see
also
Coates &
Srinivasan
supra
note 155, at 55 (touting difference-in-difference studies).
209
This seems to have been true in some of the earliest studies of the effects of SOX, which found di…
This seems to have been true in some of the earliest studies of the effects of SOX, which found differences in US. firms after SOX compared to Canadian or U.K. firms. For a selection of these studies, see Coates &
Srinivasan
supra
note 155, at 29-31. Those differences, however, either started well before SOX, or affected U.S. firms not subject to SOX as much as they did U.S. firms subject to SOX, such that no consensus has emerged as to whether SOX had the studied effects.
Id.
210
See the studies reviewed in Coates and
Srinivasan
supra
note 155, at 27, 30, 56
See the studies reviewed in Coates and
Srinivasan
supra
note 155, at 27, 30, 56
211
One could imagine a law like SOX 404 applying to all firms with a past (and so not easily manipula…
One could imagine a law like SOX 404 applying to all firms with a past (and so not easily manipulated) market capitalization of between $75 million and $100 million, or between $100 million and $125 million, or between $150 million and $175 million, and so on all the way through the full distribution of market capitalizations Needless to say, even though it may be the only way to derive reliable estimates of the aggregate social costs and benefits of the rule,
sch
a novel regulatory design would likely generate protest from covered companies, who would rightly complain that they compete with the exempt companies in the product, labor, and capital markets and that they were being potentially disadvantaged by any regulatory costs the rule might impose.
212
Peter
Iliev
The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices
, 65
Fin
1…
Peter
Iliev
The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices
, 65
Fin
1163 (2010).
213
Coates &
Srinivasan
supra
note
153
Coates &
Srinivasan
supra
note
153
214
Stefan
Arping
& Zacharias
Sautner
Did SOX Section 404 Make Firms Less Opaque?
Evidence from Cross…
Stefan
Arping
& Zacharias
Sautner
Did SOX Section 404 Make Firms Less Opaque?
Evidence from Cross-Listed Firms
, 30
Contemp Acct. Res.
1133 (2013); Christian
Leuz
et al.,
Why Do Firms Go Dark?
Causes and Economic Consequences of Voluntary SEC
Deregistrations
, 45
J. Acct. & Econ.
181 (2008).
215
At first pass, it might seem that the dual effects of this choice on both costs and benefits would…
At first pass, it might seem that the dual effects of this choice on both costs and benefits would cancel out as long as the choices were consistent, but in fact that would require a further debatable assumption—that is, that the functional relationship between actual legal compliance on the rule’s effects is the same for both costs and benefits That assumption seems at least possibly mistaken, because (for example) the extra costs from assuming a realistic baseline should be larger for larger companies, but they should increase at a decreasing rate in relation to firm size. On the other hand, the extra benefits might not follow that pattern, and in fact might increase at an increasing rate, if (for example) large firm frauds (as at Enron) have externalities that are not only larger than externalities of smaller firms, but also larger by a multiple greater than one due to informational cascades and threshold effects in how the media report on frauds.
216
Another open issue for CBA/FR is whether to use a national or supranational unit of analysis for p…
Another open issue for CBA/FR is whether to use a national or supranational unit of analysis for purposes of estimating welfare effects If, for example, SOX 404 prevented fraud by U.S.-listed but foreign-based companies that harms foreign investors, should that count as a social gain? What if, as some studies suggest,
e.g.
, Coates &
Srinivasan
supra
note 155, SOX 404 reduced cross-listings in the U.S. of foreign firms but with an effect that was concentrated among the most fraud-prone firms? If the result was to shift sales of stock by fraud-prone companies from the U.S. to other countries but not to reduce the total amount of fraud, should that count as a “benefit” for CBA/FR purposes under U.S. law? A similar unresolved issue concerns the costs of the rule: if the shift of firms from the U.S. to foreign stock markets harmed the New York economy but benefited the London or Hong Kong economies, should the losses count in a CBA/FR of the rule? The authors of the CCMR report seem to think such losses to the U.S. economy should count as “costs” under CBA.
CCMR Report
supra
note 4, at 10 (criticizing the SEC for not attempting to measure whether new rules “would . . . deter foreign companies from tapping U.S. capital markets”). But that report does not defend the position and does not take the correlative position that an increase in larger company cross-listings (for example, by lowering the cost of capital relative to foreign jurisdictions by reducing information asymmetries) should count as a benefit (and if a benefit, whether it should be a gross benefit to the United States or net of lower benefits to the issuers’ home countries). Neither the CFTC’s nor the SEC’s governing statutes specify the United States as the governing unit when commanding those agencies to consider “costs and benefits” or “efficiency,” respectively.
See
sources cited
supra
note 6.
217
See Harrington et al,
supra
note 34, for evidence of this outside the financial context.
See Harrington et al,
supra
note 34, for evidence of this outside the financial context.
218
See
FEI/FERF Survey
supra
note 166
See
FEI/FERF Survey
supra
note 166
219
See
Coates &
Srinivasan
supra
note 155, at 25-29
See
Coates &
Srinivasan
supra
note 155, at 25-29
220
SOX 404, for example, generates higher costs for larger firms, as well as for firms with less cent…
SOX 404, for example, generates higher costs for larger firms, as well as for firms with less centralized decision making and more dispersed or fragmented assets
Id.
To some extent, the RFA and analyses thereunder have produced useful methods of breaking down costs by firm size, but some of the more important differences may have less to do with size and more to do with industry, complexity, or geographic dispersion.
221
Office of Chief Accountant,
Study and Recommendations on Sections 404(b) of the Sarbanes-Oxley Act…
Office of Chief Accountant,
Study and Recommendations on Sections 404(b) of the Sarbanes-Oxley Act of 2002 for Issuers with Public Float Between $75 and $250 Million
Sec & Exch. Commission
2011) [hereinafter SEC,
Study and Recommendations
],
/news/studies/2011/404bfloat-study.pdf
[http://perma.cc/L5P7-PSHX]; Office of Econ. Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64.
222
See
Leonce
Bargeron
et al.,
Sarbanes-Oxley and Corporate Risk-Taking
, 49
J. Acct. & Econ.
34 (20…
See
Leonce
Bargeron
et al.,
Sarbanes-Oxley and Corporate Risk-Taking
, 49
J. Acct. & Econ.
34 (2010) (finding reduced risk-taking by U.S. companies subject to SOX compared to non-U.S. companies not subject to SOX).
But see
Ana M. Albuquerque & Julie L. Zhu,
Has Section 404 of the Sarbanes-Oxley Act Discouraged Corporate Risk-Taking? New Evidence from a Natural Experiment
Bos
. Univ. Sch. of Mgmt. Research Paper Series, Working Paper No. 2013-6, 2013),
[http://perma.cc/J88G-TTN9] (finding a trend towards reduced risk-taking by U.S. companies prior to SOX).
223
The cost estimates range from more than $44 million per year on average (firms with an average of …
The cost estimates range from more than $44 million per year on average (firms with an average of $6 billion in revenues in 2004, based on a FEI/FERF survey) to $350,000 (firms with market capitalizations under $10 billion in 2012, based on a GAO survey).
See
FEI/FERF Survey,
supra
note 166;
U.S. Gov’t Accountability Office
, GAO-13-582,
Internal Controls: SEC Should Consider Requiring Companies To Disclose Whether They Obtained an Auditor Attestation 23
(2013).
224
For one economist’s highly skeptical assessment of IAMs in the environmental context, see Robert…
For one economist’s highly skeptical assessment of IAMs in the environmental context, see Robert S
Pindyck
Climate Change Policy: What Do the Models Tell Us
51
J. Econ. Lit.
860 (2013).
Pindyck
calls for environmental policymaking to be informed by research, including empirical research, but ultimately based not on IAMs or guesstimated CBA but on “simpler” policy approaches that use a “plausible” range of outcomes and probabilities, where “plausible” is what is acceptable to a range of economists and subject matter experts (in his analysis, climate scientists).
Id.
at 869-70.
225
PV=C/R
, where
PV
is the present value,
is the annual cost, and
is the discount rate
PV=C/R
, where
PV
is the present value,
is the annual cost, and
is the discount rate
226
This is a rough range of per-year, per-firm direct cost estimates reflected in the SEC’s compreh…
This is a rough range of per-year, per-firm direct cost estimates reflected in the SEC’s comprehensive survey of such costs in 2007 and 2008
See
Office of Econ. Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64, at 46 tbl.9 (2009). The estimates were reduced by an arbitrary thirty percent to reflect increases that would have occurred without SOX, due to market pressures reacting to Enron and related scandals.
227
The Office of Management and Budget suggests these discount rates OMB Guidance,
supra
note 20, at …
The Office of Management and Budget suggests these discount rates OMB Guidance,
supra
note 20, at 18. Whether they are appropriate at all, or for assessing financial regulation, is unclear.
See
Martin L. Weitzman,
Tail-Hedge Discounting and the Social Cost of Carbon
, 51
J. Econ. Lit.
873 (2013) (critiquing the current discount rate of three percent recommended by OMB and suggesting one percent instead, based on current yields on U.S. Treasuries).
If a discount rate of one percent were used instead of three percent, the sensitivity to the net costs and benefits reported in Table 3 below for discount rates would increase by another 852%. One can also argue for discount rates higher than seven percent, depending on what time period one uses to average returns on equity investments. As discussed in Part III.C, two further discount rates (2.5% and 5%) are used by the Bank for International Settlements in its CBA/FR of the Basel III capital rules discussed below, and yet another (3.5%) is used by the FSA in its CBA/FR of the mortgage reforms discussed in Part III.E below. That six different discount rates (1%, 2.5%, 3%, 3.5%, 5%, 7%) are plausible is itself a source of concern about CBA/FR.
228
See
Office of Econ Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64, at 27 tbl.1 (showing …
See
Office of Econ Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64, at 27 tbl.1 (showing 2205 companies subject to 404(b) that did not answer the survey and 2081 companies subject to 404(b) that did answer the survey, totaling 4286, grossed up to 4400 to reflect growth in the number of listed companies since 2009).
229
See supra
text accompanying
note 180
See supra
text accompanying
note 180
230
This range is roughly equivalent at the high end to reductions in the shares of US. public compani…
This range is roughly equivalent at the high end to reductions in the shares of US. public companies that were meeting or just beating analyst estimates in the post-SOX period, with the low end being motivated by the likelihood that SOX’s effects on fraud are diminishing over time and/or caused by changes other than SOX 404.
Eli
Bartov
& Daniel A. Cohen,
The “Numbers Game” in the Pre- and Post-Sarbanes-Oxley Eras
, 24
J. Acct. Auditing & Fin.
505, 517 fig.2 (2009).
231
This range extends from 50% to 200% of the point estimate of the relationship between transfers an…
This range extends from 50% to 200% of the point estimate of the relationship between transfers and externalities of crime from
Anderson,
supra
note 183, at 629 tbl7.
232
SEC,
Study and Recommendations
supra
note 223, at
53-55
; Office of Econ
Analysis,
Study of the Sa…
SEC,
Study and Recommendations
supra
note 223, at
53-55
; Office of Econ
Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64.
233
Another method for estimating the net costs and benefits of a financial regulation is the “event…
Another method for estimating the net costs and benefits of a financial regulation is the “event study,” which examines market reactions to events leading up to a regulation’s enactment One estimate of the negative effects of SOX overall, based on stock market reactions to events leading to its passage, was roughly -0.07% of the U.S. equity market capitalization. Ivy
Xiying
Zhang,
Economic Consequences of the Sarbanes-Oxley Act of 2002
44 J. Acct. & Econ
74, 92 tbl.2 (2007).
That represented a net effect of more than negative $980 billion, based on U.S. equity market capitalization in 2003 (when SOX § 404 was adopted) of roughly $14 trillion.
Market Capitalization of Listed Companies
World Bank
[http://perma.cc/8FYT-9CNM]. By contrast, other studies of the stock market reaction to SOX produced results ranging from positive $420 billion to $1.7 trillion.
Aigbe
Akhigbe
& Anna D. Martin,
Valuation Impact of Sarbanes-Oxley: Evidence from Disclosure and Governance Within the Financial Services Industry
, 30
J. Banking & Fin. 989
(2006);
Pankaj
K.
Jain &
Zabihollah
Rezaee
The Sarbanes-Oxley Act of 2002 and Capital-Market Behavior: Early Evidence
23 Contemp. Acct. Res
629
(2006)
Haidan
Li et al.,
Market Reaction to Events Surrounding the Sarbanes-Oxley Act of 2002
and Earnings Management
51 J.L. & Econ.
111
(2008).
The studies were
published in peer-reviewed journals, and they included plausible cross-sectional tests of the validity of the estimates. For example, each contrasted differing market reactions to firms that theory would predict to be more or less benefited or harmed by SOX and found results consistent with at least some of those theories.
234
Fidelity turned out not to be a target of the investigations, but Spitzer did not let that get in …
Fidelity turned out not to be a target of the investigations, but Spitzer did not let that get in the way of a dramatic moment
235
2006 Performance and Accountability Report
Sec & Exch.
Comm’n
23 (2006), http://www.sec.gov/about…
2006 Performance and Accountability Report
Sec & Exch.
Comm’n
23 (2006),
[http://perma.cc/A474-TGZ4] (noting that “fair funds” were established pursuant to SEC enforcement actions concerning market timing and late trading); John C. Coates IV,
Reforming the Taxation and Regulation of Mutual Funds: A Comparative Legal and Economic Analysis
1 J. Legal Analysis
591, 592-93 & n.3 (2009). I served as an independent distribution consultant in connection with one of the Fair Funds created as a result of the SEC’s investigations of the fund industry that came in the wake of Spitzer’s announcement.
See
Order Approving Modified Distribution Plan, Mass. Fin.
Servs
. Co., S.E.C. 56122 (2007),
-56122.pdf [http://perma.cc/G36G-JK3F].
236
See, eg.
, Complaint at
¶¶
9, 20, New York v. Canary Capital Partners, LLC, No. 2003-402830, 2003 W…
See, eg.
, Complaint at
¶¶
9, 20, New York v. Canary Capital Partners, LLC, No. 2003-402830, 2003 WL 25691660 (N.Y. Sup. Ct. Sept. 3, 2003),
/default/files/press-releases/archived/canary_complaint.pdf [http://perma.cc/9GLR-VXG8] (alleging that Bank of America agreed to let a hedge fund place illegal late trades in return for keeping investments in funds sponsored by Bank of America). For a good analysis of the market reaction to the revelation of the scandals, see Stephen Choi & Marcel
Kahan
The Market Penalty for Mutual Fund Scandals
, 87
B.U. L. Rev.
1021 (2007).
237
Various sections of the ICA govern conflict of interest transactions
See, e.g.
, Investment Company…
Various sections of the ICA govern conflict of interest transactions
See, e.g.
, Investment Company Act of 1940, Pub. L. No. 76-768, § 17, 54 Stat. 815 (codified as amended at 15 U.S.C. § 80a-17 (2012)) (banning purchases, sales, borrowing, and loans to or from a fund by “any affiliated person”). The exemptions adopted by the SEC under the ICA are numerous and collected at Investment Company Governance, 69 Fed.
Reg. 46,378, 46,379 n.9 (Aug. 2, 2004) (to be codified at 17 C.F.R. pt. 270).
238
Investment Company Governance, 69 Fed
Reg. at 46,582-82.
The SEC also added requirements for fund …
Investment Company Governance, 69 Fed
Reg. at 46,582-82.
The SEC also added requirements for fund boards to perform self-assessments at least annually, hold executive sessions for independent directors at least quarterly, and give independent directors authority to hire their own staff.
Id
. at 46,381.
None of these requirements were the focus of subsequent litigation, although each plausibly contributes to both the overall benefits and overall costs of the combined package of conditions, by enhancing the power of independent directors, for both good and ill.
239
Amy
Borrus
& Paula Dwyer,
Who’s Right, the SEC or Ned Johnson
Bloomberg
Businessweek
, June 27, 2…
Amy
Borrus
& Paula Dwyer,
Who’s Right, the SEC or Ned Johnson
Bloomberg
Businessweek
, June 27, 2004,
-the-sec-or-ned-johnson [http://perma.cc/9YVJ-76ED].
240
See
Letter from Eric D Router, Senior Vice President and Gen. Counsel, Fidelity Mgmt. & Research C…
See
Letter from Eric D Router, Senior Vice President and Gen. Counsel, Fidelity Mgmt. & Research Co. to Jonathan G. Katz,
Sec’y
, U.S. Sec. & Exch.
Comm’n
(Mar. 18, 2004),
[http://perma.cc/UF86-8JGK].
241
Investment Company Governance, 69 Fed
Reg. at 46,386-87 (applying cost-benefit analysis);
id.
at
4…
Investment Company Governance, 69 Fed
Reg. at 46,386-87 (applying cost-benefit analysis);
id.
at
46,381-86 (discussing conditions, including qualitative assessment of benefits).
242
Id
at 46,386.
Id
at 46,386.
243
Id
at 46,380.
Id
at 46,380.
244
The SEC noted that “[
e]
ven
accepted at face value, Fidelity’s data constitute muddy and unpersua…
The SEC noted that “[
e]
ven
accepted at face value, Fidelity’s data constitute muddy and unpersuasive evidence for continuing to allow senior management company officials to sit in the fund chairman’s chair”
Id.
at 46,383 n.52 (citing John C.
Bogle
, Founder and Former CEO, Vanguard Group, Remarks Before the Institutional Investor Magazine Mutual Fund Regulation and Compliance Conference (May 5, 2004)).
245
As noted by Sherwin, this rider was first introduced in S 2908, 108th Cong. (2004), by Senator Gre…
As noted by Sherwin, this rider was first introduced in S 2908, 108th Cong. (2004), by Senator Gregg on September 15, 2004, and was later incorporated into H.R. 4818, 108th Cong. (2004), the version of the spending bill passed into law, during the House-Senate conference. Sherwin,
supra
note
15
, at 27 n.159. For Fidelity’s role, see Carrie Johnson,
Trade Groups,
Firms
Push to Ease Tough Federal Scrutiny
Wash.
Post
, Jan. 3, 2005,
].
246
412 F3d 133, 144 (D.C. Cir. 2005).
412 F3d 133, 144 (D.C. Cir. 2005).
247
Chamber of Commerce v SEC, 443 F.3d 890 (D.C. Cir. 2006).
Chamber of Commerce v SEC, 443 F.3d 890 (D.C. Cir. 2006).
248
The SEC’s Chief Economist was Chester S
Spatt
, who had been a Professor of Finance at Carnegie-Mel…
The SEC’s Chief Economist was Chester S
Spatt
, who had been a Professor of Finance at Carnegie-Mellon.
249
See
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir. from Chester
Spatt
, Chief …
See
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir. from Chester
Spatt
, Chief Economist, Sec. & Exch.
Comm’n
, to the Inv. Co. File S7-03-04 (Dec. 29, 2006),
[http://perma.cc/XF8H-FXYE]; OEA Memorandum re: Power Study as Related to
Indep
Mut
. Fund Chairs from Chester S.
Spatt
, Chief Economist, Sec. & Exch.
Comm’n
, to the Inv. Co. Governance File S7-03-04 (Dec. 29, 2006),
[http://perma.cc/4PXD-F42K].
250
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir.,
supra
note
249
, at 1. While t…
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir.,
supra
note
249
, at 1. While the Chief Economist did not spell out the point, “structural model” here presumably refers to a model in which potential causal relationships among exogenous and endogenous variables needed to measure fund value or fund performance are specified—in other words, a theoretical model of fund value or performance.
See, e.g.
, Peter C. Reiss & Frank A.
Wolak
Structural Econometric Modeling: Rationales and Examples from Industrial Organization
in
6A Handbook of Econometrics
4277, 4363 (James J. Heckman & Edward E.
Leamer
eds
.,
2007) (contrasting structural models with non-structural “descriptive” empirical models). Most empirical corporate governance research, including research relevant to mutual funds, remains closer to the “descriptive” than to the “structural.”
251
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir.,
supra
note
249
, at 2.
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir.,
supra
note
249
, at 2.
252
Eg.
Sanjai
Bhagat
& Bernard Black,
The Non-Correlation Between Board Independence and Long-Term F…
Eg.
Sanjai
Bhagat
& Bernard Black,
The Non-Correlation Between Board Independence and Long-Term Firm Performance
, 27
J. Corp. L.
231 (2002); Benjamin E.
Hermalin
& Michael S.
Weisbach
The Effects of Board Composition and Direct Incentives on Firm Performance
, 20
Fin. Mgmt
. 101 (1991); Eugene Kang &
Asghar
Zardkoohi
Board Leadership Structure and Firm Performance
, 13
Corp. Gov.: Int’l Rev
. 785 (2005); April Klein,
Firm Performance and Board Committee Structure
, 41
J.L. & Econ.
275 (1998); Hamid
Mehran
Executive Compensation Structure, Ownership, and Firm Performance
, 38
J.
Fin
. Econ
163 (1995); M.
Babajide
Wintoki
et al.,
Endogeneity
and the Dynamics of Internal Corporate Governance
, 105
J. Fin.
Econ
581 (2012).
253
Eg.
Sanjai
Bhagat
& Richard H.
Jefferis
, Jr., The Econometrics of Corporate Governance Studies
(2…
Eg.
Sanjai
Bhagat
& Richard H.
Jefferis
, Jr., The Econometrics of Corporate Governance Studies
(2002); Michael R. Roberts & Toni M. Whited,
Endogeneity
in Empirical Corporate Finance
in
Handbook of the Economics of Finance 493
(George M.
Constantinides
et al. eds
.,
2013);
Yair
Listokin
Interpreting Empirical Estimates of the Effect of Corporate Governance
, 10
Am.
L. & Econ.
Rev.
90 (2008).
This does not mean empirical studies of governance are useless. Such studies are essential sources of descriptive information about important organizations, without which neither social scientists nor practitioners can hope to understand them at all. For example, the fact of the extent and generality of variation in governance’s fine details emerged only from such studies. Such studies can provide partial, weak, and provisional evidence about the effects of governance arrangements, and when replicated with sufficient frequency in a variety of settings by a variety of researchers, they may allow tentative inferences to augment raw experience-based judgment in tentative evaluations. They can reject certain theories about governance, prompt refinements in theory, and provide a basis for more serious experimentation. At least over short time frames, they can allow for useful out-of-sample predictions even without reliable proof of causal mechanisms.
254
Compare, for example, the effect of financial collapse (as in 2008), accounting scandals (as in 20…
Compare, for example, the effect of financial collapse (as in 2008), accounting scandals (as in 2002), a market crash (as in 1987 and 1989), or war (shooting or trade), pandemic, or drought
255
Thus, as with SOX, a valid criticism of the SEC’s CBA/FR is that the SEC failed to adequately ex…
Thus, as with SOX, a valid criticism of the SEC’s CBA/FR is that the SEC failed to adequately explain why quantitative analysis was not feasible, and that it failed to present an adequate conceptual CBA/FR—not, as argued by others, that it failed to conduct adequate quantitative analysis
See
e.g.
, Chamber of Commerce v. SEC, 412 F.3d 133, 144 (D.C. Cir. 2005);
CCMR Report
supra
note
, at 9; Edward Sherwin, The Cost-Benefit Analysis of Financial Regulation: What the SEC Ignores in the Rulemaking Process, Why It Matters, and What To Do About It 53, 65 (Working Paper, 2005),
[http://perma.cc/7TWL-8GNR]. For example, the SEC never noted in its rule release that heightened independence requirements could result in less informed and more cumbersome boards or divisiveness and conflict on boards, undermine board culture, and dilute the effectiveness of board decision making.
Investment Company Governance, 69 Fed.
Reg. at 46,386-87.
These costs seem likely to swamp the short-term compliance costs on which the SEC, the D.C. Circuit, and commentators have focused.
See
Letter from John C. Coates IV, Professor of Law and Econ
.,
to Nancy M. Morris,
Sec’y
, Sec. & Exch.
Comm’n
(Mar. 1, 2007),
[http://perma.cc/8R5X-F38D] (discussing the costs of an independent board chair).
256
Chamber of Commerce v SEC, 443 F.3d 890 (D.C. Cir. 2006) (nowhere discussing these costs); Chamber…
Chamber of Commerce v SEC, 443 F.3d 890 (D.C. Cir. 2006) (nowhere discussing these costs); Chamber of Commerce v. SEC, 412 F.3d 133 (D.C. Cir. 2005) (same);
CCMR Report
supra
note
, at 4; CCMC
Report,
supra
note
at 29-30; Sherwin,
supra
note
15
, at 32-33.
257
See
Letter from John C Coates IV
supra
note
255
See
Letter from John C Coates IV
supra
note
255
258
I also argued that “[
]f
[CBA/FR] is to assist the regulatory process, the minimum one would expec…
I also argued that “[
]f
[CBA/FR] is to assist the regulatory process, the minimum one would expect before adding regulations is at least some economic evidence that the regulations will provide some benefit”
Id.
at 2
I continue to hold that view. But a desire for “evidence” is not the same as a mandate to conduct
quantified
CBA/FR. One can believe financial regulations aimed at improving or constraining governance are not susceptible to quantified CBA/FR without giving up on the goal of obtaining “evidence” that can inform consideration of the rules and their alternatives. Evidence is commonly adduced in court and in other contexts that do not admit of quantification, reliable causal inference, or anything approaching “science.”
259
Cf
Robert A.
Kagan
Adversarial Legalism and American Government
in
The New Politics of Public Po…
Cf
Robert A.
Kagan
Adversarial Legalism and American Government
in
The New Politics of Public Policy
88 (Marc K.
Landy
& Martin A. Levin eds
.,
1995) (litigation drains agency resources, causing agencies to alter their behavior in an effort to avoid it).
260
Letter from Warren Buffett, Chairman, Berkshire Hathaway Inc, to Shareholders (Feb. 28, 2002), htt…
Letter from Warren Buffett, Chairman, Berkshire Hathaway Inc, to Shareholders (Feb. 28, 2002),
[http://perma.cc/S7WA-BH85].
261
See
Capital Purchase Program: Program Purpose and Overview
US. Dep’t of Treasury
(Jan. 15, 2014, …
See
Capital Purchase Program: Program Purpose and Overview
US. Dep’t of Treasury
(Jan. 15, 2014, 3:10 PM),
[http://perma.cc/YY5Y-M5RN].
262
Wells Fargo’s then-CEO has criticized what he viewed as US. government efforts to pressure his c…
Wells Fargo’s then-CEO has criticized what he viewed as US. government efforts to pressure his company to accept a bailout under the Emergency Economic Stabilization Act (also known as the Troubled Asset Relief Program), and Wells Fargo repaid the investment as soon as it was permitted under the terms of the investment. Mark
Calvey
Former Wells Fargo CEO Dick
Kovacevich
Blasts TARP: An
Unmitigated Disaster
S.F. Bus. Times
, June 13, 2012,
[http://perma.cc/86D4-5NW4];
Wells’ TARP Plan Brings End to Bailout Era
N.Y. Times:
DealBook
(Dec. 14, 2009, 6:33 PM),
[http://perma.cc/ZMA2-N7VD]. However, Wells Fargo was found to need more capital in the course of the “stress tests” conducted during the crisis, in circumstances in which not all banks were required to raise capital. Wells Fargo & Co., Annual Report (Form 10-K) 8 (Feb. 26, 2010),
[http://perma.cc/YW49-8TJE] (“[
I]n
2009, the [Federal Reserve] conducted a test under the [Supervisory Capital Assessment Program, i.e., the stress test program] to forecast capital levels . . . in an adverse economic scenario. Following . . . that stress test, the [Federal Reserve] required [Wells Fargo] to generate a $13.7 billion regulatory capital buffer . .
. .
[Wells Fargo] exceeded this requirement through an $8.6 billion . . . common stock offering . .
. .
”).
263
See
Brett W
Fawley
& Christopher J. Neely,
Four Stories of Quantitative Easing
, 95
Fed. Reserve Ba…
See
Brett W
Fawley
& Christopher J. Neely,
Four Stories of Quantitative Easing
, 95
Fed. Reserve Bank St. Louis Rev
. 51 (2013),
/Fawley.pdf [http://perma.cc/EV39-BRNT].
264
See
Jennifer G Hill,
Why Did Australia Fare So Well in the Global Financial Crisis
in
The Regula…
See
Jennifer G Hill,
Why Did Australia Fare So Well in the Global Financial Crisis
in
The Regulatory Aftermath of the Global Financial Crisis
203, 287 (
Eilís
Ferran
et al. eds., 2012) (reporting that no bailouts occurred in Australia or Canada, and noting that “[b]
etween
2003 and 2005, [Australia’s financial services regulator] created a new regulatory framework, which was focused on close supervision, effective risk management, governance, and strong, well-enforced, capital adequacy rules”); Michael D.
Bordo
et al.,
Why Didn’t Canada Have A Banking Crisis in 2008 (or in 1930, or 1907, or . . . )?
25 (Nat’l Bureau of Econ. Research, Working Paper No. 17312, 2011),
[http://perma.cc/ZYUs-CMTD] (“Canadian regulation under OSFI proved tougher than in the United States, mandating higher capital requirements, lower leverage, less securitization, the curtailment of off balance sheet vehicles, and restricting the assets that banks could purchase.”).
265
See
Andrea
Beltratti
& René M
Stulz
The Credit Crisis Around the Globe: Why Did Some Banks Perfor…
See
Andrea
Beltratti
& René M
Stulz
The Credit Crisis Around the Globe: Why Did Some Banks Perform Better
105
J. Fin. Econ
1, 8-10 (2012).
266
See
Basel Committee on Banking Supervision
Bank for Int’l Settlements
, http://wwwbis.org/bcbs [ht…
See
Basel Committee on Banking Supervision
Bank for Int’l Settlements
[http://perma.cc/7YUX-FQPA].
267
The Federal Reserve supervises systemically important financial institutions and other bank and fi…
The Federal Reserve supervises systemically important financial institutions and other bank and financial holding companies, as well as state banks that are members of the Federal Reserve System (FRS) The OCC supervises national banks and federal thrifts. The FDIC supervises state FDIC-insured banks that are not members of the FRS and has back-up authority over other insured banks.
See
Edward V. Murphy, Cong. Research Serv., R43087, Who Regulates Whom and How?
An Overview of U.S. Financial Regulatory Policy for Banking and Securities Markets
13, 16 (2013).
268
See Basel Committee Membership
Bank for Int’l Settlements
, http://wwwbis.org/bcbs/membership.htm …
See Basel Committee Membership
Bank for Int’l Settlements
[http://perma.cc/69B3-76LZ].
269
Basel Comm on Banking Supervision,
Basel III: A Global Regulatory Framework for More Resilient Ban…
Basel Comm on Banking Supervision,
Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems
Bank for Int’l Settlements
1 (June 2011),
[http://perma.cc/7D9U-YM8F].
270
See
Basel Comm on Banking Supervision,
Basel III: The Liquidity Coverage Ratio and Liquidity Risk …
See
Basel Comm on Banking Supervision,
Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools
Bank
for Int’l Settlements
paras
1-3
, at 1 (Jan. 2013),
[http://perma.cc/DU8G-YDLM].
The new requirements include a liquidity coverage ratio, which requires banks to have enough high quality liquid resources to survive an acute stress scenario lasting for one month, and a net stable funding ratio, designed to address liquidity risk by creating incentives for banks to rely on funding with maturities of a year or longer.
Id
paras
14-17, at 4.
In general terms, liquidity is the amount of cash or other assets readily convertible to cash on a timely basis, to meet withdrawal demands or other cash requirements. The Basel Committee also circulated an earlier discussion paper related to liquidity.
See
Basel Comm. on Banking Supervision,
Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring
Bank for Int’l Settlements
(Dec. 2010),
[http://perma.cc/6J2Y-64BE].
271
Under prior capital rules, securitized assets with high credit ratings were given a low risk weigh…
Under prior capital rules, securitized assets with high credit ratings were given a low risk weighting and so required less capital than other kinds of assets
See
Basel Comm. on Banking Supervision,
Revisions to the Basel
Securitisation
Framework
Bank for Int’l Settlements
4 (Dec. 2012),
[http://perma.cc/QF6Z-RBCL] (“The recent financial crisis revealed that external credit ratings often did not adequately reflect the risk of certain structured finance asset classes, such as mortgage backed securities, including but not limited to
resecuritisation
exposures.”).
272
See
Basel Comm on Banking Supervision,
Basel III Counterparty Credit Risk and Exposures to Central…
See
Basel Comm on Banking Supervision,
Basel III Counterparty Credit Risk and Exposures to Central Counterparties - Frequently Asked Questions
Bank for Int’l Settlements
(Dec. 2012),
[http://perma.cc/9329-V35D]; Basel Comm. on Banking Supervision,
Basel Committee on Banking Supervision Reforms - Basel III
Bank for Int’l Settlements
[http://perma.cc/D6KL-V4A7]; Basel Comm. on Banking Supervision,
Global Systemically Important Banks: Assessment Methodology and the Additional Loss Absorbency Requirement
Bank for Int’l Settlements
(July 2011),
[http://perma.cc/TQH2-UCXP].
273
See
Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, T…
See
Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-Weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 78 Fed Reg. 62,018, 62,023 (Oct. 11, 2013) (to be codified at 12 C.F.R. pts. 208, 217, 225) (final rule, consolidating three proposed rules, and noting that there were over 2,500 comments for these proposed rules); Liquidity Coverage Ratio: Liquidity Risk Measurement, Standards and Monitoring, 78 Fed. Reg. 71,818 (proposed Nov. 29, 2013) (to be codified at 12 C.F.R. pt. 249); Regulatory Capital Rules: Advanced Approaches Risk-Based Capital Rule; Market Risk Capital Rule, 77 Fed. Reg. 52,978 (proposed Aug. 30, 2012) (to be codified at 12 C.F.R. pts. 3, 217, 324); Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action, 77 Fed. Reg. 52,792 (proposed Aug. 30, 2012) (to be codified at 12 C.F.R. pts. 208, 217, 225); Regulatory Capital Rules: Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements, 77 Fed.
Reg. 52,888 (proposed Aug. 30, 2012) (to be codified at 12 C.F.R. pt. 217).
274
Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Trans…
Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-Weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 78 Fed
Reg. at 62,024.
275
See
Basel Comm on Banking Supervision,
An Assessment of the Long-Term Economic Impact of Stronger …
See
Basel Comm on Banking Supervision,
An Assessment of the Long-Term Economic Impact of Stronger Capital and Liquidity Requirements
Bank for Int’l Settlements (
Aug.
2010)
[hereinafter BCBS 173],
[http://perma.cc/JL5H-4PU6] (estimating both costs and benefits of higher capital requirements); Macroeconomic Assessment
Grp
.,
Final Report: Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements
Bank for Int’l Settlements (
Dec.
2010),
[http://perma.cc/FZ45-39XB] (estimating the effects of higher capital requirements).
276
Basel Comm on Banking Supervision,
Results of the Comprehensive Quantitative Impact Study
Bank fo…
Basel Comm on Banking Supervision,
Results of the Comprehensive Quantitative Impact Study
Bank for Int’l Settlements 1, 4 (
Dec.
2010),
[http://perma.cc/BY4F-QSE8]. The Basel Committee compiled those inputs and analyzed the results in a “quantitative impact study,”
id
and the results are reflected in the Committee’s final CBA/FR, Macroeconomic Assessment
Grp
.,
supra
note
275
. This consultation was confidential, at both agency and bank levels, and individual bank or national regulator inputs to the Basel Committee process are not available to the public.
Id.
277
The FSA was required to conduct CBA/FR
See supra
text accompanying note
81
The FSA was required to conduct CBA/FR
See supra
text accompanying note
81
278
Ray
Barrell
et al,
Optimal Regulation of Bank Capital and Liquidity: How To Calibrate New Internat…
Ray
Barrell
et al,
Optimal Regulation of Bank Capital and Liquidity: How To Calibrate New International Standards
Fin. Services Authority
(Occasional Paper Series No. 38, July 2009) [hereinafter FSA 38], [http://www.fsa.gov.uk/pubs/occpapers/op38.pdf [http://perma.cc/G7JM-2ZTH]; Sebastian de-Ramon et al.,
Measuring the Impact of Prudential Policy on the
Macroeconomy
: A Practical Application to Basel III and Other Responses to the Financial Crisis
Fin.
Servs
Auth.
(Occasional Paper Series No. 42, May 2012) [hereinafter FSA 42],
].
279
Eric Posner & E Glen
Weyl
Benefit-Cost Analysis for Financial Regulation
, 103
Am
. Econ.
Rev.
, May…
Eric Posner & E Glen
Weyl
Benefit-Cost Analysis for Financial Regulation
, 103
Am
. Econ.
Rev.
, May 2013, at 393, 394 (citing
Carmen M. Reinhart & Kenneth S.
Rogoff
, This Time is Different: Eight Centuries of Financial Folly
(2009)).
280
Andrew G Haldane, Exec.
Dir., Fin.
Stability, Bank of Eng., Address at the Institute of Regulation…
Andrew G Haldane, Exec.
Dir., Fin.
Stability, Bank of Eng., Address at the Institute of Regulation & Risk in Hong Kong: The $100 Billion Question (Mar. 30, 2010),
[http://perma.cc/9SEQ-9KYK]; FSA 42,
supra
note 280, at 63 tbl.7;
Meilan
Yan et al., A Cost-Benefit Analysis of Basel III: Some Evidence from the UK 26 tbl.10 (Working Paper, Aug. 20, 2011),
[http://perma.cc/UAD5-64BB].
281
This date is from
Reinhart &
Rogoff
supra
note
279
, at 230 fig14.4. Posner and
Weyl
do not provid…
This date is from
Reinhart &
Rogoff
supra
note
279
, at 230 fig14.4. Posner and
Weyl
do not provide details on which of Reinhart and
Rogoff’s
estimates they used; in some of the latter’s datasets, for example,
id
at
295 app.A.1, they list datasets on crises dating back to 1800 or even 1258. I assume few would use data from the thirteenth century in modern CBA/FR.
282
See infra
Part IVA.1.
See infra
Part IVA.1.
283
That a crisis could have zero social cost disconcerted the authors of BCBS
173,
supra
note
275
, wh…
That a crisis could have zero social cost disconcerted the authors of BCBS
173,
supra
note
275
, who found the result driven by “definitions of what constitutes a systemic banking crisis For example, some studies assume that Canada had a banking crisis in 1983. While two small banks failed, experts at the Bank of Canada do not consider this event a systemic banking crisis. Unsurprisingly, most studies find zero output costs for this crisis.”
Id.
at 36 (citation omitted).
284
John H Boyd et al.,
The Real Output Losses Associated with Modern Banking Crises
, 37
J. Money, Cre…
John H Boyd et al.,
The Real Output Losses Associated with Modern Banking Crises
, 37
J. Money, Credit & Banking
977, 978, 994 tbl.7 (2005).
285
BCBS 173,
supra
note
275
, at 34
BCBS 173,
supra
note
275
, at 34
286
Id
at 11.
Id
at 11.
287
Id
at 35 & tbl.A1.1.
Id
at 35 & tbl.A1.1.
288
Id
Id
289
One prominent study asserts that the definitions used in it and in other cross-country studies are…
One prominent study asserts that the definitions used in it and in other cross-country studies are “qualitative” Glenn
Hoggarth
et al
.,
Costs of Banking System Instability: Some Empirical Evidence
, 26
J. Banking & Fin.
825, 829 (2002).
290
See, eg.
, Michael
Bordo
et al.,
Is the Crisis Problem Growing More Severe
16
Econ.
Pol’y
53, 55 …
See, eg.
, Michael
Bordo
et al.,
Is the Crisis Problem Growing More Severe
16
Econ.
Pol’y
53, 55 (2001).
291
See, eg.
Reinhart &
Rogoff
supra
note
279
, at 8-11
FSA 38,
supra
note
278
, at 12.
See, eg.
Reinhart &
Rogoff
supra
note
279
, at 8-11
FSA 38,
supra
note
278
, at 12.
292
See, eg.
Reinhart &
Rogoff
supra
note
279
, at 8-11;
Bordo
et al.,
supra
note
290
, at 55; FSA 38,…
See, eg.
Reinhart &
Rogoff
supra
note
279
, at 8-11;
Bordo
et al.,
supra
note
290
, at 55; FSA 38,
supra
note
278
, at 12.
293
See, eg.
Bordo
et al.,
supra
note
290
, at 55
FSA 38,
supra
note
278
, at 12.
See, eg.
Bordo
et al.,
supra
note
290
, at 55
FSA 38,
supra
note
278
, at 12.
294
See, eg.
, Boyd et al.,
supra
note
284
, at 980-81.
See, eg.
, Boyd et al.,
supra
note
284
, at 980-81.
295
See, eg.
, FSA 38,
supra
note
278
, at 12.
See, eg.
, FSA 38,
supra
note
278
, at 12.
296
See, eg.
Bordo
et al.,
supra
note
290
, at 55.
See, eg.
Bordo
et al.,
supra
note
290
, at 55.
297
As the FSA noted, the use of binary crisis dummies (as is typical in the studies reviewed here) …
As the FSA noted, the use of binary crisis dummies (as is typical in the studies reviewed here) “inevitably mean[s] that the start and end dates are ambiguous” FSA 38,
supra
note
278
, at 12. The use of annual dummies allows for up to twenty-two months of variance in actual duration without affecting the data used (eleven months for the start date, eleven months for the end date), and, “[
s]
ince
the end-dates are to some extent subjectively chosen[,] there are potential
endogeneity
problems with estimation: the explanatory variables will be affected by ongoing crises.”
Id.
298
Eg.
Bordo
et al.,
supra
note
290
, at 68 tbl.3.
Eg.
Bordo
et al.,
supra
note
290
, at 68 tbl.3.
299
Boyd et al,
supra
note
284
, at 980 (comparing their choice of twenty-three crises with 160 “or s…
Boyd et al,
supra
note
284
, at 980 (comparing their choice of twenty-three crises with 160 “or so” identified by Gerard
Caprio
, Jr. & Daniela
Klingebiel
Bank Insolvency: Bad Luck, Bad Policy, or Bad Banking
in
Annual World Bank Conference on Development Economics
(Michael Bruno & Boris
Pleskovic
eds., 1997));
see also
BCBS 173,
supra
note
275
, at 9 (“Different authors classify crises differently. Reinhart and
Rogoff
(2008) find 34 crises over the 25 year period, while
Laeven
and Valencia (2008) report only 24.”).
300
If a stable or smooth relationship existed between the number of crises and the average losses cau…
If a stable or smooth relationship existed between the number of crises and the average losses caused by crises, then choices affecting size might be balanced by effects in the second component of the CBA/FR of capital rules, namely, the probability of a crisis, but no such relationship is evident from the studies
301
R&R concede the spreadsheet error,
see
Full Response from Reinhart and
Rogoff
NY. Times:
Economix
R&R concede the spreadsheet error,
see
Full Response from Reinhart and
Rogoff
NY. Times:
Economix
, Apr. 17, 2013,
[http://perma.cc/W5VJ-2GFA], but not other critiques of their estimates,
see id
Paul
Krugman
Reinhart-
Rogoff
Continued
N.Y. Times: Conscience of a Liberal
(Apr. 16, 2013, 7:31 PM),
[http://perma.cc/S6AW-476F].
Krugman
takes R&R to task for their response to their critics; R&R take
Krugman
to task for his taking them to task. Carmen M. Reinhart,
Letter to PK
Carmen M. Reinhart Author Website
(May 25, 2013),
[http://perma.cc/BLQ3-BM75].
302
The original R&R publication was a working paper released in early 2010
See
Carmen M. Reinhart & K…
The original R&R publication was a working paper released in early 2010
See
Carmen M. Reinhart & Kenneth S.
Rogoff
Growth in a Time of Debt
(Nat’l Bureau of Econ.
Research, Working Paper No. 15639, 2010),
[http://perma.cc/9QR3-2NGL].
The data flaw did not get noticed until 2013.
See
Thomas Herndon et al.,
Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and
Rogoff
(Political Econ.
Research Inst., Working Paper No. 322, 2013),
[http://perma.cc/W3TL-NX6B].
303
As noted in Herndon et al,
supra
note
302
, at 4, R&R’s 2010 paper “is the only evidence cited …
As noted in Herndon et al,
supra
note
302
, at 4, R&R’s 2010 paper “is the only evidence cited in the ‘Paul Ryan Budget’ on the consequences of high public debt for economic growth.” British politician George Osborne (later Chancellor of the Exchequer) relied on R&R to argue most financial crises are caused by excessive public debt in a speech quoted in an April 2013
New Yorker
article on the R&R kerfuffle. John Cassidy,
The Reinhart and
Rogoff
Controversy: A Summing Up
New Yorker: John Cassidy,
Apr. 26, 2013,
.html
[http://perma.cc/K33X-YCR5].
304
Herndon et al,
supra
note
302
, at 5.
Herndon et al,
supra
note
302
, at 5.
305
Carmen M Reinhart & Kenneth S.
Rogoff
, Op-Ed,
Reinhart and
Rogoff
: Responding to Our Critics
N.Y.…
Carmen M Reinhart & Kenneth S.
Rogoff
, Op-Ed,
Reinhart and
Rogoff
: Responding to Our Critics
N.Y. Times,
Apr. 25, 2013,
[http://perma.cc/46UB-RH8V].
306
BCBS 173,
supra
note
275
, at 3 (“Using the median estimate . . across all comparable studies . …
BCBS 173,
supra
note
275
, at 3 (“Using the median estimate . . across all comparable studies . . . each 1 percentage point reduction in the annual probability of a crisis yields an expected benefit per year equal to 0.6% of output when banking crises are allowed to have a permanent effect on real activity. Using the median estimate . . . when crises are seen to have only a temporary effect . . . each 1 percentage point reduction . . . yields an expected benefit per year equal to 0.2% of output.”).
307
BCBS 173,
supra
note
275
, at 29 tbl8 (subtracting amounts in the column labeled “Net benefits (l…
BCBS 173,
supra
note
275
, at 29 tbl8 (subtracting amounts in the column labeled “Net benefits (large permanent effect)” from amounts in the column labeled “Net benefits (no permanent effect),” adding back the amount in column labeled “Expected costs,” and comparing the difference).
308
BCBS 173,
supra
note
275
, at 36 (noting that “median losses are sensitive to the choice of disco…
BCBS 173,
supra
note
275
, at 36 (noting that “median losses are sensitive to the choice of discount rate,” and that “the median loss . . is 82% if a discount rate of 2.5% is used” but is 63% if 5% is assumed). On discount rates in CBA/FR,
see generally
Pindyck
supra
note
224
309
See generally
Tetlock
supra
note
64
See generally
Tetlock
supra
note
64
310
Edward
Ashbee
, Fiscal Policy Responses to the Economic Crisis in the United Kingdom and the United…
Edward
Ashbee
, Fiscal Policy Responses to the Economic Crisis in the United Kingdom and the United States: A Comparative Assessment 1 (Am Political Sci.
Ass’n
, Annual Meeting Paper, 2011),
[http://perma.cc/Y8BN-8RNV].
311
See
Michael Joyce,
Quantitative Easing and Other Unconventional Monetary Policies: Bank of England…
See
Michael Joyce,
Quantitative Easing and Other Unconventional Monetary Policies: Bank of England Conference Summary
, 52
Bank Eng Q. Bull.
48, 49 (2012),
[http://perma.cc/NU62-CQ3V] (contrasting the U.S., U.K., and European Central Bank responses to the crisis); Leonardo
Gambacorta
et al.,
The Effectiveness of Unconventional Monetary Policy at the Zero Lower Bound: A Cross-Country Analysis
5-6 (Bank for Int’l Settlements, Working Paper No. 384, 2012),
[http://perma.cc/FU6G-LEVM].
312
Eg.
, James R. Lothian,
U.S. Monetary Policy and the Financial Crisis
, 6
J. Econ.
Asymmetries
25, 2…
Eg.
, James R. Lothian,
U.S. Monetary Policy and the Financial Crisis
, 6
J. Econ.
Asymmetries
25, 27-28 (2009).
313
Eg.
, Mariko
Fujii
& Masahiro Kawai,
Lessons from Japan’s Banking Crisis, 1991-2005
, at 4-8 (Asian …
Eg.
, Mariko
Fujii
& Masahiro Kawai,
Lessons from Japan’s Banking Crisis, 1991-2005
, at 4-8 (Asian Dev. Bank Inst., Working Paper No. 222, 2010),
[http://perma.cc/RT9B-S2UM].
314
Eg.
, Lothian,
supra
note
312
; Adam S. Posen, External Member of the Monetary Policy Comm., Bank of…
Eg.
, Lothian,
supra
note
312
; Adam S. Posen, External Member of the Monetary Policy Comm., Bank of Eng. and Senior Fellow, Peterson Inst. for Int’l Econ
.,
Why Is Their Recovery Better Than Ours? (Even Though Neither Is Good Enough), Speech at the National Institute of Economic and Social Research, London 2 (Mar. 27, 2012),
[http://perma.cc/WK2L-U3LE] (“[
T]he
US has had significantly more GDP growth with somewhat lower inflation over the last thirty-two months than in the UK . . . [because, among other factors] there was significantly less net withdrawal of fiscal stimulus in the US than the UK.”); Jeremy C. Stein, Member, Bd. of Governors of the Fed. Reserve,
Evaluating Large-Scale Asset Purchases
, Remarks at the Brookings Institution (Oct. 11, 2012),
[http://perma.cc/P8FH-K6W4] (noting that large-scale asset purchases by the Federal Reserve “played a significant role in supporting economic activity and in preventing a worrisome undershoot of the Committee’s inflation objective”); Martin Feldstein,
Quantitative Easing and America’s Economic Rebound
Project Syndicate
(Feb. 24, 2011),
[http://perma.cc/N8WQ-JJ8S] (suggesting that the 2011 economic rebound in the United States was due to increases in stock prices and consumer spending driven by quantitative easing, which would not be sustainable beyond 2011).
315
It is tempting to suggest that CBA/FR could be made tractable by just ignoring future policy respo…
It is tempting to suggest that CBA/FR could be made tractable by just ignoring future policy responses in modeling the costs of future crises But that is to make an implicit assumption, too, and one that is more likely to be counterfactual than an assumption based on past (or at least recent) policy responses. The assumption would tend to inflate the cost of future crises beyond reasonable levels because every crisis would tend, absent a policy response, to generate large and sustained reductions in GDP, as in the Great Depression. The result would be to expand greatly the range of defensible regulations and to eliminate any disciplining effect of CBA/FR while adding a great deal of camouflage to the regulatory process.
316
BCBS 173,
supra
note
275
, at 9 (citing Carmen M Reinhart & Kenneth S.
Rogoff
Banking Crises: An E…
BCBS 173,
supra
note
275
, at 9 (citing Carmen M Reinhart & Kenneth S.
Rogoff
Banking Crises: An Equal Opportunity Menace
(Nat’l Bureau of Econ. Research, Working Paper No. 14587, 2008),
[http://perma.cc/BX8V-CD5F]); Luc
Laeven
& Fabian Valencia,
Systemic Banking Crises: A New Database
(Int’l Monetary Fund, Working Paper No. 08-224, 2008,
[http://perma.cc/FVC8-7XHY].
317
See
BCBS
173,
supra
note
275
, at 39 tblA1.4.
See
BCBS
173,
supra
note
275
, at 39 tblA1.4.
318
FSA 38,
supra
note
278
, at 12
FSA 38,
supra
note
278
, at 12
319
BCBS 173,
supra
note
275
, at 9
BCBS 173,
supra
note
275
, at 9
320
FSA 38,
supra
note
278
, at 15 tbl2.
FSA 38,
supra
note
278
, at 15 tbl2.
321
FSA 42,
supra
note
278
, at 38 & tbl5.1, adds current account balances to the
logit
model used in F…
FSA 42,
supra
note
278
, at 38 & tbl5.1, adds current account balances to the
logit
model used in FSA 38, and adjusts the data for comparability across countries. The modest change “results in a significant improvement in” the model’s classification performance.
Id
. FSA 42 also examines a larger family of different crisis prediction models.
Id
. at 38-45.
The authors later present information on the overall uncertainty associated with their bottom-line estimates of the net benefits of higher capital requirements,
id.
at
60-64, but they do not break out the specific potential impact of different models of crisis frequency.
322
A fourth, equally difficult challenge is to anticipate and model the private market responses to t…
A fourth, equally difficult challenge is to anticipate and model the private market responses to the rule, particularly responses that include moving assets or activities outside of regulated banks into unregulated entities—that is, Basel III may shift risk into “shadow banks” If those assets or activities nevertheless create risks for the financial system as a whole, or otherwise generate external risks, such a response would represent an offset to the benefits of higher capital requirements, to be included on the cost side of the CBA/FR ledger.
323
FSA 42,
supra
note
278
, at 47
FSA 42,
supra
note
278
, at 47
324
The Financial Crisis Response in Charts
US. Dep’t Treasury 12
(Apr. 2012), http://www.treasury.go…
The Financial Crisis Response in Charts
US. Dep’t Treasury 12
(Apr. 2012),
[http://perma.cc/5HUD-ZBGN].
325
FSA 42,
supra
note
278
, at 47
FSA 42,
supra
note
278
, at 47
326
Id
at 48.
Id
at 48.
327
Id
at 50-51.
Id
at 50-51.
328
BCBS
173,
supra
note
275
, at 21-22; FSA 38,
supra
note
278
, at 39 & tbl4.
BCBS
173,
supra
note
275
, at 21-22; FSA 38,
supra
note
278
, at 39 & tbl4.
329
BCBS 173,
supra
note
275
, at 22, notes that reducing the assumed cost of bank equity from the 1993…
BCBS 173,
supra
note
275
, at 22, notes that reducing the assumed cost of bank equity from the 1993 to 2007 average of 148% to 10.0% cuts the impact of higher capital requirements from a one-to-thirteen basis point impact to a one-to-seven basis point impact. The report goes on to note that “there are good reasons to believe that the cost of capital would
decline
in response to a reduction in bank leverage” due to increased bank capital requirements, and that “in the limit, the change in the cost of capital could reduce to tax effects.”
Id.
(citing Franco Modigliani & Merton H. Miller,
The Cost of Capital, Corporation Finance and the Theory of Investment
, 48
Am. Econ. Rev.
261 (1958) (finding that, under stylized assumptions, a firm’s returns are invariant to how it finances itself, but for taxes)). As BCBS 173 notes, prior research suggests that the long-run effect on banks’ funding costs of higher capital requirements is likely to be smaller than the numbers used in BCBS 173—a four percentage point increase is assumed to increase borrowing costs by fifty-two basis points in BCBS 173,
supra
note 277, at 23 tbl.6, versus only twenty basis points in Douglas J. Elliott,
A Further Exploration of Bank Capital Requirements: Effects of Competition from Other Financial Sectors and Effects of Size of Bank or Borrower and of Loan Type
Brookings Inst.
22 (Jan. 28, 2010),
[http://perma.cc/9C6R-5GPF], and ten to eighteen basis points in Anil K.
Kashyap
et al.,
An Analysis of the Impact of “Substantially Heightened” Capital Requirements on Large Financial Institutions
17 (May 2010) (unpublished manuscript),
[http://perma.cc/WY6E-GHRE]. For a discussion of some of the drivers of disagreements on the effect of capital requirements on lending costs, see Douglas J. Elliott,
Higher Bank Capital Requirements Would Come at a Price
Brookings Inst.
(Feb. 20, 2013)
[http://perma.cc/GJ7J-LRDL].
330
Anat
Admati
et al.,
Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulati…
Anat
Admati
et al.,
Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Socially Expensive
, at
(Stanford Graduate Sch. of Bus.
Working Paper No. 2065, 2013),
[http://perma.cc/4LR5-97HX].
These authors
also rely on Modigliani & Miller
supra
note
329
331
Admati
et al,
supra
note
330
, at 19-20.
Admati
et al,
supra
note
330
, at 19-20.
332
Id
at 21-23.
Id
at 21-23.
333
BCBS 173,
supra
note
275
, at 27 tbl7.
BCBS 173,
supra
note
275
, at 27 tbl7.
334
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub
L. No. 111-203, § 619, 124 Stat. 1…
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub
L. No. 111-203, § 619, 124 Stat. 1376, 1620 (2010) (codified at 12 U.S.C. § 1851 (2012)).
Section 619 is called the “Volcker Rule” because former Federal Reserve Board Chairman Paul Volcker was a prominent backer of the law.
335
The banking agencies and the SEC issued a joint final rule Prohibitions and Restrictions on Propri…
The banking agencies and the SEC issued a joint final rule Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, 79 Fed. Reg. 5,536 (Jan. 31, 2014) (to be codified at 12 C.F.R. pt. 44 (OCC); 12 C.F.R. pt. 248 (Fed. Reserve); 12 C.F.R. pt. 351 (FDIC); 17 C.F.R. pt. 255 (SEC)). The CFTC issued a final rule separately. Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds,
79 F
ed.
Reg
. 5,808 (
Jan. 31, 2014) (to be codified at
17 C.F.R. pt. 75).
336
Bank Holding Company Act of 1956, Pub
L. No. 84-511, 70 Stat. 133 (codified as amended in scattere…
Bank Holding Company Act of 1956, Pub
L. No. 84-511, 70 Stat. 133 (codified as amended in scattered sections of
12 U.S.C.)
The Bank Holding Company Act of 1956 (BHCA) initially contained a broad regulatory delegation of authority to the Federal Reserve Board to “issue such regulations and orders as may be necessary to enable it to administer and carry out the purposes” of the Act and to “prevent evasions thereof.”
Id.
§ 5(b), 70 Stat. at 137.
That provision remains in 12 U.S.C. § 1844(b), with amendments to clarify that the authority includes the power to adopt capital requirements for bank holding companies.
337
See
7 US.C. § 19(a)(1) (2012) (requiring the CFTC to “consider the costs and benefits” of its…
See
7 US.C. § 19(a)(1) (2012) (requiring the CFTC to “consider the costs and benefits” of its regulatory actions). This is true even though the SEC and the CFTC were also required to adopt the Volcker Rule because their authority (and mandate) to do so is (unusually) in the BHCA, not the statutes that traditionally authorize them to act.
Office of the Comptroller of the Currency,
Analysis of 12 CFR Part 44
U.S. Dep’t Treasury
(Mar. 2014),
[http://perma.cc/BA7-R4PG].
338
The specific section that authorizes the Volcker Rule, 12 US.C. § 1851 (2012), added to the BHCA…
The specific section that authorizes the Volcker Rule, 12 US.C. § 1851 (2012), added to the BHCA by the Dodd-Frank Act, contains a similarly broad grant of authority and does not condition rulemaking on any particular finding or process, other than (1) to “consider” a statutorily mandated January 2011 study of how to implement the section conducted by the Financial Stability Oversight Council,
see
12 U.S.C. § 1851(b)(1)-(2)(A) (2012);
Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds
Fin. Stability Oversight Council
(Jan. 2011),
[http://perma.cc/JFW4-E2XZ]; and (2) to coordinate rulemaking among the Federal Reserve Board, FDIC, OCC, SEC, and CFTC so as to “
assur
e], to the extent possible, that such regulations are comparable and provide for consistent application and implementation . . . to avoid providing advantages or imposing disadvantages to the companies affected . . . and to protect the safety and soundness of banking entities and nonbank financial companies supervised” by the Federal Reserve, 12 U.S.C. § 1851(b)(2)(B)(ii) (2012).
339
Prohibitions and Restrictions on Proprietary Trading, 79 Fed
Reg. at 65,744 (conducting analysis u…
Prohibitions and Restrictions on Proprietary Trading, 79 Fed
Reg. at 65,744 (conducting analysis under the PRA);
id.
at
65,778 (conducting analysis under the RFA). The American Bankers Association (ABA) and other plaintiffs sued to enjoin enforcement of the Volcker Rule on the ground that the agencies’ RFA analysis failed to consider the rule’s “significant economic impact on a substantial number of community banks.”
See
Emergency Motion of Petitioners for Stay of Agency Action Pending Review at 15, Am. Bankers
Ass’n
v. Bd. of Governors of the Fed. Reserve Sys
.,
No. 13-1310 (D.C. Cir.
Dec. 24, 2013),
[http://perma.cc/6HSX-PNE8].
The Joint Volcker Rule Release specifically addressed potential impacts by exempting banks below various specified size thresholds from reporting and compliance burdens. The ABA suit focuses on one indirect effect of the rule, which is to ban “banking entities” (including all depository institutions, small or large) from holding “ownership interests” in hedge and private equity funds (Subpart C of the Volcker Rule), including
debt
instruments that give holders the right to remove a collateral manager for a collateralized debt obligation–an entity that holds multiple trust-preferred or other securities, which (as the ABA in its papers admits) collapsed in value during the financial crisis.
See id.
at
2, 7.
340
See
Office of the Comptroller of the Currency
supra
note
337
See
Office of the Comptroller of the Currency
supra
note
337
341
Id
at 18-22.
The FSOC also identified the benefit that the rule would reduce the risk that banks h…
Id
at 18-22.
The FSOC also identified the benefit that the rule would reduce the risk that banks have effective liability for nominally off-balance sheet funds they sponsor.
Fin. Stability Oversight Council,
supra
note 340, at 56.
342
Office of the Comptroller of the Currency,
supra
note
337
, at 1
Office of the Comptroller of the Currency,
supra
note
337
, at 1
343
Id
at 15.
Id
at 15.
344
Cf
James D. Cox et al.,
A Better Path Forward on the Volcker Rule and the Lincoln Amendment
Bipar…
Cf
James D. Cox et al.,
A Better Path Forward on the Volcker Rule and the Lincoln Amendment
Bipartisan
Pol’y
Center
8 (Oct. 2013),
[http://perma.cc/4QPL-27Z9].
345
See
Office of the Comptroller of the Currency,
supra
note
337
, at 1, 23
See
Office of the Comptroller of the Currency,
supra
note
337
, at 1, 23
346
Shanny
Basar
Paul Volcker Fights for Volcker Rule
Fin.
News
(Feb. 14, 2012), http://www.efinanci…
Shanny
Basar
Paul Volcker Fights for Volcker Rule
Fin.
News
(Feb. 14, 2012),
[http://perma.cc/8R2E-5PZ2]; Bill Moyers,
Paul Volcker on the Volcker Rule
Moyers & Co.
(Apr. 5, 2012),
].
347
Office of the Comptroller of the Currency,
supra
note
337
, at 17 (citing Joel Hasbrouck,
Trading C…
Office of the Comptroller of the Currency,
supra
note
337
, at 17 (citing Joel Hasbrouck,
Trading Costs and Returns for US. Equities: Estimating Effective Costs from Daily Data
, 64
J. Fin.
1445 (2009)).
348
Id
at
1, 23
Id
at
1, 23
349
See
CCMR
Report
supra
note 4, at 13-16
See
CCMR
Report
supra
note 4, at 13-16
350
Cross-Border Security-Based Swap Activities, 78 Fed
Reg. 30,968 (proposed May 23, 2013) (to be cod…
Cross-Border Security-Based Swap Activities, 78 Fed
Reg. 30,968 (proposed May 23, 2013) (to be codified at 17 C.F.R. pts. 240, 242, 249) [hereinafter Cross-Border Swap Release].
351
The
gap was cemented by the Commodity Futures Modernization Act of 2000, Pub
L. No. 106-554, 114 S…
The
gap was cemented by the Commodity Futures Modernization Act of 2000, Pub
L. No. 106-554, 114 Stat. 2763, 2763A-365. The 262-page bill, attached as an appendix to a budget bill, barred the SEC from regulating OTC derivatives as “securities” and the CFTC from regulating them as “futures,” leaving regulation only through general (and much less specific) “safety and soundness” oversight by regulatory supervisors of OTC issuers and users (which was non-existent for companies that did not accept deposits, invest or deal in securities or futures, or underwrite or sell insurance, including companies that were affiliated with regulated entities, such as AIG).
See
Sheila Bair, Bull by the Horns: Fighting To Save Main Street from Wall Street and Wall Street from Itself
333 (2012);
Simon Johnson & James
Kwak
13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
7-11, 78-82, 92, 121-26, 134-37, 169-70, 202 (2010).
352
See
Report Pursuant to Section 129 of the Emergency Economic Stabilization Act of 2008: Restructur…
See
Report Pursuant to Section 129 of the Emergency Economic Stabilization Act of 2008: Restructuring of the Government’s Financial Support to the American International Group, Inc
on March 2, 2009
Fed.
Reserve
Sys.
(2009)
[http://perma.cc/V6J8-HNLW].
353
The CFTC now regulates “swaps,” the SEC now regulates “security-based swaps,” and both hav…
The CFTC now regulates “swaps,” the SEC now regulates “security-based swaps,” and both have authority over “mixed swaps” Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 721, 761, 124 Stat. 1376, 1658-72, 1754-59 (2010). A “swap” is a contract that requires conditional payments between counterparties derived from changes in specified prices or events, generally related to financial markets, such as interest or currency exchange rates, but can also include “credit” events, such as the default by a borrower on an unrelated “reference” security or loan.
354
Regulated entities include swap dealers, major swap participants, data repositories, clearing agen…
Regulated entities include swap dealers, major swap participants, data repositories, clearing agencies, and execution facilities
Id.
Where regulated by the SEC, relevant entities have the phrase “security-based” added to qualify “swap,” but otherwise the definitions are identical to those applicable to the CFTC for other swaps.
Id.
§ 761.
For definitions of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” see 77 Fed.
Reg. 30,596, 30,751-53 (May 23, 2012) (to be codified at 17 C.F.R. pts. 1, 240).
355
Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement…
Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed
Reg. 48,208 (Aug. 13, 2012) (to be codified at 17 C.F.R. pts. 1, 230, 240, 241) (adopting product definitions); Further Definition of “Swap Dealer,” 77 Fed.
Reg. at 30,596 (adopting intermediary definitions);
see also
Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant” and “Eligible Contract Participant,” 75 Fed.
Reg. 80,174 (proposed Dec. 21, 2010) (to be codified at 17 C.F.R. pts. 1, 240) (proposing intermediary definitions).
356
Capital Margin and Segregation Requirements for Security-Based Swap Dealers and Major Security-Bas…
Capital Margin and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers, 77 Fed
Reg. 70,214 (Nov. 23, 2012) (to be codified at 17 C.F.R. pt. 240) (proposing capital, margin, and segregation rules); Clearing Agency Standards, 77 Fed.
Reg. 66,220 (Nov. 2, 2012) (to be codified at 17 C.F.R. pt. 240) (adopting clearing agency standards); Process for Submissions for Review of Security-Based Swaps for Mandatory Clearing and Notice Filing Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4 and Form 19b-4 Applicable to All Self-Regulatory Organizations, 77 Fed.
Reg. 41,602 (July 13, 2012) (to be codified at 17 C.F.R. pts. 240, 249) (adopting clearing procedures); Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, 76 Fed.
Reg. 65,784 (Oct. 24, 2011) (to be codified at 17 C.F.R. pts. 240, 249) (proposing registration rules for dealers and major swap participants); Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, 76 Fed.
Reg. 42,396 (July 18, 2011) (to be codified at 17 C.F.R. pt. 240) (proposing standards for external business conduct); Registration and Regulation of Security-Based Swap Execution Facilities, 76 Fed.
Reg. 10,948 (Feb. 29, 2011) (to be codified at 17 C.F.R. pts. 240, 242, 249) (proposing registration framework for execution facilities); Trade Acknowledgment and Verification of Security-Based Swap Transactions, 76 Fed.
Reg. 3,859 (Jan. 21, 2011) (to be codified at 17 C.F.R. pt. 240) (proposing trade acknowledgement rules); End-User Exception to Mandatory Clearing of Security-Based Swaps, 75 Fed.
Reg. 79,992 (Dec. 21, 2010) (to be codified at 17 C.F.R. pt. 240) (proposing end-user exceptions); Security-Based Swap Data Repository Registration, Duties, and Core Principles, 75 Fed.
Reg. 77,306 (Dec. 10, 2010) (to be codified at 17 C.F.R. pts. 240, 249),
corrected at
75 Fed.
Reg. 79,320 (Dec. 20, 2010) (to be codified at 17 C.F.R. pts. 240, 249)
and
76 Fed.
Reg. 2,287 (Jan. 13, 2011) (to be codified at 17 C.F.R. pts. 240, 249) (proposing data repository rules); Regulation SBSR-Reporting and Dissemination of Security-Based Swap Information, 75 Fed.
Reg. 75,208 (Dec. 2, 2010) (to be codified at 17 C.F.R. pts. 240, 242) (proposing reporting rules).
357
Dodd-Frank Act § 752.
Dodd-Frank Act § 752.
358
See
77 Fed
Reg. 70,214, 70,299-328 (Nov. 23, 2012) (to be codified at 17 C.F.R. pt. 240) (showing …
See
77 Fed
Reg. 70,214, 70,299-328 (Nov. 23, 2012) (to be codified at 17 C.F.R. pt. 240) (showing that economic analysis takes up roughly 20% of the total release); 77 Fed.
Reg. 66,220, 66,263-84 (Nov. 2, 2012) (to be codified at 17 C.F.R. pt. 240) (showing that economic analysis takes up roughly 30% of the total release); 77 Fed.
Reg. 30,596, 30,722-42 (May 23, 2012) (to be codified at 17 C.F.R. pt. 240) (showing that economic analysis takes up roughly 12% of the total release).
359
See
CCMR
Report
supra
note 4, at 14
See
CCMR
Report
supra
note 4, at 14
360
Id
(emphasis added). The CCMR Report does not provide any specific cites or examples from within t…
Id
(emphasis added). The CCMR Report does not provide any specific cites or examples from within the Cross-Border Swap Release to back up this characterization, instead citing to the release as a whole.
Id.
361
Cross-Border Swap Release,
supra
note 352, at 386
Cross-Border Swap Release,
supra
note 352, at 386
362
Id.
Id.
363
Id
at 413-16.
Id
at 413-16.
364
Id
at 416-18.
Id
at 416-18.
365
Id
at 509-10.
In the discussion of the benefits of the rules covering swap executive facilities, t…
Id
at 509-10.
In the discussion of the benefits of the rules covering swap executive facilities, there is no quantification, nor does the release quantify major potential non-compliance costs of such rules, which are noted in qualitative terms in the release and include the possibility that disclosure obligations will drive swap participants from the market, reducing liquidity, or force participants to fragment trades to discourage front-running, resulting in greater transaction costs.
Id
. at 505-08 (benefits), 510-12 (non-quantifiable costs).
366
See
CCMR
Report
supra
note 4, at 13-16.
See
CCMR
Report
supra
note 4, at 13-16.
367
Eg.
, Cross-Border Swap Release,
supra
note 352 at 16 n.5, 34 n.76, 356 & n.1218, 359 & n.1226, 364…
Eg.
, Cross-Border Swap Release,
supra
note 352 at 16 n.5, 34 n.76, 356 & n.1218, 359 & n.1226, 364-66, 365 nn.1245-46, 366 n.1251, 371, 373, 388 n.1301, 392-93. All of these estimates relate to the less important assessment costs, the scope of or changes in relevant markets, or other data, and none are estimates of the more important programmatic costs or programmatic benefits.
368
Id.
Id.
369
For example, in assessing how much voluntary swap clearing is already occurring, the release notes…
For example, in assessing how much voluntary swap clearing is already occurring, the release notes that “if the counterparties choose to transact in a reference entity that is accepted for clearing in a currency other than US. dollars, the transaction is no longer eligible for clearing.”
Id.
at 486 n.1618.
This fact would be of significance for assessing the rules, since one would expect many cross-border swaps to be denominated in other currencies. No data on the currency profile of cross-border swaps is provided. As another example, the release states in another footnote the fact that less than five percent of margin received by swaps association members was segregated with a third-party custodian.
Id.
at 467 n.1549.
This fact directly bears on the potential gross benefits of a rule requiring segregation.
370
Cross-Border Swap Release,
supra
note 352, at 467-68 (footnotes omitted)
Cross-Border Swap Release,
supra
note 352, at 467-68 (footnotes omitted)
371
I think thirty-five words could preserve the meaning: “Segregation may protect customers, depend…
I think thirty-five words could preserve the meaning: “Segregation may protect customers, depending on US. and foreign laws, and if so may increase market confidence and the value of swaps, consistent with our experience with broker-dealer segregation, but those benefits cannot be quantified.”
372
George Parker & Brooke Masters,
Osborne Abolishes FSA and Boosts Bank
Fin
Times,
June 16, 2010, h…
George Parker & Brooke Masters,
Osborne Abolishes FSA and Boosts Bank
Fin
Times,
June 16, 2010,
].
The theory of the split-up of the FSA was that it had neglected systemic issues due to a “pre-occupation with consumer protection matters.”
Eilis
Ferran
Regulatory Lessons from the Payment Protection Insurance
Mis
-selling Scandal in the UK
, 13
Eur.
Bus. Org. L. Rev
. 247, 248 (2012). Going forward, the Prudential Regulation Authority is meant to engage in prudential supervision, while the Financial Conduct Authority will govern consumer finance.
Id.
373
Mortgage Market Review: Proposed Package of Reforms
Consultation Paper CP11/31
Fin
Servs
Auth
. …
Mortgage Market Review: Proposed Package of Reforms
Consultation Paper CP11/31
Fin
Servs
Auth
. 7 (Dec. 2011),
[https://perma.cc/K3YW-VWUN].
374
Id
Id
375
See
supra
note 83
See
supra
note 83
376
Mortgage Market Review
supra
note 375, at A1
:1
Mortgage Market Review
supra
note 375, at A1
:1
377
Id
at A1
:3
. The FSA’s conceptual CBA/FR is much more complex than depicted in the text. In one …
Id
at A1
:3
. The FSA’s conceptual CBA/FR is much more complex than depicted in the text. In one figure alone, it identifies four channels for reforms to affect welfare by cutting both affordable and unaffordable loans and increasing the suitability of loans made: (1) reducing resources spent on loans in arrears or repossession; (2) changing welfare from fewer loans; (3) changes in the buy-to-let mortgage market; and (4) lower home prices.
Id
. at A1
:11
. The reforms also affect competition and raise compliance costs, increasing mortgage prices and contributing to lower home prices. Lower home prices would cut the odds of a new crisis, benefiting the economy, and would also affect the economy through the rental, savings, and pension markets. All this would be happening simultaneously with changes in the identified baseline, such as market corrections in the home loan market; stricter prudential requirements, such as those imposed under Basel III; the collapse and re-launch of a new securitization market; and changes in the supply and demand for housing due to government policy changes, partly driven in turn by the macroeconomic loss. The FSA’s efforts to guesstimate the costs and benefits of the reforms aim at a subset of these channels. Other effects (e.g., changes in monetary or fiscal policy, effects on the “buy-to-let” market, effects on competition) are not quantified “because they are unlikely to be significant or because data constraints prevent us from providing any meaningful estimate.”
Id
. Also not quantified were benefits from reduced transfers of homes from borrowers to mortgagors, because although reducing transfers “is likely to be regarded as socially beneficial . . . it is difficult to assess the size of the benefit relative to the size of the transfer.”
Id
. at A1
:27
. Nevertheless, despite this complexity, the bottom line of the FSA’s CBA is driven by what is described in the text.
Id
. at A1
:8
-9 (noting that “[o]
verall
CBA balance” is dominated by net well-being benefit).
378
Impairment was defined as either being in arrears (that is, paying late) or having a home reposses…
Impairment was defined as either being in arrears (that is, paying late) or having a home repossessed
Id
. at A1
:27
. The breakdown between these types was roughly 85%/15%.
See id.
379
Id
at A1
:32
. For the other two reforms, the FSA used a separate “model” that simply identified…
Id
at A1
:32
. For the other two reforms, the FSA used a separate “model” that simply identified a subset of loans that passed the affordability test but were made to borrowers with high debt-service ratios (mortgage payments to after-tax income), which was taken as a proxy for loan non-affordability.
Id
. at 141.
380
Id
at A1
:4
. This cut-off point was identified by looking visually at a plot of the average underwr…
Id
at A1
:4
. This cut-off point was identified by looking visually at a plot of the average underwriting risk scores by the lenders in its sample, identifying a region in which the scores increased at an increasing rate, selecting the midpoint of the visually identified range, and usually the average underwriting score for the lender so identified.
Id
. at A1
:35
. It then arbitrarily chose a range that bracketed this score by a round +/- 0.1.
Id
. at A1
:36
381
Id
at A1
:4
. The FSA broke its sample into two sub-periods—2005 to 2007 and 2009 to 2010—to “…
Id
at A1
:4
. The FSA broke its sample into two sub-periods—2005 to 2007 and 2009 to 2010—to “construct different estimates of the impacts the affordability assessment would have in boom and subdued periods” of lending.
Id
. at A1
:39
. The FSA does note that this period experienced generally low (by historical standards) and falling interest rates, which likely means its estimates of loan defaults are low by historical standards; this may have led it to underestimate the benefits of its rules.
Id
. at A1
:32
382
Id
at A1
:8
. To do this, the FSA estimated the likely impact of the reforms on the size of loans th…
Id
at A1
:8
. To do this, the FSA estimated the likely impact of the reforms on the size of loans that would be made, breaking down loans into those of new buyers, home movers, and re-mortgagors.
Id
. at A1
:69
-71. For new buyers, loans were reduced until they “
compli
ed
]” with the rules under the FSA’s model, unless the reduction exceeded an arbitrarily chosen 30%, at which point the FSA assumed (absent data) the loan would be foregone.
Id.
at 70-71.
For other borrowers, they estimated the impact on the marginal increased loan of the new rules.
Id
. Of these, the FSA estimated that 75,000 would obtain a smaller mortgage while the rest would be pushed to delay their borrowing.
Id
. at A1
:79
383
Id
at A1
:76
. The FSA partly motivates this strong pair of assumptions by further assuming that “…
Id
at A1
:76
. The FSA partly motivates this strong pair of assumptions by further assuming that “most borrowers would prefer to borrow affordably.”
Id
384
Id
at A1
:26
. “Others whose borrowing is affected by the [rules] would in any case not have exper…
Id
at A1
:26
. “Others whose borrowing is affected by the [rules] would in any case not have experienced mortgage impairment. These consumers experience
only
a reduction in well-being (a cost), for example from having to buy a less desirable property, from delaying their property purchase or, in the case of some re-mortgagors, from not obtaining desired additional lending to support consumption.”
Id
. (emphasis added). The FSA implicitly defends this assumption with the claim that “some of these [borrowers] would have been willing and able to deal with high repayment burdens without much stress.”
Id
. at A1
:78
385
Id
at A1
:76
Id
at A1
:76
386
Id
at A1
:80
Id
at A1
:80
387
Id
at A1
:82
-84. The FSA refers to them as “weights.”
Id
. at A1
:83
Id
at A1
:82
-84. The FSA refers to them as “weights.”
Id
. at A1
:83
388
The FSA generated a variety of comparative statics for different subgroups of borrowers and differ…
The FSA generated a variety of comparative statics for different subgroups of borrowers and different types of housing-related events
Id
. at A1
:82
-84. Because of the variety of comparisons possible, there is no single ratio that emerges from the analysis, other than the general qualitative conclusion that effects of payment problems and defaults are “much greater” than the effects of delayed or foregone housing improvements.
Id.
at A1
:83
389
Id
at A1
:84
. Positive effects were larger during housing booms, with slightly negative effects in …
Id
at A1
:84
. Positive effects were larger during housing booms, with slightly negative effects in subdued markets.
Id
390
Id
at A1
:85
-86.
Id
at A1
:85
-86.
391
Id
at A1
:8
, A1:86.
Id
at A1
:8
, A1:86.
392
Id
at A1
:8
Id
at A1
:8
393
Id
at A1
:8
, A1:102-09.
Id
at A1
:8
, A1:102-09.
394
Id
at A1
:112
Id
at A1
:112
395
The National Institute for Economic and Social Research created the model, and describes it as usi…
The National Institute for Economic and Social Research created the model, and describes it as using “a ‘New-Keynesian’ framework in that agents are presumed to be forward-looking but nominal rigidities slow the process of adjustment to external events”
See
Model Overview
Nat’l Inst. Global Econ. Model
-intro/nigemintro.php?t=2&b=1 [http://perma.cc/8VXH-6QP6].
396
Mortgage Market Review
supra
note 375, at A1
:72
This modeling was off a baseline that took into a…
Mortgage Market Review
supra
note 375, at A1
:72
This modeling was off a baseline that took into account the effects of Basel III estimated by the FSA,
id
at
A1:72 n.37, and so builds in all of the uncertainties and assumptions of that exercise,
see
infra
Part III.C, along with a variety of other assumptions used to calibrate the
NiGEM
model, including assumptions about economic growth, inflation, and home prices, and how those macroeconomic forces interact.
Id.
at A1
:72
-74.
397
These categories were (1) a reduction in home lending due to increased lending costs from the rule…
These categories were (1) a reduction in home lending due to increased lending costs from the rules, (2) reduced home prices, which lower household expectations of capital gains from investments in homes, (3) increased household savings and reduced consumption to offset the reduction in expected home investments, (4) decreased inflation and lower central and interbank borrowing rates due to reduced consumption, increased savings, and lower household borrowing, (5) increased business lending as banks use funds freed up by reduced household and mortgage borrowing, and because of the lower bank rate, and (6) increased business investment due to additional business lending, which adds to productive capacity and increases overall output
Id.
at A1
:72
-74.
398
Id
at A1
:74
Id
at A1
:74
399
This discount rate is mentioned in passing in another part of the FSA’s CBA/FR, without explanat…
This discount rate is mentioned in passing in another part of the FSA’s CBA/FR, without explanation of how it was derived
Id
. at A1
:112
. The FSA does not translate its macroeconomic impact estimates into present values.
400
Id
at A1
:9
Id
at A1
:9
401
This may suggest that if new CBA/FR mandates are to be adopted, which Part IV below argues against…
This may suggest that if new CBA/FR mandates are to be adopted, which Part IV below argues against, they should be confined to the consumer protection context
402
Mortgage Market Review
supra
note 375, at A1
:85
Mortgage Market Review
supra
note 375, at A1
:85
403
Id
at A1
:70
n.33. The FSA defends thirty percent as more realistic than zero or 100%, which seems …
Id
at A1
:70
n.33. The FSA defends thirty percent as more realistic than zero or 100%, which seems right, but better would have been to present a sensitivity analysis for this assumption.
404
Id
at A1
:79
n.42. As the FSA laconically notes, “it is therefore likely that over the long run w…
Id
at A1
:79
n.42. As the FSA laconically notes, “it is therefore likely that over the long run we are over-estimating the impacts of the [rules] on lending volumes in the market.”
Id.
405
Id
at A1
:83
. This means that benefits are likely understated.
Id
at A1
:83
. This means that benefits are likely understated.
406
Id
at A1
:82
. This assumption seems implausible because borrowers will tend to “stretch” in the…
Id
at A1
:82
. This assumption seems implausible because borrowers will tend to “stretch” in their borrowing for housing in response to career developments, which will correlate with time, so any time trends in well-being reports will be reflected in the implicit before-and-after comparisons.
407
Id
at A1
:93
. Better would have been to include some data from periods of high or rising interest r…
Id
at A1
:93
. Better would have been to include some data from periods of high or rising interest rates, but the FSA faced data limitations similar to those faced by all financial regulators.
408
Id.
at A1
:87
Id.
at A1
:87
409
Cf id
at
A1:8 n.3, A1:27. The FSA noted this assumption was likely counterfactual, although it di…
Cf id
at
A1:8 n.3, A1:27. The FSA noted this assumption was likely counterfactual, although it did not elaborate on why—presumably because the non-market value of a home to the defaulting borrower exceeds the value of the home to the lender and/or a new buyer, on average.
410
Compare with OMB
Guidance,
supra
note 20, at 2 (“It is usually necessary to provide a sensitivit…
Compare with OMB
Guidance,
supra
note 20, at 2 (“It is usually necessary to provide a sensitivity analysis to reveal whether, and to what extent, the results of the analysis are sensitive to plausible changes in the main assumptions and numeric inputs”).
411
Mortgage Market Review
supra
note 375, at A1
:40
This estimate is for the affordability component …
Mortgage Market Review
supra
note 375, at A1
:40
This estimate is for the affordability component of the reforms alone; for the package of reforms, the results were similar.
Id.
at A1
:62
. The FSA also showed breakdowns by borrower type in the
subperiods
Id.
at A1
:41
-42, A1:63-64.
412
Id
at A1
:65
Id
at A1
:65
413
Id
at A1
:2
. Another disclaimer: “No amount of quantification would remove the need to make such a
Id
at A1
:2
. Another disclaimer: “No amount of quantification would remove the need to make such a
judgement
. We illustrate, however, our quantification of the tradeoff. This should not be interpreted as providing a precise measure of well-being effects, but rather as supporting some reasonable assumptions about the relative weight attached to different positive and negative effects, and illustrating that such relative weights might support different
judgements
.”
Id.
at A1
:80
414
Id
at A1
:5
. While the FSA believed those judgments “are best informed” by its CBA/FR, it prese…
Id
at A1
:5
. While the FSA believed those judgments “are best informed” by its CBA/FR, it presented no evidence to show that was true, or if so, how.
Id.
415
Id
at A1
:3
Id
at A1
:3
416
Eg.
CCMR Report
supra
note 4, at 13 (rebutting the belief that “quantifying the expected benef…
Eg.
CCMR Report
supra
note 4, at 13 (rebutting the belief that “quantifying the expected benefits of a regulation is impossible,” instead claiming that “rigorous cost-benefit analysis is not only feasible but has been successfully employed by regulators both in the United States and abroad”).
417
John Y Campbell et al.,
Consumer Financial Protection
, 25
J. Econ.
Persp
91, 98-99 (2011).
John Y Campbell et al.,
Consumer Financial Protection
, 25
J. Econ.
Persp
91, 98-99 (2011).
418
Luigi
Zingales
The Future of Securities Regulation
, 47 J
Acct. Res
. 391, 393-401 (2009).
Luigi
Zingales
The Future of Securities Regulation
, 47 J
Acct. Res
. 391, 393-401 (2009).
419
Using partially quantified CBA to generate bounds is sometimes offered as a solution to the proble…
Using partially quantified CBA to generate bounds is sometimes offered as a solution to the problematic output of CBA
See, e.g
.,
Sunstein
supra
note 19, at 2 (describing that estimates of expected value are useful to identifying regulatory benefits). But bounds do not generally make quantified CBA/FR useful, for two reasons. First, estimates of bounds themselves are highly imprecise. For example, even the “easily” quantified subsets of costs for many financial rules, such as the direct costs of SOX 404, have wide confidence intervals; for SOX 404, they range from $400,000 to $4 million per firm per year, and that range has changed over time.
See
supra
text accompanying notes 164-
167
. The lower bound on a lower bound (here, that is, $400,000) is all that partial quantified CBA can typically produce to guide policy judgment. Second, and more importantly, also as shown in Part III, when estimates of costs and benefits are
both
highly uncertain and imprecise, as is common in CBA/FR, the lower bound on the lower bound that can emerge from partial quantified CBA may not be a meaningful aid to policy judgment. If we know, for example, that a subset of costs can be estimated at $2.2 billion, plus or minus $1.8 billion, but we do know the benefits, a CBA advocate would argue that we have advanced the analysis because now we know that unless the benefits exceed the lower bound of the lower bound (that is, $400 million), the rule is not justified. But if any expert would have already had a prior judgment that the
unquantifiable
costs are likely to be an order of magnitude larger than $400 million, we have not significantly advanced the analysis, because we already knew benefits would have to be more than $400 million (indeed, more than $4 billion—an order of magnitude larger than $400 million). Quantification of the lower bound of the lower bound of the subset of costs may look precise (it produces a number), but it has not in fact improved our bottom-line estimate of the net benefits and costs, because our rough estimate of the benefits would already have had to be far higher before considering the rule. Put differently, only when partial quantification produces a lower bound on a lower bound on
costs that is
surprisingly
high (or vice versa, in the case of bounds on benefits) will the exercise aid policymaking judgment.
420
Compare, eg.
Sunstein
The Cost-Benefit State
supra
note 11, at 20-21 (advocating a “suitably …
Compare, eg.
Sunstein
The Cost-Benefit State
supra
note 11, at 20-21 (advocating a “suitably devised system of CBA,” albeit with caveats),
with
Sinden
supra
note 42, at 191-95 (critiquing the use of cost-benefit analysis).
421
See, eg.
Sunstein
supra
note 36, at 2289 (“A skeptic might conclude that because the range of …
See, eg.
Sunstein
supra
note 36, at 2289 (“A skeptic might conclude that because the range of uncertainty [about the net costs and benefits of a regulation designed to reduce arsenic intake] is so large, any number at all could be justified and the ultimate decision is essentially political or based on ‘values.’ This view is not exactly wrong, but it should not be taken as a convincing challenge to CBA.”). Even the arsenic rule had considerably simpler potential effects on welfare than several of the case studies reviewed in Part III (for example, SOX 404 or the Volcker Rule).
422
See
supra
text accompanying notes 373-375
See
supra
text accompanying notes 373-375
423
Compare
Cliff
Asness
et al,
Open Letter to Ben Bernanke
Wall St. J.
Real Time Econ.
(Nov. 15, 20…
Compare
Cliff
Asness
et al,
Open Letter to Ben Bernanke
Wall St. J.
Real Time Econ.
(Nov. 15, 2010, 12:01 AM),
[http://perma.cc/3VKA-UL8W] (posting an open letter from multiple economists, including former Chairman of Council of Economic Advisors, former Director of the Congressional Budget Office, former Senior Economist of the Board of Governors of the Federal Reserve, and former Deputy Assistant Treasury Secretary, among others, stating that “[
w]e
believe the Federal Reserve’s large-scale asset purchase plan (so-called ‘quantitative easing’) . . . risk[s] currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment”),
with Reply to Open Letter to Ben Bernanke from Federal Reserve Spokeswoman
Wall St. J.
Real Time Econ.
(Nov. 15, 2010, 12:01 AM)
[http://perma.cc/3VKA-UL8W] (defending the Federal Open Market Committee’s “recent actions”—that is, “quantitative easing”—as reflecting the Federal Reserve’s “Congressionally-mandated objectives [of]
promot
ing
] increased employment and price stability”).
See also
supra
notes 330-335 (noting disagreements among economists over whether an increase in bank capital requirements will reduce socially beneficial lending).
424
See
Cass R
Sunstein
The Real World of Cost-Benefit Analysis: Thirty-Six Questions (and Almost as …
See
Cass R
Sunstein
The Real World of Cost-Benefit Analysis: Thirty-Six Questions (and Almost as Many Answers)
, 114
Colum. L. Rev. 167, 185
(2014) (citing 75 Fed.
Reg. 76,186, 76,238).
The proposed rule was adopted on March 31, 2014.
See
NHTSA Announces Final Rule Requiring Rear Visibility Technology
Nat’l Highway Traffic & Safety Admin.
(Mar. 31, 2014)
].
425
The DOT’s CBA is confusing (and perhaps in error) in its presentation of cost estimates, 75 Fed
Re…
The DOT’s CBA is confusing (and perhaps in error) in its presentation of cost estimates, 75 Fed
Reg. 76,237 (Table 15 and text); 75 Fed.
Reg. 76,240 (Table 19 and text), in that it presents both a “primary estimate” and a “high estimate” of costs that are higher when using a 7% discount rate than when using a 3% discount rate, and the text of the rule does not refer to the numbers in the tables. It is also of note that rather than monetizing a cost of a child’s life differently from that of an adult, and then using the numbers so estimated in its analysis, it used a conventional value of an adult life, concluded that its quantified CBA produced a net cost, but then adopted the rule anyway based on what it determined was the non-quantifiable additional value of a child’s life.
Id.
at 76,238-39.
426
Marsili
Toy Models and Stylized Realities
, 55
Eur.
Physical J.
169, 173 (2007).
Marsili
Toy Models and Stylized Realities
, 55
Eur.
Physical J.
169, 173 (2007).
427
An exception is climate change, where the effects of US. regulations will depend upon how other go…
An exception is climate change, where the effects of US. regulations will depend upon how other governments cope with climate change. Quantitative CBA may for that and other reasons be less useful for coping with climate change than for regulations responding to less world-threatening problems.
See
Pindyck
supra
note 226
428
Paul A
Tipler
Physics
or Scientists and Engineers
336-37
(4th ed. 1999) (relating gravitational …
Paul A
Tipler
Physics
or Scientists and Engineers
336-37
(4th ed. 1999) (relating gravitational constant to the force of gravity at various depths).
429
Other physical constants relevant to non-financial domains include the magnetic constant, the elec…
Other physical constants relevant to non-financial domains include the magnetic constant, the electric constant, the mass of a proton, the gas constant, the speed of light, Planck’s constant, etc
430
Eugene F
Fama
& Kenneth R. French,
Disappearing Dividends: Changing Firm Characteristics or Lower …
Eugene F
Fama
& Kenneth R. French,
Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay
60
J. Fin. Econ.
3 (2001);
Zingales
supra
note 420, at 392. More companies are now paying dividends again, following the financial crisis, partly as a result of the extremely low interest rate environment created by quantitative easing by the Fed.
431
Fin Crisis Inquiry
Comm’n
The Financial Crisis Inquiry Report
38-51 (2011).
Fin Crisis Inquiry
Comm’n
The Financial Crisis Inquiry Report
38-51 (2011).
432
Marsili
supra
note
426
, at 173
Marsili
supra
note
426
, at 173
433
Larry Tribe made the same point in this journal forty years ago when discussing CBA of environment…
Larry Tribe made the same point in this journal forty years ago when discussing CBA of environmental regulation Laurence H. Tribe,
Ways Not To Think About Plastic Trees: New Foundations for Environmental Law
, 83
Yale L.J.
1315, 1322 (1974) (“[
E]
ven
before anyone is very good at the task of attaching shadow prices to varying levels of constraints as elusive as ecological diversity, the
attempt
to attach them rather than simply incorporating such constraints in an all-or-nothing fashion should lead to better decision processes even if not better outcomes.”). I thank Duncan Kennedy for the reference.
434
See
Chamber of Commerce v SEC
, 443 F.3d 890 (D.C. Cir. 2006);
Chamber of Commerce v. SEC
, 412 F.3d…
See
Chamber of Commerce v SEC
, 443 F.3d 890 (D.C. Cir. 2006);
Chamber of Commerce v. SEC
, 412 F.3d 133 (D.C. Cir. 2005);
see also
CCMC
Report
supra
note 6, at 30 (characterizing the costs as “minor”);
supra
notes 18, 89-102 and accompanying text.
435
This was the view of none other than Douglas Ginsburg (now on the DC. Circuit, author of the
Busin…
This was the view of none other than Douglas Ginsburg (now on the DC. Circuit, author of the
Business Roundtable
decision,
see
supra
notes 103-126 and accompanying text), writing about his experience as the first head of OIRA from 1984 to 1985.
See
Christopher C.
DeMuth
& Douglas H. Ginsburg,
White House Review of Agency Rulemaking
, 99
Harv
. L. Rev.
1075, 1085-86 (1986) (“The private nature of the regulatory review process [i.e., OIRA’s review of executive agency rulemaking] has been a strength . . . because . . . it can flourish only if the agency head or his delegate, and OMB as the president’s delegate, are free to discuss frankly the merits of a regulatory
proposal.
. . . The administration’s deliberative process would be significantly compromised if the preliminary rounds in any [interagency] disagreement were routinely publicized.”).
DeMuth
and Ginsburg acknowledge that private interagency review suffers from a legitimacy problem—it makes it hard for OIRA to rebut allegations that it acts to smuggle politics or private interests into the review process, out of the public’s eye—but they go on to argue that the problem is more apparent than real and in any event justified by the benefits of the process.
Id.
at 1086-87.
436
See
supra
note 134 and accompanying text
See
supra
note 134 and accompanying text
437
See
Alan B Morrison,
The Administrative Procedure Act: A Living and Responsive Law
, 72
Va. L. Rev.
See
Alan B Morrison,
The Administrative Procedure Act: A Living and Responsive Law
, 72
Va. L. Rev.
253, 256 (1986) (“[
R]
ulemakings
are often more controversial than adjudications [under the APA], whose very processes are hidden from outsiders.”).
438
Eg.
, Nat’l
Ass’n
of Mfrs. v. SEC, 956 F. Supp. 2d 43, 46 (D.D.C. 2013) (upholding an SEC rule prom…
Eg.
, Nat’l
Ass’n
of Mfrs. v. SEC, 956 F. Supp. 2d 43, 46 (D.D.C. 2013) (upholding an SEC rule promulgated under section 1502 of the Dodd-Frank Act, which directed the agency “to develop and promulgate a rule requiring greater transparency and disclosure regarding the use of ‘conflict minerals’ coming out of the DRC and its neighboring countries”),
aff’d
in part
, 748 F.3d 359 (D.C. Cir. 2014). This consequence appears to be a novel or at least recent dysfunction in the administrative state.
See
Jacob E.
Gersen
& Anne Joseph O’Connell,
Deadlines in Administrative Law
, 156
U. Pa. L. Rev.
923, 926 (2008) (“Because narrow delegations with extensive substantive restrictions would eliminate agency discretion and expertise in policymaking, it is rare that Congress specifies the actual content or substance of agency decisions.”);
cf.
Michael
Herz
Judicial
Textualism
Meets Congressional Micromanagement: A Potential Collision in Clean Air Interpretation
, 16
Harv
Envtl
. L. Rev. 175, 179
(1992) (arguing that in environmental regulation, judicial deference to regulatory discretion absent statutory specificity had created incentives for Congress to impose specific mandates as the best way to control agencies).
439
Cf
Vermeule
supra
note 9 (critiquing judicial review of agency decisions under conditions of unce…
Cf
Vermeule
supra
note 9 (critiquing judicial review of agency decisions under conditions of uncertainty).
440
See
id
at
2-3 for a different but complementary argument that courts should be more deferential to…
See
id
at
2-3 for a different but complementary argument that courts should be more deferential to agencies in contexts requiring arbitrary decisions.
441
For evidence that judicial review of agency action outside the financial regulatory context is mot…
For evidence that judicial review of agency action outside the financial regulatory context is motivated by politics and judicial ideology, despite nominal legal standards requiring deference and permitting court intervention only if the agency acts “arbitrarily” or “capriciously,” see
supra
note 127 and accompanying text
442
Kraus &
Raso
supra
note 12, at 338-42;
see also
Fisch
supra
note 116, at 718-21 (discussing the …
Kraus &
Raso
supra
note 12, at 338-42;
see also
Fisch
supra
note 116, at 718-21 (discussing the application of the Government in the Sunshine Act, 5 US.C. § 522(b) (2012), to the SEC).
443
Freedom of Information Act, 5 US.C. § 552 (2012).
Freedom of Information Act, 5 US.C. § 552 (2012).
444
Id
Id
445
See
sources cited
supra
note 81
See
sources cited
supra
note 81
446
See
sources cited
supra
note 82
See
sources cited
supra
note 82
447
See
supra
text accompanying notes 86-87
See
supra
text accompanying notes 86-87
448
Kraus &
Raso
supra
note 12, at 341
Kraus &
Raso
supra
note 12, at 341
449
See
OMB
Guidance,
supra
note 20, at 4-15
See
OMB
Guidance,
supra
note 20, at 4-15
450
CBA/FR advocates,
see,
eg.
CCMR Report
supra
note 4, at 14, rightly point to the SEC’s pilot p…
CBA/FR advocates,
see,
eg.
CCMR Report
supra
note 4, at 14, rightly point to the SEC’s pilot program on short sale rules, which randomly exempted a stratified sample from new rules for purposes of evaluating the rules’ effects in a statistically reliable way.
See
Office of Econ.
Analysis
Economic Analysis of the Short Sale Price Restrictions Under the Regulation SHO Pilot
, Sec. & Exch.
Comm’n
(2007),
[http://perma.cc/EE3U-VAUD].
451
CCMR Report
supra
note 4, at 9
CCMR Report
supra
note 4, at 9
452
I take up the task of making such proposals in a related paper
See
Coates
supra
note 10
I take up the task of making such proposals in a related paper
See
Coates
supra
note 10
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Throughout, I use the awkward acronym “CBA/FR” to flag that the analysis focuses on CBA of financial regulation, and that my conclusions may but do not necessarily carry over to CBA in other regulatory domains Part IV.A,
infra
, discusses potential differences between financial and other regulation.
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub
L. No. 111-203, 124 Stat. 1376 (2010) [hereinafter Dodd-Frank Act].
A trade group recently sued to enjoin the most prominent rule under the Dodd-Frank Act, the Volcker Rule, in part on grounds that the agencies ignored economic effects of one small part of the rule on small banks. Matthew Goldstein & Peter
Eavis
Banks’ Suit Tests Limits of Resisting Volcker Rule
N.Y. Times:
DealBook
(Dec. 24, 2013, 8:13 PM),
[http://perma.cc/Y78M-CKY7]. For the plaintiff’s motion for an emergency stay in the case, see Emergency Motion of Petitioners for Stay of Agency Action Pending Review, Am. Bankers
Ass’n
v. Fed. Reserve, No. 13-1310 (D.C. Cir.
Dec. 24, 2013).
On the current state of the law of CBA/FR, see
infra
Part II.A; for a discussion of the Volcker Rule and the trade group’s lawsuit, see
infra
Part III.D.
See
Regulatory Tracker
Davis Polk & Wardwell LLP
davispolk.com/dodd-frank/regulatory-tracker
[http://perma.cc/G7PQ-5LHZ]
See, eg.
Comm. on Capital
Mkts
. Regulation
A Balanced Approach to Cost-Benefit Analysis Reform 3, 9
(2013) [hereinafter
CCMR Report
] (citing the Dodd-Frank Act as the reason for Congress to pass a law requiring CBA by independent agencies and noting that “the SEC and the CFTC still often fall short of conducting meaningful cost-benefit analysis of new regulations”);
see also
Hester Peirce,
Economic Analysis by Federal Financial Regulators
, 9
J.L. Econ.
Pol’y
569 (2013).
See, for example, the Independent Agency Regulatory Analysis Act of 2013, S 1173, 113th Cong., described
infra
Part II. For other bills, see
infra
note
144
CCMR Report,
supra
note 4, at 4 (using legislative history to argue that the National Securities Markets Improvement Act of 1996, Pub L. No. 104-290, 110 Stat. 3416 (codified as amended in scattered sections of 15 U.S.C.) requires the SEC to conduct CBA based on the statutory requirement that the SEC consider “efficiency” as one of a number of factors in rulemaking);
Paul Rose & Christopher Walker
Ctr. for Capital
Mkts
. Competitiveness,
The Importance of Cost-Benefit Analysis in Financial Regulation
24-33 (2013) [hereinafter
CCMC Report
]. Critics also point to an efflorescence of decisions by the D.C. Circuit striking down SEC regulations as “arbitrary and capricious” under the Administrative Procedure Act (APA), 5 U.S.C. §§ 500-596 (1946), because of the agency’s failure to “consider” certain costs as part of its “efficiency” analysis; these cases are discussed in Part II below. Critics also note that the Commodity Exchange Act, Pub. L. No. 74-675, 49 Stat. 1491 (1936) (codified as amended at 7 U.S.C. §§ 1-27f) requires the CFTC to “consider the costs and benefits” of its regulatory actions.
Id.
§ 19(a)(1).
The Consumer Financial Protection Bureau is required to consider the “potential benefits and costs” as part of its rulemaking authority.
Dodd-Frank Act § 1022.
Bus
Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
I discuss this case in more detail in Part II below.
See infra
notes
114
125
and accompanying text.
The decision was written by Judge Douglas Ginsburg, joined by Chief Judge David
Sentelle
and Judge Janice Brown,
each appointed by a Republican President. Commentators have extensively criticized this decision,
see
infra
note
114
, but it remains a binding precedent. For completeness, I note that the U.S. Chamber of Commerce, a party to the case, paid two professors who wrote a report defending the decision.
See
CCMC
Report
supra
note 6, at ii (discussing “financial and administrative support” for the report).
Nat’l
Ass’n
of Mfrs v. SEC, 956 F. Supp. 2d.
43 (D.D.C. 2013),
aff’d
in part
, 748 F.3d 18 (D.C. Cir. 2014). The trial court decision was by Judge Robert L. Wilkins, who was subsequently nominated to the D.C. Circuit by President
Obama,
only to have his nomination filibustered by Senate Republicans. Todd
Ruger
Senate Blocks Robert Wilkins’ Nomination to D.C. Circuit
Legal
Times: BLT
(Nov. 18, 2013, 6:44 PM),
[http://perma.cc/75P8-PYM6]. This occurrence helped prompt the Senate to abolish filibusters of lower court appointments. Jeremy W. Peters,
In Landmark Vote, Senate Limits Use of the Filibuster
N.Y. Times
, Nov. 21, 2013,
[http://perma.cc/68ME-L8VL]. Judge Wilkins was confirmed to the D.C. Circuit under the Senate’s new rules. Pete
Kasperowicz
Senate Confirms Third Judicial Nominee
The Hill
(Jan. 13, 2014, 6:22 PM),
[http://perma.cc/6GA5-84ZW]. Earlier, a panel of the D.C. Circuit upheld a decision of the Office of Thrift Supervision against a CBA-based challenge, Stilwell v. Office of Thrift Supervision, 569 F.3d 514 (2009), and another Obama-appointed judge upheld a decision of the CFTC against a CBA-based challenge in 2012, despite the CFTC’s not having quantified the benefits or certain costs of the rule, Inv. Co. Inst. v. Commodity Futures Trading Comm., 891 F. Supp. 2d 162 (2012).
For a different but consistent critique of judicial review of agency decisions under conditions of uncertainty, see Adrian
Vermeule
Rationally Arbitrary Decisions (in Administrative Law)
(Harvard Law Sch, Working Paper No. 13-24, 2013),
[http://perma.cc/5AY8-WN7L] (arguing that courts should defer to agencies when agencies must act under conditions of uncertainty, even when the action is arbitrary).
10
In a related paper, I make further recommendations on how law and legal institutions can promote good CBA/FR as policy analysis, without risking the negative consequences of judicially enforced quantification
See
John C. Coates IV,
Towards Better Cost-Benefit Analysis: An Essay on Regulatory Management
, 78
Law & Contemp. Probs.
forthcoming
2015),
[http://perma.cc/W5KF-44KT].
11
For overviews outside the financial regulatory context, see
Matthew D Adler & Eric Posner, New Foundations of Cost-Benefit Analysis
(2006);
Cass R.
Sunstein
, The Cost-Benefit State: The Future Of Regulatory Protection
(2002) [hereinafter
Sunstein
, The Cost-Benefit State]
; and
Cass R.
Sunstein
, Risk and Reason
(2003).
12
Supporters and critics of CBA alike tend to elide distinctions between different meanings of “cost-benefit analysis” Supporters—who, ironically, often defend CBA as promoting transparency—elide these distinctions to make CBA look appealing to the broadest possible audience, including skeptics and optimists about quantification, advocates of regulation and deregulation, regulators and the regulated, and intended regulatory beneficiaries and taxpayers. Critics of CBA elide the distinctions because they see efforts to promote CBA as policy as a step on a slippery slope to CBA law. Of late, others have taken a more nuanced position, supporting CBA/FR as policy without supporting CBA/FR law.
See, e.g.
, Bruce Kraus & Connor
Raso
Rational Boundaries for SEC Cost-Benefit Analysis
30
Yale J. on Reg.
289
(2013).
13
Lawyers negotiating contracts know the difference, too For example, they do not view a clause requiring a party to act reasonably or the like as innocuous: it is a “get” by the counterparty and a “give” by the party subject to the requirement.
14
Part IV,
infra
, develops this point in further detail
15
See
Edward Sherwin,
The Cost-Benefit Analysis of Financial Regulation: Lessons from the SEC’s Stalled Mutual Fund Reform Effort
12 Stan J.L. Bus. & Fin.
1, 47 (2006) (arguing that “[
t]he
SEC’s failure to express the costs and benefits of its proposed rulemakings in numerical terms represents a significant shortcoming in its analysis”);
see also
U.S. Gov’t Accountability Office, Dodd-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination 17-18
(Nov. 2011) (“Without monetized or quantified benefits and costs, or an understanding of the reasons they cannot be monetized or quantified, it is difficult for businesses and consumers to determine if the most cost-beneficial regulatory alternative was selected . . . .”).
16
For a discussion of these Executive Orders, see
infra
text accompanying note
79
17
Robert W Hahn et al.,
Assessing Regulatory Impact Analyses: The Failure of Agencies To Comply with Executive Order 12,866
23
Harv
J.L. & Pub.
Pol’y
859, 861, 864 n.22 (1999-2000) (citing Exec. Order No. 12,866 § 6(a)(3)(C)(ii), 3 C.F.R. § 638, 645 (1993)). The authors acknowledge that the agencies were required to quantify costs and benefits only to “the extent feasible,”
id.
at
864 (citing Exec. Order No. 12,866, 3 C.F.R. § 645), and that “[
]t
is arguably not always possible or desirable to monetize all benefits and costs,”
id.
at
864 n.18 (citing Exec.
Order No. 12,866, 3 C.F.R. § 638-39;
Office of Mgmt. & Budget, Economic Analysis of Federal Regulations Under Executive Order 12,866
(Jan. 11, 1996)).
More recently, supporters of proposed legislative CBA mandates, including former commissioners of some of the independent agencies, have argued in favor of the bill on the ground that “not one of the 21 major rules issued by independent agencies in 2012 was based on a
complete, quantified
” CBA. Letter from Nancy Nord et al. to Thomas R. Carper, Chair of the Senate Homeland Sec. and Gov’t Affairs Comm., and Thomas A. Coburn, Ranking Member of the Senate Homeland Sec. and Gov’t Affairs Comm. 2 (June 18, 2013) (emphasis added),
serve
?File
_id=8eb0dbd9-5631-4878-bfb2-e040407cf0ba [http://perma.cc/BB9B-HER8].
18
412 F3d 133, 144 (D.C. Cir. 2005).
19
Robert W Hahn,
The Economic Analysis of Regulation: A Response to the Critics
, 71
U. Chi. L. Rev.
1021, 1049-50 (2004) (rebutting critiques of CBA by noting that it “does not require that costs and benefits be expressed in the same units or that agencies monetize benefits that may not be quantifiable” and arguing that CBA should “be careful to reflect those uncertainties and account for qualitative factors”); Cass R.
Sunstein
Nonquantifiable
(May 1, 2013) (unpublished manuscript),
[http://perma.cc/H6N8-KZTT].
20
Office of Management and Budget guidelines are not entirely consistent on whether CBA entails quantification On the one hand, they emphasize that CBA should contain, in addition to quantification, the specification of baselines, alternatives, and a
qualitative
description of how a rule will produce benefits and what side effects it may have,
Circular A-4: Regulatory Analysis
Off. Mgmt. & Budget
2 (2003) [hereinafter
OMB Guidance
],
[http://perma.cc/TZ3F-S8UU], and they explicitly provide that
where full monetization of all costs and benefits is not feasible, agencies should relate what can be quantified to what cannot be, so as to specify how large
unquantified
benefits could be or how small
unquantified
costs could be before a rule would “yield zero net benefits,”
id.
On the other hand,
the guidelines contain statements suggesting that CBA entails full quantification; for example, the guidelines
state that
“[a] distinctive feature of [CBA] is that both benefits and costs are expressed in monetary units, which allows you to evaluate different regulatory options with a variety of attributes using a common measure.”
Id.
at 6.
21
Letter from Nancy Nord et al to Thomas R. Carper and Thomas A. Coburn
supra
note 17
22
Kenneth J Arrow et al.,
Is There a Role for Benefit-Cost Analysis in Environmental, Health, and Safety Regulation
272
Science
221, 222 (1996). Neither Arrow et al. nor Hahn et al.,
supra
note
17
, provide evidence or cite to research supporting their views that quantification “should be possible” in “most” instances as applied to executive agencies.
Sunstein
likewise asserts without evidence that quantification will be impossible only in “rare” instances: “In the most extreme (and admittedly rare) cases, agencies may be operating under circumstances of
ignorance
, in which they cannot specify either outcomes or probabilities.”
Sunstein
supra
note 19, at 7.
23
For discussions, see, for example,
Frank Ackerman & Lisa
Heinzerling
, Priceless: On Knowing The Price of Everything and the Value of Nothing
(2004);
David S Brookshire et al.,
Valuing Public Goods: A Comparison of Survey and Hedonic Approaches
, 72
Am. Econ. Rev
. 165 (1982)
David S. Bullock & Nicholas Minot,
On Measuring the Value of a Nonmarket Good Using Market Data
, 88
Am. J. Agric. Econ.
961 (2006);
and
Karl-
Göran
Mäler
A Method of Estimating Social Benefits from Pollution Control
73
Swedish J. Econ
121 (1971).
24
See
infra
Part III for further discussion of the relevant non-market goods affected by financial regulation
25
Consultative Document: Assessment Methodologies for Identifying Non-Bank Non-Insurer Global Systemically Important Financial Institutions
Fin Stability Bd. & Int’l Org. Sec.
Comm’ns
3 (Jan. 8, 2014),
[http://perma.cc/LS8E-TAHJ] (identifying three transmission mechanisms for systemic risk: (1) direct exposure to failed institutions; (2) forced asset liquidations by failed institutions that disrupt trading or funding in key markets; and (3) disruption of a critical service or function without substitutes);
see also
Stephen L.
Schwarcz
Systemic Risk
97 Geo.
L.J. 193
(2008) (identifying relationships between markets and institutions and noting how risk can spread through interconnected financial systems).
26
OMB Guidance,
supra
note 20, at 2
27
5 US.C. § 706(2)(A) (2012).
28
Eg.
, OMB Guidance,
supra
note 20.
29
Eg.
, Eric Posner & E. Glen
Weyl
Benefit-Cost Analysis for Financial Regulation
, 103
Am
. Econ. Rev.: Papers & Proc.
393, 397 (2013) (arguing that CBA “should be applied to the introduction of new [derivatives] products into markets by private participants”). This approach is close to the one currently used in regulation of mutual funds in both the United States and the European Union, which generally forbid innovation in the design of collective investments without prior regulatory approval; as a result, proponents are generally required to demonstrate that the benefits of the design will outweigh its risks to investors.
See
John C. Coates IV,
Reforming the Taxation and Regulation of Mutual Funds: A Comparative Legal and Economic Analysis
, 1
J. Legal Analysis
591 (2009).
30
5 US.C. § 553 (2012).
31
See, eg.
, Matthew D. Adler & Eric A. Posner,
Introduction,
Cost
-Benefit Analysis: Legal, Economic, and Philosophical Perspectives
, 29
J. Legal Stud.
837, 841 (2000) (“Much has been written about whether the cost-benefit analysis executive orders have actually influenced the behavior of agencies. Knowledgeable scholars in this area seem to doubt that the executive orders have had much influence.”).
32
No published study examines empirically whether CBA produces benefits that outweigh its costs—whether CBA in practice passes its own test Closest are studies assessing whether ex ante quantitative CBA by executive agencies produced CBA that was consistent with retrospective estimates.
E.g
.,
Robert W. Hahn et al.,
Do Federal Regulations Reduce Mortality
? 19 (2000) (finding that nine of twenty-four rules passed a cost-benefit test); Winston Harrington et al.,
On the Accuracy of Regulatory Cost Estimates
, 19
J.
Pol’y
Analysis & Mgmt
. 297, 314 (2000) (finding that for fourteen of twenty-eight Occupational Safety and Health Administration or EPA rules, total costs were overestimated, while for only three were they underestimated, and overestimates were often due to difficulties in determining the baseline and incomplete compliance). These studies do not provide reliable evidence about whether CBA would pass its own test, because they do not model the counterfactual of interest: how does regulation under CBA compare to regulation without it? For that analysis, one would need to match rules subject to CBA with those not subject to CBA, and study which did better at achieving net benefits. One method may be to exploit the fact that “economically significant rules” (ESRs) are subject to more stringent CBA under OMB Guidance,
supra
note 20, than other rules, so one could compare outcomes for rules just above and below the ESR threshold. Any objection that this question is simply too hard to study should lead to a similar conclusion as the one reached by this Article—in other words, that CBA/FR itself is unreliable.
33
Eg
., Matthew D. Adler & Eric A. Posner,
Rethinking Cost-Benefit Analysis
, 109
Yale L.J.
165, 239 (1999) (tentatively recommending CBA over “
unidimensional
” or “
nonaggregative
” decision procedure alternatives).
34
Eg.
, Cass R.
Sunstein
The Arithmetic of Arsenic
, 90
Geo.
L.J
. 2255, 2289-90 (2002) (defending CBA on the ground that, although the bottom-line quantification of the arsenic rule was so uncertain that no conclusion could be reached from it, it was successful because it allowed the government to be “transparent” about why the rule’s net benefits were uncertain).
Transparency is often presented as an obviously good thing.
Id
.; Adler & Posner,
supra
note 35, at 239 (asserting the “inherent transparency of CBA itself” and noting that oversight bodies such as OMB can prevent agencies from misusing CBA or applying it in a way that decreases transparency).
But see
Troy A.
Paredes
Blinded by the Light: Information Overload and Its Consequences for Securities Regulation
81
Wash. U. L.Q.
417, 444-45 (2003) (arguing that information overload can lead to disclosures that are not meaningful or effective).
35
Eg
., Cass R.
Sunstein
Cost-Benefit Default Principles
, 99
Mich.
L. Rev.
1651, 1662, 1709 (2001) (stating that “
the case for cost-benefit analysis is strengthened by the fact that interest groups are often able to use . . . cognitive problems strategically, thus fending off regulation that is desirable or pressing for regulation when the argument on its behalf is fragile
”;
and
noting the risk that, if permitted to adopt rules that do not pass a CBA test, agencies “
will conceal an effort to placate powerful private groups not having a strong claim to governmental assistance
”)
W. Kip
Viscusi
Risk Equity
, 29
J. Legal Stud.
843 (2000) (agencies sometimes adopt rules that benefit private interests)
36
Adler & Posner,
supra
note 35, at 245 (“CBA is a useful decision procedure and it should be routinely used by agencies CBA is superior to rival method[s] . . . [and] allows agencies to take into account all relevant influences on overall well-being . . . and . . . to weigh the advantages and disadvantages in a clear and systematic way . .
. .
”).
37
Compare
Sunstein
supra
note 37, at 1662 (arguing that unless people “are asked to seek a full accounting, they are likely to focus on small parts of problems” and explaining that CBA “is a way of producing [a] full accounting” and is a “natural corrective” for “systematic errors” and “misperceptions of facts” caused by the use of “rules of thumbs, or heuristics”),
with
Richard A Posner,
Cost-Benefit Analysis: Definition, Justification, and Comment on Conference Papers
, 29
J. Legal Stud.
1153, 1161-62 (2000) (critiquing the justification of CBA as a corrective for cognitive biases),
and
Joshua D. Wright & Douglas H. Ginsburg,
Behavioral Law and Economics: Its Origins, Fatal Flaws, and Implications for Liberty
, 106
Nw.
U. L. Rev.
1033 (2012) (critiquing
Sunstein’s
research and attempts to account for cognitive biases in policymaking).
38
Despite being generally in favor of CBA, Adler and Posner acknowledge this point, but they do not develop it as a theoretical reason to resist legalizing CBA Adler & Posner,
supra
note 35, at 172 (“Agencies sometimes appear to use CBA to rationalize decisions made on other grounds.”).
39
Paredes
supra
note 36, at 420 (“[
T]he
specter of information overload casts doubt on the long-held belief and policy choice that more disclosure is better than less”).
Paredes
was a Republican Commissioner of the SEC until 2013, and as Commissioner,
Paredes
was a strong proponent of CBA.
See
Troy A.
Paredes
, Remarks at AICPA Council Spring Meeting (May 17, 2012),
.VEMV6ecdVEA
(“[The SEC] must engage in rigorous [CBA] when fashioning . . . securities law . . . . I have expressed these views several times before in advocating for rigorous [CBA] at the SEC.”);
see also
Alex
Edmans
et al.,
The Real Costs of Disclosure
2 (Nat’l Bureau of Econ. Research, Working Paper No. 19420, 2013) (arguing that “even if the actual act of disclosure is costless, high-disclosure policy can still be costly due to differential verifiability of some kinds of information”).
40
Duncan Kennedy,
Cost-Benefit Analysis of Entitlement Problems: A Critique
, 33
Stan L. Rev.
387, 443 (1981) (“[CBA] is arbitrary. It provides yet another medium for the introduction of political preferences through what seem merely necessary ‘practical’ assumptions of any
analysis.
. . . The focus on particular problems legitimates arbitrary assumptions and masks their political content.”)
Amy
Sinden
Cass
Sunstein’s
Cost-Benefit Lite: Economics for Liberals
, 29
Colum. J.
Envtl
. L.
191, 194 (2011) (book review) (“The danger of CBA . . . lies in its false promise of determinacy, its pretense of objectivity and scientific
accuracy.
. . . [
T]his
false promise . . . renders CBA . . . vulnerable to manipulation and . . . destructive to democratic decision-making, as . . .
Sunstein’s
analysis of the arsenic CBA amply demonstrates.”).
41
Eg.
, Adler & Posner,
supra
note 35, at 169 & n.5 (citing
Ajit
K.
Dasgupta
& D.W. Pearce, Cost-Benefit Analysis: Theory and Practice
12-13 (1972)).
42
Flood Control Act of 1936, 33 US.C. § 701a (2012);
see also
Sherwin,
supra
note 15, at 6 (citing
James T.
Campen
, Benefit, Cost, and Beyond: The Political Economy of Benefit-Cost Analysis 16
(1986)). Sherwin correctly notes but does not discuss an earlier statute, the River and Harbor Act of 1902,
ch.
1079, § 3, 32 Stat. 331, 372. That statute directed the organization and authorized the funding of a board of engineers reporting to the Chief of Engineers of the United States Army. The board was directed “so far as in the opinion of the Chief of Engineers may be necessary” to review reports for proposed river and harbor improvements and submit recommendations and “have in view the amount and character of commerce existing or reasonably prospective which will be benefited by the improvement, and the relation of the ultimate cost of such work . . . to the public commercial interests involved, and the public necessity for the work.”
33 U.S.C. § 541 (2012).
The board was instructed to do the same for past projects upon request by relevant congressional committees.
Id.
43
Theodore M Porter,
Trust in Numbers: The Pursuit of Objectivity in Science and Public Life
148-90 (1995).
44
Id
at 153.
45
Id
46
Id
at 155.
47
Id
48
Id
at 157.
49
Id
at 160.
50
Id
at 161.
51
Id
52
Id
at 149.
53
Adler & Posner,
supra
note 35, at 194 (noting “an argument [they] believe has currency among economists although it is rarely defended in print . . is that CBA is desirable because there are no superior alternatives that provide determinate, or relatively determinate, prescriptions”).
54
Isaac
Alfon
& Peter Andrews,
Cost-Benefit Analysis in Financial Regulation: How To Do It and How It Adds Value
Fin Services Authority,
Sept. 1999, at 11
[http://perma.cc/XY93-BFA3].
55
Sinden
supra
note 42, at 226-27
56
See
Risk Versus Risk: Tradeoffs in Protecting Health and the Environment
(John D Graham & Jonathan
Baert
Weiner eds
.,
1995).
57
Henry M Levin, Cost-Effectiveness: A Primer 17-18
(1983).
58
An example is the Bank Holding Company Act of 1956, which bans banks from being owned by or affiliating with companies engaged in non-financial activities
Bank Holding Company Act of 1956 § 4, 12 U.S.C. § 1843 (2010).
The Federal Reserve Board and other banking agency regulations interpreting this statute do not engage in CBA when they evaluate whether an activity is prohibited by the statute.
59
Despite the repeal in the Gramm-Leach-
Blilely
Act, Pub
L. No. 106-102, 113 Stat. 1338 (1999) (codified in scattered sections of 12 U.S.C.), of the Glass-
Steagall
Act of 1933, 48 Stat. 162, banks and companies that control banks are still banned from most non-financial activities and investments under the Bank Holding Company Act of 1956. The Volcker Rule is similar, as discussed
infra
Part III.D, in that it bans banks from specified activities.
60
OMB Guidance,
supra
7note 71erm
ing
the ban and has signaled a desire to address the issue in the coming
legisrting
oil produced
domestically.siona
note 20 (suggesting the use of “judgment” or “professional judgment” fourteen times, including the use of formal Delphi methods for eliciting expert seat-of-the-pants estimates). On Delphi methods, see
M. Granger Morgan & Max
Henrion
, Uncertainty: A Guide to Dealing with Uncertainty in Quantitative Risk and Policy Analysis
164-68 (1990). For a trenchant attack on CBA generally, arguing in favor of the use of “intelligent deliberation” as the alternative, see Henry S. Richardson,
The Stupidity of the Cost-Benefit Standard
29
J. Legal Stud.
971 (2000).
61
The expertise of the financial agencies includes vastly more firepower than is available to OIRA, which has a total staff of roughly fifty
Office of Information and Regulatory Affairs (OIRA) Q & A’s
Off.
Mgmt. & Budget
(Nov. 2009),
[http://perma.cc/AA96-TFKU].
The Federal Reserve Board alone has 220 Ph.D. economists on staff.
See
Ryan Grim,
Priceless: How the Federal Reserve Bought the Economics Profession
Huffington Post,
Oct. 23, 2009,
/2009/09/07/priceless-how-the-federal_n_278805.html [http://perma.cc/M9AN-FZRL]. The SEC has more than fifty economists.
See Economists
Sec. & Exch. Commission
(Oct. 7, 2014),
[http://perma.cc/NT98-GHUU]. For a discussion of the careers of SEC Commissioners and staff, see John C. Coates IV,
Private vs. Political Choice of Securities Regulation: A Political Cost/Benefit Analysis
41
Va. J. Int’l L
531 (2001).
62
Eg.
Cybersecurity
Roundtable
Sec. & Exch.
Comm’n
(May 14, 2014),
] (example of consultation by SEC with experts); Office of Econ.
Analysis,
Economic Analysis of the Short Sale Price Restrictions Under the Regulation SHO Pilot
Sec. & Exchange Commission
(Feb. 6, 2007),
[http://perma.cc/23G6-S9YC] (example of regulatory experiment); Office of Econ. Analysis,
Study of the Sarbanes-Oxley Act of 2002 Section 404 Internal Control over Financial Reporting Requirements
Sec. & Exchange Commission (2009) [
hereinafter Office of Econ.
Analysis,
Study of the Sarbanes-Oxley Act
] (example of study including survey data).
63
See Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States
Fin Crisis Inquiry Commission
27-82 (Jan. 2011),
[http://perma.cc/43W2-7WAU].
64
See
Philip E
Tetlock
, Expert Political Judgment: How Good Is It? How Can We Know?
(2005) (
noting
that expert political opinion is often wrong);
Tom Stark, Fed. Reserve Bank of
Phila
.,
Realistic Evaluation of Real-Time Forecasts in the Survey of Professional Forecasters
2 (May 28, 2010) (unpublished paper),
[http://perma.cc/W4GG-J84W] (concluding that expert economic forecasts beat “no change” forecasts and simple direct and indirect
autoregression
models, but performance of forecasts fell sharply for predictions more than three months in the future)
65
See infra
note 73
66
More specifically, the Rule calls for the Fed to set the federal funds rate (traditionally its principal instrument for setting monetary policy) at one plus 15 times the inflation rate plus 0.5 times the “output gap,” defined as the percentage deviation of actual GDP from “potential” GDP.
See
John B. Taylor,
Discretion Versus Policy Rules in Practice
, 39
Carnegie-Rochester Conf. Series on Pub.
Pol’y
195, 202 (1993).
“Potential” GDP is an estimate of “the trend growth in the productive capacity of the economy . . . an estimate of the level of GDP attainable when the economy is operating at a high rate of resource use . . . [that is, an estimate of] maximum
sustainable
output—the level of real GDP in a given year that is consistent with a stable rate of inflation.”
CBO’s Method for Estimating Potential Output: An Update
Cong. Budget Off.
(Aug. 2001),
[http://perma.cc/L68J-SMQV].
Although models of potential GDP vary, the CBO publishes estimates that are widely used, based on the “Solow growth model,” a simple projection of GDP based on two supply-side factors: “labor input (hours worked) and accumulation of physical capital (additions to the nation’s stock of plant and equipment).”
Id.
at 3.
67
See
Taylor,
supra
note
66
, at 207-08 For prior theoretical work, see Finn E.
Kydland
& Edward C. Prescott,
Rules Rather than Discretion: The Inconsistency of Optimal Plans
, 85
J. Pol. Econ
473 (1977).
68
In fact, Taylor has argued that the Federal Reserve has repeatedly deviated from his rule John B. Taylor,
Getting Back on Track: Macroeconomic Policy Lessons from the Financial Crisis
, 92
Fed. Res. Bank of St. Louis Rev
. 165-76 (May/June 2010) [hereinafter Taylor,
Getting Back on Track
]; John B. Taylor,
A Historical Analysis of Monetary Policy Rules
in
Monetary Policy Rules
319 (John B. Taylor ed., 1999) [hereinafter Taylor,
A Historical Analysis
]. On the other hand, recently departed Federal Reserve Chairman Ben Bernanke, Federal Reserve Board members, and staff economists have argued the contrary—and, moreover, have claimed that Taylor’s 1993 formulation of his rule differs from his 1999 formulation. Ben Bernanke, Chairman, Fed. Reserve, Monetary Policy and the Housing Bubble, Speech at the Annual Meeting of the American Economic Association (Jan. 3, 2010),
[http://perma.cc/KT3L-6SVD]; Laurence Meyer,
Dueling Taylor Rules
Macroeconomic Advisors: Monetary
Pol
Insights,
Aug. 20, 2009; Glenn
Rudebusch
The Fed’s Monetary Policy Response to the Current Crisis
, 2009-17
Fed. Res. Bank of S.F. Econ.
Letter
(May 22, 2009).
69
Alex
Nikolsko-Rzhevskyy
& David H
Papell
, Taylor’s Rule Versus Taylor Rules 1 (Sept. 15, 2012) (unpublished paper),
[http://perma.cc/7U7U-Q552] (referring to the period under Greenspan from 1987 to 1992).
70
Compare
Kydland
& Prescott,
supra
note
67
, at 487 (advocating that Congress select a “simple and easily understood” monetary policy rule and have it take effect prospectively after a two-year delay—without explaining how such a law could be made binding on a future Congress),
with
Ricardo Reis,
Central Bank Design
27
J Econ.
Persp
17, 18 (2013) (stating that central banks’ objectives have usually been “vague”);
id.
at
19 (stating that “some discretion” may better allow a central bank to achieve even clearly stated objectives);
id.
at
25-26 (stating that central banks “always have some discretion”),
and
John B. Taylor,
A Steadier Course for Monetary Policy
, Testimony Before the Joint Economic Committee on “The Fed at 100: Can Monetary Policy Close the Growth Gap and Promote a Sound Dollar?” 3-4 (Apr. 18, 2013),
[http://perma.cc/8KB2-B5WA] (calling for a “return to a more rules-based policy” and a “gradual exit” from what he criticizes as unfortunate policy decisions, and not for a sudden or strict “rule” to set policy; declaring that, under his proposal, “while discretion would be constrained, it would not be eliminated”).
71
See infra
notes 146-148 and accompanying text Even those who advocate greater Fed transparency—as reflected in the various bills known colloquially as “Audit the Fed” laws—would not subject the Fed’s monetary policy choices to either ex ante CBA requirements or ex post review by courts or another agency.
See, e.g.
, Federal Reserve Transparency Act of 2013, S. 209, 113th Cong. (2013) (proposing to repeal exemption from audit by the Comptroller General of the Federal Reserve, contained in 31 U.S.C. § 714, for various transactions, deliberations, and communications relating to, among other things, monetary policy).
72
Sewall Chan,
From Tea Party Advocates, Anger at the Federal Reserve
, NY.
Times,
Oct. 10, 2010,
0/11/us/politics/11fed.html [http://perma.cc/74TA-GNYU] (describing Republican politicians’ criticisms of the Fed based on Fed policy decisions during the economic crisis).
73
On the overall goals pursued by the Fed, see
What Is the Purpose of the Federal Reserve System
Board Governors Fed Res. Sys
.,
[http://perma.cc/TW9Z-ANYL] (outlining the Fed’s legal responsibilities and goals, including an effective payment system and a stable financial system). The Fed’s statutory mandate relating to monetary policy is narrower, consisting of seeking to maintain the “long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
12 U.S.C. § 225a (2012).
I am informed by close observers of Congress that the Office of Legislative Council—which provides confidential drafting advice to members of Congress and their staffs—routinely suggests exemptions for monetary policy from bills imposing procedural or other requirements on regulatory action, based on a strong norm of preserving the Fed’s independence in overseeing monetary policy.
74
See
Roger E Backhouse, The Puzzle of Modern Economics: Science or Ideology?
117-37 (2010) (describing historical and ongoing debates within economics over whether and how to construct macroeconomic models, and detailing continuing disputes over the ability of such models to adequately forecast economic behavior).
75
The APA defines a “rule” as any “statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy”
5 U.S.C. § 551 (2012).
If the pending bills did not exempt monetary policy, then any “statement” by the Federal Reserve Board meant to “implement . . . policy” would arguably require CBA/FR under the APA.
Id.
76
OMB Guidance,
supra
note 20, at 2 (“You will find that you cannot conduct a good regulatory analysis according to a formula Conducting high-quality analysis requires competent professional judgment.”).
77
See
Taylor,
Getting Back on Track
supra
note 70; Taylor,
A Historical Analysis
supra
note 70
78
Independent regulatory agencies are listed in the Paperwork Reduction Act of 1980
44 U.S.C. § 3502(5) (2012).
Not all financial regulations are issued by independent agencies; the Department of Labor, which is an executive agency, promulgates regulations relevant to pension funds, for example, and is governed by the executive orders listed
infra
note 81.
79
Exec Order No. 12,291, 46 Fed.
Reg. 13,193 (Feb. 17, 1981) (requiring, inter alia, CBA for new regulations),
superseded by
Exec.
Order No. 12,866, 58 Fed.
Reg. 51,735 (Sept. 30, 1993) (modestly amending prior CBA requirements, imposing heightened requirements for “significant regulatory action” and further requirements for actions likely to have an economic impact of $100 million per year (hereinafter, an “economically significant rulemaking”)),
amended by
Exec.
Order No. 13,258, 67 Fed.
Reg. 9385 (Feb. 26, 2002) (eliminating the role of the Vice President in the CBA process),
supplemented by
Exec.
Order No. 13,563, 76 Fed.
Reg. 3821 (Jan. 18, 2011).
Under these orders, executive agencies are required to conduct quantified CBA to the extent feasible, to submit significant rules to OIRA in advance, to provide CBAs to OIRA, to wait until OIRA reviews the CBAs before publishing rules for public comment, and to publish CBAs with rules.
Id.
Independent agencies are required only to provide OMB with an annual agenda of significant regulatory actions for the upcoming year, including, “to the extent feasible and permitted by law,” a summary CBA.
Id.
Sherwin reports having reviewed these agendas for the SEC in the period leading up to 2006, and he found they did not generally include summary CBA. Sherwin,
supra
note 15, at 12. These executive orders were joined by the Unfunded Mandates Reform Act requirement that executive agencies, but not independent agencies, include written CBAs for each economically significant rulemaking.
Unfunded Mandates Reform Act of 1995, Pub.
L. No. 104-4, 109 Stat. 48 (codified as amended in scattered sections of 2 U.S.C.).
80
Eg.
Monetary Policy and the State of the Economy: Hearing Before the H. Comm. on Fin.
Servs
113th Cong. 8 (2013) (statement of Federal Reserve Chairman Ben Bernanke that Federal Open Market Committee purchases of financial assets are conducted “within a [CBA] framework”);
SEC Office of the Inspector
Gen.,Compliance
Handbook
38-39 (1999) (stating that SEC rule proposals should contain CBAs). This handbook reflected OMB’s best practices guidance issued in 1996,
see
Gov’t Accountability Office,
GAO-12-151
Dodd-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination
n.14 (2011);
see also
Budget Hearing—Securities and Exchange Commission: Hearing Before the Fin.
Servs
and
Gen. Gov’t
Subcomm
of
the H. Comm. on Appropriations
, 112th Cong. (2011) (statement of SEC Chairman Mary Schapiro), Federal News Service, Inc., transcript at 26-27;
SEC Office of the Inspector General, Office of Audits, SEC OIG 499, Follow-Up Review of Cost-Benefit Analyses in Selected Dodd-Frank Rulemakings 6
(2012) (“SEC Chairman Arthur Levitt stated that there was an expectation that the SEC would perform cost-benefit analyses as part of the rulemaking process.”).
See generally
Barry D. Friedman, Regulation in the Reagan-Bush Era: The Eruption of Presidential Influence
78 (1995); Richard H.
Pildes
& Cass R.
Sunstein
Reinventing the Regulatory State
, 62
U. Chi. L. Rev.
1, 11-18 (1995); Peter L. Strauss,
The Place of Agencies in Government: Separation of Powers & the Fourth Branch
, 84
Colum. L. Rev.
573, 591-93 (1984).
81
Financial Services Act, 2012, amending inter alia sections 138I (Financial Conduct Authority) and 138J (Prudential Regulation Authority) of the Financial Services and Markets Act 2000 In striking contrast to the recent U.S. experience, the FSA and its successors’ rulemakings and CBA (while subject to judicial review) have not been subjected to numerous court decisions striking down rules for inadequate CBA. The only example of a court decision that even refers to CBA by the Financial Services Authority (FSA) is
R (on the application of the British Bankers Association) v. FSA et al.
, [2011] EWHC (Admin) 999 (Eng.), which rejected a challenge by a banking trade group to the handling of complaints about “Payment Protection Insurance” by the FSA and the Financial Ombudsman Service, which handles consumer financial complaints.
82
Pub L. No. 104-13, 109 Stat. 163 (1995) (codified at 44 U.S.C. §§ 3501-3520).
83
Pub
L. No. 96-354, 94 Stat. 1164 (1980) (codified at 5 U.S.C. §§ 601-612).
The RFA was one basis for the recent suit against the Volcker Rule by the American Bar Association.
See
infra
note 341.
84
Technically, the reports are submitted to the head of the GAO, the Comptroller General Contract with America Advancement Act of 1996, Pub. L. No. 104-121, 110 Stat. 847 (1996) (codified as amended in 5 U.S.C. §§ 801 et seq.). This statute exempts monetary policy by the Federal Reserve Board and the Federal Open Market Committee.
5 U.S.C. § 807.
85
5 US.C. § 804.
Under the statute, major rules do not go into effect for sixty days, and Congress has the power to veto “major rules” by joint resolution passed within that period, subject to presidential veto of the joint resolution.
5 U.S.C. §§ 801-802.
Courts have interpreted this statute to preclude judicial review of agency compliance with the statute, including agency determinations of whether a rule is “major.”
See, e.g.
, Via Christi
Reg’l
Med. Ctr., Inc. v. Leavitt,
509 F.3d 1259, 1271 n.11 (10th Cir. 2007) (“The Congressional Review Act specifically precludes judicial review of an agency’s compliance with its terms.”);
Operation of the Missouri River Sys.
Litig
.,
363 F. Supp. 2d 1145, 1173 (D. Minn. 2004) (agency’s determination under CRA that a rule is not a “major rule” is not subject to judicial review);
see also
Montanans for Multiple Use v.
Barbouletos
568 F.3d 225 (D.C. Cir. 2009);
Tex.
Sav
. &
Cmty
Bankers
Ass’n
v. Fed.
Hous
. Fin.
Bd.,
201 F.3d 551 (5th Cir. 2000).
86
Eg.
GAO-03-933R
Report
nder 5 U.S.C. § 801(a)(2)(A) on a Major Rule
U.S. Gov’t Accountability O
ff.
(June 25, 2003),
[http://perma.cc/CEG8-WVRH] (reviewing the rule proposed by the SEC for the implementation of section 404 of the Sarbanes-Oxley Act, discussed more
infra
Part III.A);
GAO-14-147R,
Report
nder 5 U.S.C. § 801(a)(2)(A) on a Major Rule
U.S. Gov’t Accountability Off.
(Oct. 30, 2013)
[http://perma.cc/VXV7-A35V] (reviewing the rule proposed by the Office of the Comptroller of the Currency (OCC) and the Federal Reserve to implement Basel III, discussed more
infra
Part III.C); Off.
Info. & Regulatory Affairs,
2012 Report to Congress on the Benefits and Costs of Federal Regulations and Unfunded Mandates on State, Local, and Tribal Entities
Off.
Mgmt. Budget
app. C
[http://perma.cc/2N6B-NKL7] (assessing CBA of “major rules” issued by independent agencies in the prior fiscal year).
87
Chamber of Commerce v SEC, 412 F.3d 133 (D.C. Cir. 2005).
88
412 F3d at 142 (citing 15 U.S.C. § 80a-2(c) (2012)).
89
National Securities Markets Improvement Act, Pub
L. No. 104-290, § 106, 110 Stat. 3416, 3425 (1996) (codified at 15 U.S.C. § 80a-2).
Identical requirements were added to the other federal securities laws.
Id.
90
412 F3d at 144.
91
Id
92
Id
at 143.
93
Id
at 144.
The third failing did not raise CBA issues, and arose under the APA directly: the SEC had not formally considered a disclosure alternative to its proposals, in which funds would prominently disclose whether they had independent chairs. Here, the court pointed to the fact that two dissenting Commissioners had suggested the alternative, along with a number of commentators, and that the SEC’s only stated reasons for not considering it were that it had no obligation to consider every alternative raised, that it did consider other alternatives, and that Congress in the ICA itself had not relied on disclosure to police conflicts of interest in funds. To this, the court noted, “[
T]hat
the Congress required more than disclosure with respect to some matters governed by the ICA does not mean it deemed disclosure insufficient with respect to all such matters.”
Id.
at 144-46.
94
Id
at 137 (citing Investment Company Governance, 69 Fed. Reg. 46,387 n.81) (stating that “[
w]e
have no reliable basis for estimating those costs”).
95
Id
at 144 (“The Commission did violate the APA by failing adequately to consider the costs mutual funds would incur in order to comply with the conditions.”);
accord id.
at
136.
96
The only precedent cited by the court in its critique of the SEC’s CBA was
Public Citizen v Federal Motor Carrier Safety Administration
, 374 F.3d 1209 (D.C. Cir. 2004). In that case, an executive (not independent) agency that was specifically required by statute to “consider the costs and benefits” of its regulation was held to have violated a distinct statutory requirement to “
deal[
] with . . . fatigue-related issues pertaining to . . . vehicle safety,” which the court there interpreted as requiring the agency to collect and analyze data on the costs and benefits of a specific possible regulation.
Id.
at 1211-12 (citing 49 U.S.C. §§ 31502, 31506, 31136 (2012));
see also id.
at
1221 (“This directive, in our view, required the agency, at a minimum, to collect and analyze data on the costs and benefits.”). No specific directive of that kind was at issue in
Chamber of Commerce
, only the open-ended directive for the SEC to consider the effects of its rules on “efficiency, competition, and capital formation.”
412 F.3d at 140 (citing 15 U.S.C. § 80a-2(c) (2012)).
97
See, eg.
Mas-
Collel
et al.,
supra
note 32, at 127, 152-53 (discussing “efficiency” without reference to quantitative data).
98
See
Bowman Transp, Inc. v. Ark.-Best Freight Sys
.,
Inc., 419 U.S. 281, 285-86 (1974). After
Chamber of Commerce
, the D.C. Circuit has held that courts should be “particularly deferential in matters implicating predictive judgments,” Rural Cellular
Ass’n
v. FCC, 588 F.3d 1095, 1105 (D.C. Cir. 2009), which led another panel of the D.C. Circuit to hold that the APA “imposes no general obligation on agencies to produce empirical evidence” when it is not in the agency’s record.
Stilwell v. Office of Thrift Supervision, 569 F.3d 514, 519 (D.C. Cir. 2009).
99
Nat’l Wildlife
Fed’n
v EPA, 286 F.3d 554, 563 (D.C. Cir. 2002).
This fact has led another panel of the D.C. Circuit, after
Chamber of Commerce
, to announce sweepingly that courts should “review . . . cost-benefit analysis deferentially.”
Nat’l
Ass’n
of Home Builders v. EPA, 682 F.3d 1032, 1040 (D.C. Cir. 2012).
100
OMB Guidance,
supra
note 20 The OMB does not specify that an agency engaging in quantification “to the extent feasible” must quantify costs on a conditional basis.
101
647 F3d 1144 (D.C. Cir. 2011).
102
For the total number of major rules, see
Office of Info
& Regulatory Affairs, Office of Mgmt. & Budget, Exec.
Office of the President, 2012 Report to Congress on the Benefits and Costs of Federal Regulations and Unfunded Mandates on State, Local, and Tribal Entities
app. c (2012).
103
Goldstein v. SEC, 451 F.3d 873 (D.C. Cir. 2006).
104
Fin
Planning Ass’n v. SEC, 482 F.3d 481 (D.C. Cir. 2007).
105
PAZ Sec., Inc. v. SEC, 494 F.3d 1059 (D.C. Cir. 2007).
106
Am
Equity Inv. Life Ins. Co. v. SEC, 613 F.3d 166 (D.C. Cir. 2010).
107
Chamber of Commerce v SEC, 443 F.3d 890 (2006) (holding that the SEC’s re-proposal of the mutual fund governance rules violated the APA because the SEC relied on materials not in the public record and had not reopened the rule for public comment).
Some commentators have suggested that the SEC’s rapid re-adoption of its rule with the cost estimates called for by the D.C. Circuit in
Chamber of Commerce I
shows that it was less than diligent in failing to provide the cost estimates in the first release.
E.g.
CCMC Report
supra
note 6, at 30; Sherwin,
supra
note 15, at 164. This criticism is unfair, because it fails to explain why the SEC should have understood that it had an obligation to provide that cost information in its first release; at the time of that release, neither the APA nor NSMIA nor court precedents would have made it apparent that the cost considerations—referred to by the Chamber of Commerce’s own report as “relatively minor,” CCMC
Report,
supra
note 6, at 30—would be an independently important component of the SEC’s regulatory analysis, or were otherwise required to be set forth in the release. It is even more deceptive to imply that the SEC was able in its second release to do something it had said it could not do in its first release, as the CCMC report suggests,
id.
noting
that “the court’s incredulity about the SEC’s position that the agency could not determine these costs proved true”), because the SEC’s position was not that it could not estimate conditional cost estimates, but only that these conditional cost estimates could not be translated into an actual aggregate compliance estimate—which it never provided, even in its second release.
108
Nat’l
Ass’n
of Mfrs v. SEC, 748 F.3d 359 (D.C. Cir. 2014).
109
Inv Co. Inst. v. CFTC, 891 F. Supp. 2d 162, 215 (D.D.C. 2012) (“While the CFTC did not calculate the costs of the Final Rule down to the dollar-and-cent, it reasonably considered the costs and benefits of the Final Rule, and decided that the benefits outweigh the costs.”).
110
Stilwell v Office of Thrift Supervision, 569 F.3d 514 (D.C. Cir. 2009).
111
See
cases cited
supra
notes 103-112
112
956 F Supp. 2d 43, 53 (D.D.C. 2013) (“All of those cases involved rules or regulations that were proposed and adopted by the SEC of its own accord, with the Commission having independently perceived a problem within its purview and having exercised its own judgment to craft a rule or regulation aimed at that problem.”).
113
See
Brandice
Canes-
Wrone
Bureaucratic Decisions and the Composition of the Lower Courts
, 47
Am
J. Pol. Sci.
205, 205 (2003) (using a dataset of Army Corps of Engineers decisions from 1988 to 1996 to conclude that “judicial ideology significantly affects bureaucratic decision making,” consistent with the idea that agencies may seek to shelter decisions from court review by obtaining Congressional mandates);
Yehonatan
Givati
Strategic Statutory Interpretation by Administrative Agencies
, 12
Am.
L. & Econ.
Rev.
95 (2010) (finding that, in a theoretical model, stricter judicial review of agency action can result in “safer” statutory interpretations by the agency, due to the relative shift in utility of safe and aggressive interpretations); M. Elizabeth Magill,
Agency Choice of Policymaking Form
, 71
U. Chi. L. Rev.
1383, 1437-42 (2004) (noting that agencies can and do choose among rulemaking, enforcement, and informal guidance for various reasons and that judicial review is affected by and affects these choices); Matthew C. Stephenson,
The Strategic Substitution Effect: Textual Plausibility, Procedural Formality, and Judicial Review of Agency Statutory Interpretations
, 120
Harv
. L. Rev
. 528 (2006) (concluding that procedural formality substitutes for textual interpretation of statutes that authorize agency actions); Emerson H. Tiller,
Controlling Policy by Controlling Process: Judicial Influence on Regulatory Decision Making
, 14
J.L. Econ.
& Org.
114 (1998) (presenting a model of judicial review of agency decision making, in which “process review” under the APA for arbitrariness forces agencies to expend resources to reduce the risk of judicial reversal); Emerson H. Tiller & Pablo T. Spiller,
Strategic Instruments: Legal Structure and Political Games in Administrative Law
, 15
J.L. Econ.
& Org
. 349 (1999) (finding that agencies choose among “instruments of decision making” so as to increase costs of court review).
For an account of executive agency efforts to avoid CBA review by OIRA, see Jennifer
Nou
Agency Self-Insulation Under Presidential Review
126
Harv
. L. Rev
. 1755 (2013).
114
The decision provoked unusual agreement among legal commentators—all negative
See
Robert B.
Ahdieh
Reanalyzing Cost-Benefit Analysis: Toward a Framework of Function(s) and Form(s)
, 88
N.Y.U. L. Rev.
1983 (2013); James D. Cox & Benjamin J.C.
Baucom
The Emperor Has No Clothes: Confronting the D.C. Circuit’s Usurpation of SEC Rulemaking Authority
, 90
Tex. L. Rev.
1811 (2012); Jill E.
Fisch
The Long Road Back:
Business Roundtable
and the Future of SEC Rulemaking
, 36
Seattle U. L. Rev.
695 (2013); Grant M. Hayden & Matthew T.
Bodie
The Bizarre Law & Economics of
Business Roundtable v. SEC, 38
J. Corp. L.
101 (2012); Kraus &
Raso
supra
note 12; Michael E. Murphy,
The SEC and the District of Columbia Circuit: The Emergency of a Distinct Standard of Judicial Review
, 7
Va.
L. & Bus.
Rev.
125 (2012); Comment,
D.C. Circuit Finds SEC Proxy Access Rule Arbitrary and Capricious for Inadequate Economic Analysis
, 125
Harv
. L. Rev.
1088 (2012); Anthony W.
Mongone
, Note, Business Roundtable
: A New Level of Judicial Scrutiny and Its Implications in a Post-Dodd-Frank World
, 2012
Colum. Bus. L. Rev.
746; Stephanie Lyn Parker, Note,
The Folly of Rule 14a-11:
Business Roundtable v. SEC
and the Commission’s Next Step
, 61
Am
. U. L. Rev.
715 (2012); J. Robert Brown, Jr.,
Shareholder Access and Uneconomic Economic Analysis:
Business Roundtable v. SEC
Univ. of Denver Sturm College of Law Legal Research Paper Series, Working Paper No. 11-14, 2011),
/shareholder-access-and-uneconomic-economic-analysis-business.html [http://perma.cc/PD72-8K83]; Dennis Kelleher, Stephen Hall &
Katelynn
Bradley,
Setting the Record Straight on Cost-Benefit Analysis and Financial Reform at the SEC
Better Markets, Inc.
59-68 (2012),
%20Straight.pdf [http://perma.cc/X4L8-SUK5]. The only substantial defense of the decision is in the CCMC report, CCMC
Report
supra
note 6, which, as noted above, was funded by a party to the case, the U.S. Chamber of Commerce.
Id.
at ii.
115
Indeed, the circumstances were so limited that prominent corporate law scholars labeled the rule “insignificant” Marcel
Kahan
& Edward Rock,
The Insignificance of Proxy Access
, 97
Va. L. Rev.
1347 (2011). The CCMR report’s characterization of the proxy access rule as “more substantive,”
CCMR Report
supra
note 4, at 7, than the CFTC registration and reporting requirements upheld in
Investment Company Institute v. CFTC
, 891 F. Supp. 2d 162 (2012), is mysterious. Proxy access would not have changed “substantive” corporate governance but only added disclosure and process requirements for proxy solicitation; it would have been, in effect, a cross-subsidy of large, long-term shareholders’ disclosure obligations, but would not have altered voting rights or the relative authority of boards or shareholders to make decisions for corporations.
116
Bus
Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
117
Id
at 1148
118
Id
The court also asserted the SEC had been arbitrary by using “inconsistent” estimates of the frequency with which the rule would be used.
Id.
at 1153.
To support this, the court claimed that the SEC had “predicted nominating shareholders would realize ‘direct cost savings’ from not having to print or mail their own proxy materials,” that the SEC had cited comment letters in support of this fact, and that one letter reported the rule would be frequently used, suggesting that the SEC believed that the cost savings would be large.
Id.
at 1153-54 (noting that the SEC “then cited comment letters predicting the number of elections contested under [the rule] would be quite high” and that “[
o]ne
of the comments reported . . . that . . . ‘hundreds’ of . . . companies . . . expected a shareholder . . . to nominate a director using the rule” (citing Letter from Kenneth L. Altman, President, The Altman
Grp
., Inc., to Elizabeth M. Murphy, Secretary, Sec. & Exch.
Comm’n
(Jan. 19, 2010),
.sec.gov/comments/s7-10-09/s71009-605.pdf [http://perma.cc/QTJ4-TADN]
)). The court’s opinion on this point is egregiously misleading: it falsely claims the SEC relied on the Altman comment as a basis for the SEC’s views on costs, and it then falsely claims that the SEC’s supposed view on costs contradicted other statements in the SEC’s release. In fact, the SEC did not cite
any
public comments to support its beliefs about direct cost savings, which were qualitative, a matter of common sense, and did not need such support.
See
Facilitating Shareholder Director Nominations, Exchange Act Release No. 33-9136, 75 Fed.
Reg. 56,668 (Sept. 16, 2010).
To the contrary, the SEC specifically rejected the claim that the rule would be frequently used, as claimed in the Altman letter cited by the court.
Id.
at 270.
Nowhere does the SEC cite the Altman letter to support its conclusions.
Id.
119
Bus
Roundtable
, 647 F.3d at 1149-50.
120
Id
at 1153.
121
Jess
Bravin
Why DC. Circuit, at Center of Nominee Fight, Is So Important
Wall St. J.,
Nov. 20, 2013,
/SB10001424052702304607104579210383151449004 [http://perma.cc/C5V-Q7UH].
122
Bus
Roundtable
, 647 F.3d at 1151.
123
Chamber of Commerce v SEC, 412 F.3d 133, 143 (D.C. Cir. 2005) (emphasis added).
124
Stilwell v Office of Thrift Supervision, 569 F.3d 514, 519 (D.C. Cir. 2009) (emphasis added).
Nothing in the text of the securities laws would change this; the word “efficiency” does not by any reasonable reading imply a burden to generate evidence that does not exist, and the court in
Business Roundtable
did not examine the legislative history of the requirement that the SEC consider “efficiency.”
See
Murphy,
supra
note 116, at 128-30
Mongone
supra
note 116, at 746-56.
125
On the partisan nature of the Court’s decisions on CBA, see the discussion in the text accompanying notes 7 and 8;
see also
Cass R
Sunstein
& Adrian
Vermeule
Libertarian Administrative Law
, 81
U. Chi. L. Rev.
(forthcoming 2015) (manuscript at 56) (on file with author) (noting the libertarian ideology of judges on the D.C. Circuit who have been most active in striking down agency decisions on CBA grounds, and that while this ideology does not perfectly track party affiliation, it “correlates powerfully” with it). While the D.C. Circuit now has seven active judges who were nominated by Democratic presidents and four active judges who were nominated by Republican presidents, it also has five senior judges who were nominated by Republican presidents and one senior judge who was nominated by a Democratic president. These senior judges are entitled to (and do) carry up to a full caseload. Because panels are composed of three judges, there remains a strong possibility of partisan or ideological panels reviewing independent agency decisions.
126
Gen Accounting Office
U.S. Gov’t Accountability Office
, GAO/GGD-98-30,
Unfunded Mandates: Reform Act Has Had Little Effect on Agencies’ Rulemaking Actions
30 (1998),
[http://perma.cc/5QFV-5864].
127
Sherwin,
supra
note 15, at 27-28 (citing HR. 4818, 108th Cong. (2004); H.R. R
ep
. N
. 108-472, at 841 (2004); S. 2908, 108th Cong. (2004) (introduced by Sen. Judd Gregg (R-NH)); Consolidated Appropriations Act of 2005, Pub. L. No. 108-447, 118 Stat. 2809 (2004)).
128
Full Committee Hearing on Sarbanes-Oxley 404: Will the SEC’s and PCAOB’s New Standards Lower Compliance Costs for Small Companies
?:
Hearing Before the H Comm. on Small Bus.
, 110th Cong. 97 (2007) (statement of Hal Scott, Professor, Harvard Law Sch.) (“That estimate was, we now know, off by a factor of over 48.”)
accord
CCMR
Report
supra
note 4. As noted in Part III.A,
infra
, this criticism was mistaken, but has been repeated by the Committee on Capital Markets Regulation in its 2013 report promoting CBA.
Id.
at 9.
129
A Balancing Act: Cost, Compliance, and Competitiveness After Sarbanes-Oxley: Hearing Before the
Subcomm
on
Regulatory Affairs of the H. Comm. on Government Reform
, 109th Cong. 2 (2006) (statement of Rep. Patrick T. McHenry, Chairman, H.
Subcomm
. on Regulatory Affairs) (repeating criticism).
130
Daniel M Gallagher,
Comm’r
, Sec. & Exch.
Comm’n
, Remarks Before the Corporate Directors Forum, (Jan. 29, 2013),
/1365171492142#
.VADgc7xdXkZ
[http://perma.cc/TV7S-8QW5] (“One example relates to compliance with Section 404 of Sarbanes Oxley, which the Commission estimated would cost on average roughly $91,000 a year to implement.”).
131
Memorandum from Dan M
Berkovitz
, Gen. Counsel, U.S. Commodities Futures Trading
Comm’n
, & Jim Moser, Acting Chief Economist, U.S. Commodities Futures Trading
Comm’n
, to Rulemaking Teams (Sept. 29, 2010),
/@aboutcftc/documents/file/oig_investigation_041511.pdf [http://perma.cc/M235-EUT2].
132
Id
at Exhibit 1, 2-3 (“[
S]
ection
15 does not require the [CFTC] to quantify the costs and benefits of an action. However, the [CFTC] cannot consider the costs and benefits . . . unless they are presented either quantitatively or qualitatively.”). A follow-up memo, in May 2011, required rulemaking teams to “incorporate the principles of Executive Order 13563 . . . to the extent . . . reasonably feasible” in final rulemakings. Memorandum from Dan M.
Berkovitz
, Gen. Counsel, U.S. Commodities Futures Trading
Comm’n
, & Andrei
Kirilenko
, Chief Economist, U.S. Commodity Futures Trading
Comm’n
, to Rulemaking Teams 1
May 13
, 2011
/file/oig_investigation_061311.pdf [http://perma.cc/M3SR-VYNW]. In May 2012, the CFTC and OIRA entered into a memorandum of understanding permitting OIRA staff to provide “technical assistance” to CFTC staff during implementation of the Dodd-Frank Act, “particularly with respect” to CBA/FR.
Memorandum of Understanding
between
Office of Info.
& Regulatory Affairs and U.S. Commodity Futures Trading
Comm’n
(2012),
.whitehouse.gov/sites/default/files/omb/inforeg/regpol/oira_cftc_mou_2012.pdf
133
Wall Street Reform: Oversight of Financial Stability and Consumer and Investor Protections: Hearing Before the S Comm. on Banking, Housing, and Urban Affairs
, 113th Cong. 21 (2013) (statement of Sen. Crapo).
134
Office of the Inspector Gen, Sec. & Exch.
Comm’n
, Report No. 499, Follow-Up Review of Cost-Benefit Analyses in Selected SEC Dodd-Frank Act Rulemakings 1
(2012);
Office of the Inspector Gen., U.S. Commodity Futures Trading
Comm’n
, A Review of Cost-Benefit Analyses Performed by the Commodity Futures Trading Commission in Connection with Rulemakings Undertaken Pursuant to the Dodd-Frank Act,
at
(2011).
135
Pub L. No. 112-10, § 1573(a), 125 Stat. 38, 138-39 (2011) (codified at 12 U.S.C. § 5496(b)).
136
US. Gov’t Accountability Office,
GAO-12-151,
Dodd
-Frank Act Regulations: Implementation Could Benefit from Additional Analyses and Coordination 14 (2011).
137
Id
at 16-17.
In 2012, the GAO released another report advocating CBA/FR, reiterating its view that financial regulators should “more fully incorporate OMB’s guidance into their rulemaking policies.”
U.S. Gov’t Accountability Office,
GAO-13-101,
Dodd-Frank Act: Agencies’ Efforts To Analyze and Coordinate Their Rules
(2012) (text on “highlights” page).
138
US. Gov’t Accountability Office
supra
note 138, at 17.
139
See
CCMC
Report
supra
note 6, at 9-10
CCMR Report
supra
note 4, at 7-10 Neither the GAO nor other CBA proponents have set out examples of how the SEC should conduct CBA/FR, limiting themselves to simply counting what share of rulemakings contained CBA/FR of any kind, and what share contained at least some quantification, without regard to whether the quantification is precise, reliable, or comprehensive as to either costs or benefits. The CCMR report holds up one SEC rulemaking as the “gold-standard” of CBA/FR,
CCMR Report
supra
note 4, at 13-15, as discussed
infra
at text accompanying notes 344-361.
140
Eg.
Who Is Too Big To Fail? GAO’s Assessment of the Financial Stability Oversight Council and the Office of Financial Research
Hearing Before the
Subcomm
on
Oversight and Investigations of the H. Comm. on Fin.
Serv
., 113th Cong. 26 (2013) (question from Rep. Wagner to witness from Financial Stability Oversight Council about a “GAO report that talked about [needing] a [CBA]”).
141
Memorandum from the Div of Risk, Strategy and Fin.
Innovation and the Office of the Gen. Counsel, U.S. Sec. & Exch.
Comm’n
, to the Staff of the Rulemaking Div. and Offices, U.S. Sec. & Exch.
Comm’n
, on Current Guidance on Economic Analysis in SEC Rulemakings 1
(2012),
[http://perma.cc/RDN3-NU64].
142
Id
at 3.
143
Id
at 4-15.
See
sources cited
supra
notes 20 and 81 (citing CBA Executives Orders and OMB Guidance).
144
S 1173, 113th Cong. (2013). The Senators were Senators Collins (R-ME), Portman (R-OH), and Warner (D-VA). A similar bill was introduced in 2012. S. 3468, 112th Cong. (2012). Other bills promoting CBA have been introduced in this and prior years.
E.g
., Unfunded Mandates Information and Transparency Act of 2014, H.R. 899, 113th Cong. (2014); Regulatory Sunset and Review Act of 2013, H.R. 309, 113th Cong. (2013); Startup Act 3.0, S. 310, 113th Cong. (2013); SEC Regulatory Accountability Act, H.R. 1062, 113th Cong. (2013); Startup Act 3.0, H.R. 714, 113th Cong. (2013); Congressional Office of Regulatory Analysis Creation and Sunset and Review Act of 2011, H.R. 214, 112th Cong. (2011);
Regulatory Improvement Act of 1999, S. 746, 106th Cong. (1999); Regulatory Improvement Act of 1998, S. 981, 105th Cong. (1997); Comprehensive Regulatory Reform Act of 1995, S. 343, 104th Cong. (1995); Regulatory Reform and Relief Act, H.R. 926, 104th Cong. (1995).
To date, a small number of former commissioners of independent agencies have backed the bill.
E.g
., Letter to the Chair and Ranking Member of the Senate Homeland Sec. and Gov’t Affairs Comm., June 18, 2013,
.cfm/files/serve
?File
_id=6f3f466c-e744-4d99-892a-91f6e6348ebf [http://perma.cc/9V34-W5X9].
145
S 1173, § 3(a)(6). The independent financial regulatory agencies include, among others, the Bureau of Consumer Financial Protection (CFPB), Commodity Futures Trading Commission (CFTC), Federal Deposit Insurance Corporation (FDIC), Federal Reserve System, Federal Housing Finance Agency (FHFA), Federal Trade Commission (FTC),
Office
of the Comptroller of the Currency (OCC), Office of Financial Research (OFR), and Securities Exchange Commission (SEC). S. 1173, § 2(4) (incorporating 44 U.S.C. § 3502(5) (2012)). The newly created CFPB and OFR were added to the list in the Dodd-Frank Act, § 1100D, and the OCC was added to the list in § 315 of that Act. Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub.
L. No. 111-203, 124 Stat. 1524 (codified in scattered sections).
146
S 1173, § 2(5) (incorporating the definition of “rule” under 5 U.S.C. § 551 (2012), which defines a “rule” as any “statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy”).
147
Id
§ 3(b).
148
Id
§ 3(c)(3)(B).
149
Id
§ 4(b).
150
See
Alan B Morrison,
The Administrative Procedure Act: A Living and Responsive Law
, 72
Va. L. Rev
. 253, 256 (1986) (“[
R]
ulemakings
are often more controversial than adjudications [under the APA], whose very processes are hidden from outsiders.”).
151
See
CCMR Report,
supra
note 4, at 1 (stating that CBA/FR should “[
f]
ocus
on economically significant rules”)
152
It is worth noting that no similar efforts can be found in the more prominent publications advocating CBA/FR of financial regulation
E.g.
CCMC Report
supra
note 6; CCMR
Report
supra
note 4. The closest proponents come is to point to selected CBA/FR as “gold standard” CBA/FR, but CBA/FR advocates do not review that CBA in any detail, and as discussed in Part III.E below, these “gold standards” are no more compelling in their guesstimated CBA/FR components than the examples reviewed here. This gap between what the CBA/FR proponents promise can be done and what they can demonstrate has been done is troubling.
153
This section draws extensively on John C Coates IV &
Suraj
Srinivasan
SOX After Ten Years: A Multidisciplinary Review,
29
Acct. Horizons
(forthcoming 2015),
[http://perma.cc/6SVZ-ELZW].
154
For a review and evaluation of the core elements of SOX, see John C Coates IV,
The Goals and Promise of the Sarbanes-Oxley Act
, 21
J. Econ.
Persp
91 (2007).
155
Such systems consist of methods by companies that monitor use of the company’s assets and produce accurate financial reports, including (for example) computer programs designed to detect inconsistencies between customer orders and accounting records, rules for which corporate agents can authorize certain expenditures and transactions, internal audits, and verification procedures
See
Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting, Exchange Act Release Nos. 33-8810, 34-55929, 72 Fed.
Reg. 35,324 (June 27, 2007).
156
Sarbanes-Oxley Act of 2002 § 3(a), 107 Pub
L. No. 204, 116 Stat. 745, 749 (codified at 15 U.S.C. 7202 (2012)).
157
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, 68 Fed Reg 36,636 (June 18, 2003) (codified at 17 C.F.R. pts. 210, 228, 229, 240, 249, 270, 274).
For brevity, I refer to the SEC’s “rule” in this section, although in fact the release modified a number of separate SEC rules. The effect of the SEC’s rules in practice would turn out to be heavily influenced by rules separately adopted by the PCAOB.
158
See
supra
notes 77-78, 87-88, 95-98 and accompanying text
159
This was required by the National Securities Markets Improvement Act of 1996, Pub
L. No. 104-290, 110 Stat. 3416, 3424-25 (codified in scattered sections of 15 U.S.C.), which amended three of the SEC’s governing statutes—the Securities Act of 1933, the Exchange Act of 1934, and the Investment Company Act of 1940—to require the SEC to consider whether any rulemaking done “pursuant to” those statutes would “promote efficiency, competition, and capital formation.”
15 U.S.C. §§ 77b(b), 78c(f), 80a-2(c) (2012).
160
See
supra
notes 81-82
161
68 Fed
Reg. 36,636, 36,656-57 (June 18, 2003).
162
Id
at 36,657.
163
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Exchange Act Release Nos 33-8238, 34-47986, Investment Company Act Release No. IC-26068 at pt.
V(
B) & n.174 (Aug. 14, 2003),
[http://perma.cc/XZN4-GMZ5] (“The estimate does not include the costs of the auditor’s attestation report, which many commenters have suggested might be substantial.”).
164
Full Committee Hearing on Sarbanes-Oxley Section 404: Will the SEC’s and PCAOB’s New Standards Lower Compliance Costs for Small Companies
?:
Hearing Before the H Comm. on Small Bus.
, 110th Cong. 97 (2007) (statement of Hal S. Scott, Dir., Comm. on Capital
Mkts
. Regulation) (“[The SEC’s] estimate was, we now know, off by a factor of over 48.”). Presumably, this claim is based on comparing the SEC’s cost estimate with the results of a survey (
=274) conducted by the Financial Executives International (FEI) and Financial Executives Research Foundation (FERF). That survey found the average cost of SOX 404 reported in 2004 was $4.4 million (4,400,000 / 91,000 = 48.4). FEI is a trade group, and the FERF is a related organization that performs research on topics of interest to chief finance officers of large companies and other members. The FEI/FERF study is formally titled
Financial Executives International and Financial Executives Research Foundation
Special Survey on Sarbanes-Oxley Section 404 Implementation
(2005) [hereinafter
FEI/FERF Survey
].
165
Criticisms of the SEC’s cost estimate are misplaced for two other reasons The FEI/FERF survey,
see supra
note 166, was of large firms (average revenues of $6 billion, as compared to overall average revenues for all public firms in
Compustat
in 2004 of $2 billion, and median revenues for such firms of $96 million). Since compliance costs generally, and control system costs in particular, increase at a decreasing rate in relation to firm size, $4.4 million would have been too high as an average for all covered firms even in 2004. In addition, the FEI/FERF estimate was based on data that was gathered from companies during their first year under the rule. The costs of any new rule will fall over time, with learning, as has been the case with SOX 404. Further, the agency ultimately charged with supervising section 404(b) work by audit firms, the PCAOB, modified the requirements applicable under that section in 2007, further dramatically reducing the costs of the rule. The upshot is that the best current estimate of section 404 costs is closer to $400,000 than to $4.4 million—still higher than the SEC’s estimate of section 404(a) costs, but reasonably close, once one acknowledges that the $91,000 estimate was for a part and not all of section 404’s costs.
166
See
Coates &
Srinivasan
supra
note 155, at 25
167
See
Management’s Report on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports,
supra
note 165, at pt
V(
B).
168
See
supra
note 166
169
See
infra
text accompanying notes 182-203
170
See
Amendments to Rules Regarding Management’s Report on Internal Control Over Financial Reporting, 72 Fed Reg. 35,310 (June 27, 2007) (codified at 17 C.F.R. pts. 210, 228, 229, 240); Internal Control Over Financial Reporting in Exchange Act Periodic Reports of Non-Accelerated Filers and Newly Public Companies, 71 Fed.
Reg. 76,580 (Dec. 21, 2006) (codified at 17 C.F.R. pts. 210, 228, 229, 240, 249).
171
Section 3(e) of Executive Order 12,866,
supra
note 81, defines the “regulatory action” covered by the order to include “any substantive action by an agency . . that promulgates or is expected to lead to the promulgation of a final rule or regulation,” without regard to whether the final rule adds new restrictions on private activity or exempts private activity covered by a prior regulation. Exec. Order 12,866,
58 Fed.
Reg. 51,735 (Sept. 30, 1993).
172
See
CCMC Report,
supra
note 6
CCMR Report
supra
note 4
173
Throughout this section, I use “fraud” in a loose sense, and mean it to encompass deceptive, manipulative, or misleading accounting and other financial disclosures that could be prevented or corrected in a cost-effective manner, regardless of whether proof of specific intent to deceive, reasonable reliance, or other elements of the tort or crime of fraud exists, and regardless of whether the accounting technically complies with generally accepted accounting principles
174
See
Coates &
Srinivasan
supra
note 155
175
Id
at 46.
Interestingly, the U.S. crime victimization survey does not ask questions that would be likely to elicit data on fraud incidence, instead focusing on violent crime, sexual assaults, and stalking.
See
Census Bureau,
OMB No. 1121-0111, National Crime Victimization Survey: NCVS-1 Basic Screen Questionnaire
U.S. Dep’t Commerce,
[http://perma.cc/Q8BM-N3WU]; Census Bureau,
OMB No. 1121-0302, Supplemental Victimization Survey
U.S. Dep’t Commerce
(2006),
[http://perma.cc/RJ8H-XYUN]. Identity theft and cyber crimes are types of fraud surveyed by the Bureau of Justice Statistics,
see
Erika Harrell & Lynn Langton
, Bureau of Justice Statistics, U.S. Dep’t Justice,
Victims of Identity Theft, 2012,
Dec. 2013),
[http://perma.cc/DDX4-HWPU];
Bureau of Justice Statistics
Cybercrime
U.S. Dep’t Justice,
?ty
=tp&tid=41 [http://perma.cc/9LWR-VJTY], but no general survey of fraud is conducted by the Bureau of Justice Statistics.
176
See
Jonathan S Feinstein,
Detection Controlled Estimation
, 33
J.L. & Econ.
233
, 233-34 (1990).
177
Eg.
Vikramaditya
S.
Khanna
et al.,
CEO Connectedness and Corporate Frauds
J. Fin.
forthcoming
2015),
[http://perma.cc/S3YL-ZKBM]; Si Li, Corporate Financial Fraud: An Application of Detection Controlled Estimation (Sch. of Bus. and Econ.,
Wilfrid
Laurier Univ., Working Paper, July 2013),
[http://perma.cc/WB8G-ZRNZ]; Tracy
Yue
Wang, Corporate Securities Fraud: An Economic Analysis (Carlson Sch. of Mgmt., Univ. of Minn., Working Paper, Apr. 2006),
[http://perma.cc/AW9P-33SF]. Such models have their weaknesses, as they rely in an ad hoc fashion on different instruments that are assumed to be exogenous, when none truly are exogenous; they are, however, the best that researchers have yet devised.
178
IJ. Alexander
Dyck
et al.,
How Pervasive Is Corporate Fraud?
4 (
Rotman
Sch. of Mgmt. Working Paper No. 222608, Feb. 2013),
[http://perma.cc/D7H6-G47F]. They validate this measure with a survey of fraud observed by business school students at former employers.
Id.
at 21-23.
179
For related research, using different and less theoretically grounded empirical methods, see Anastasia K
Zakolyukina
Measuring Intentional GAAP Violations: A Structural Approach
(Univ. of Chicago Booth Sch. of Bus
.,
Working Paper No. 13-45, Apr. 25, 2014),
[http://perma.cc/X4QR-4JSC] which estimates undetected intended earnings manipulation from a sample of 1400 CEOs after SOX. She finds the probability of detection is six percent and that intended earnings manipulation generates a loss of twenty-four percent to a firm’s CEO wealth when detected. The inference she draws is that seventy-three percent of her sample has incentives to manipulate earnings, and that the value-weighted bias in stock prices is 2.82%.
Id.
at 3.
A survey-based study is provided in Ilia
Dichev
et al.,
Earnings Quality: Evidence from the Field
, 56
J. Acct. & Econ
1, 30 (2013), in which respondents suggest around twenty percent of firms exploit GAAP to misrepresent reported performance in their financial statements.
180
Assume, for example, a fraudster obtains $1 from a victim and spends it on food Is the social loss $0 or $1? If the criminal’s utility is ignored and the fraud has no effect besides the transfer of $1, the social loss is $1. If the criminal’s utility is counted equally with the victim’s, and neither attaches unusual utility to the dollar, the social loss is $0.
181
For example, David A Anderson,
The Aggregate Burden of Crime
, 42 J.L. &
Econ.
611, 629 tbl.7 (1999
),
estimates that such gains, if counted, roughly double the costs of crime.
182
OMB Guidance,
supra
note 20
183
Id
184
In the context of crime, compare Philip J Cook,
Crime Statistics: Costs of Crime
in
Encyclopedia of Crime and Justice 373
(Sanford H.
Kadish
et al. eds
.,
1983) (criminals’ utility should count) with
Mark A. Cohen, The Costs of Crime and Justice
(2005) (criminals’ utility should not count), and
The Cost of Crime: Understanding the Financial and Human Impact of Criminal Activity: Hearing Before the S. Comm. on the Judiciary
, 109th Cong. 7 (2006) (statement of Jens Ludwig, Professor, Georgetown Public Policy Institute) (same).
185
Fraud is criminalized in part because it causes large externalities: direct remediable civil damages are not thought to be large enough to provide sufficient incentive for private actors to enforce optimally S.
Shavell
The Judgment Proof Problem
, 6
Int’l Rev. L. & Econ
45 (1986) (tort-
feasors
may be “judgment proof” against large civil sanctions).
But criminal sanctions are reserved for a small subset of frauds—those in which clear evidence is available ex post for frauds caused by individuals with specific intent—and the nature of fraud is such that this type of evidence is often unavailable. Section 24 of the Securities Act of 1933 imposes criminal liability for “willful” violations. Securities Act of 1933,
ch.
38, § 24, 48 Stat. 74 (codified at 15 U.S.C. § 77x (2012));
see also
Securities Exchange Act of 1934, 15 U.S.C. § 78a (2012).
186
Baruch Lev,
Corporate Earnings: Facts and Fiction
, 17
J Econ.
Persp
27, 42-44 (2003).
Anderson,
supra
note 183, at 616-17, 629, presents a similar list of indirect effects of crime generally. He estimates the indirect costs—what he categorizes as “crime-induced production,” opportunity costs, and risks to life and health—as roughly double the value of victim-to-criminal property transfers, and when he counts the costs incurred by criminals, the total costs of crime are more than double the value of those transfers.
Id.
at 629 tbl.7.
In other words, the external effects of crime generally greatly exceed their direct effects.
187
Reduced quality of financial information provided by one firm will in the first instance lower expectations of the quality of information provided by other firms, heighten expected fraud-related losses generally, and reduce confidence in public securities markets and in markets more generally Market-wide liquidity deteriorated following Enron and related scandals, and improved after SOX’s adoption.
Pankaj
K. Jain et al.,
The Sarbanes-Oxley Act of 2002 and Market Liquidity
, 43
Fin
Rev.
361 (2008).
Mariassunta
Giannetti
and Tracy
Yue
Wang show that revelation of corporate frauds in a state caused equity holdings of households in that state to fall, increasing the cost of capital for non-fraudulent firms.
Mariassunta
Giannetti
& Tracy
Yue
Wang,
Corporate Scandals and Household Stock Market Participation
(Eur. Corp. Governance Inst., Finance Working Paper No. 405/2014, 2014),
[http://perma.cc/73LY-VSWS]. For a more general study of the effect of trust on finance, see Luigi
Guiso
et al.,
Trusting the Stock Market
63
J. Fin.
2557 (2008).
See also
Emilia
Bonaccorsi
di Patti,
Weak Institutions and Credit Availability: The Impact of Crime on Bank Loans
(Bank of It., Occasional Paper No. 52, 2009),
[http://perma.cc/84L3-UWXL] (demonstrating that crime, including fraud, increases borrowing costs and increases capital constraints by the public generally).
188
Misallocation is caused by fraudulent signals of the value of firms or whole industries, as in the telecom and Internet bubbles For a review of studies showing that corporate finance decisions are driven by capital market prices, including prices that deviate from fundamental values (that is, mispricing), see Malcolm Baker,
Capital Market-Driven Corporate Finance
, 1
Ann. Rev.
Fin.
Econ
181 (2009).
See also
Malcolm Baker et al.,
When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms
Q. J. Econ.
969 (2003) (modeling and presenting evidence that bubbles affect corporate investment).
Simi
Kedia
and Thomas
Philippon
model investment decisions of firms during periods of fraud and find empirical support for their prediction that fraud and earnings management distort hiring and investment decisions of firms, leading to over-investment and excessive hiring during periods of suspicious accounting; this over-investment and excessive hiring, in turn, lead to misallocation of resources in the economy. Simi
Kedia
& Thomas
Philippon
The Economics of Fraudulent Accounting
, 22
Rev.
Fin
. Stud.
2169 (2009).
189
One can view costly acquisitions by fraudulent companies of other companies as an example of the prior category (misallocated resources), but it is important enough to warrant estimating separately Such acquisitions are often followed by mismanagement or outright theft, contributing to otherwise avoidable bankruptcies. While bankruptcy can reorganize firms, resulting in transfers among investors, they also use up real resources. For a model of merger and acquisition activity driven by mispricing, see Andrei
Shleifer
& Robert W.
Vishny
Stock Market Driven Acquisitions
, 70
J. Fin. Econ.
295 (2003).
For estimates of the costs of bankruptcy, see, for example, Arturo
Bris
et al.,
The Costs of Bankruptcy: Chapter 7 Liquidation Versus Chapter 11 Reorganization
, 61
J. Fin.
1253 (2006), which estimates that the range of firm assets resulting from formal bankruptcy is between two and twenty percent.
190
Such costs include bonding and monitoring by investors to avoid fraud, such as for audit firms, independent directors, appraisers, analysts, regulatory and enforcement agencies, and prisons Audit fees were rising prior to SOX, due to market-driven demand for increased scrutiny of financial statements following the scandals that led to SOX.
Sharad
Asthana
et al.,
The Effect of Enron, Andersen, and Sarbanes-Oxley on the US Market for Audit Services
, 22
Acct. Res. J.
4 (2009). Likewise, separate from SOX, the New York Stock Exchange and the
Nasdaq
adopted tighter corporate governance requirements in response to Enron et al., which tightened the criteria for and likely increased the costs of recruiting independent directors.
See
Coates,
supra
note 156, at 111.
191
These third parties include those dependent on the victims of the initial fraud (eg., family, business partners, creditors, and communities). For studies showing spillover effects of restatements, see Coates &
Srinivasan
supra
note 155, at 51 n.21.
192
While SOX 404 would have had no effect on
Madoff’s
scheme, since he kept his brokerage private and outside the scope of SOX, the findings are suggestive of what might be discovered if the prospect of quantifying such harms to fraud victims more generally were undertaken For the number of investors affected, see Trustee’s Ninth Interim Report for the Period Ending March 31, 2013, exhibit A at 4-5, Sec. Investor Prot. Corp. v. Bernard L.
Madoff
Inv. Sec. (
In re
Bernard L.
Madoff
), No. 08-01789 (
Bankr
. S.D.N.Y. Apr. 30, 2013). For charities harmed by the
Madoff
scandal, see Anthony Weiss & Gabrielle
Birkner
Charities, Day Schools Hard Hit by
Madoff
Scandal
Jewish Daily Forward
(Dec. 17, 2008),
[http://perma.cc/AZ7D-CPRA].
193
See
Trustee’s Ninth Interim Report,
supra
note 194,
exhibit
A at 2
194
Audrey Freshman,
Financial Disaster as a Risk Factor for Posttraumatic Stress Disorder: Internet Survey of Trauma in Victims of the
Madoff
Ponzi
Scheme
, 37
Health & Soc Work
39, 44-47 (2012).
195
Carol Graham et al, The Bigger They Are,
the
Harder They Fall: An Estimate of the Costs of the Crisis in Corporate Governance (The Brookings Inst., Working Paper, 2002),
[http://perma.cc/MK3C-MWDY]
. Another attempt to assess the size of externalities (without quantifying them for society overall) uses brokerage data of a sample of retail investors across the United States and shows that, upon the revelation of fraud in a company in a particular state, all households in the state, not just the ones owning stocks of fraud firms, reduce their equity holdings.
Giannetti
& Wang,
supra
note 189.
196
This is the model described in David
Reifschneider
et al,
Aggregate Disturbances, Monetary Policy, and the
Macroeconomy
: The FRB/US Perspective
, 85
Fed. Res. Bull.
1 (1999
),
sometimes referred to as the “FRB/US” (pronounced “
ferbus
”) model.
See
Div. of Research & Statistics,
Fed. Reserve Bd.
A Guide to FRB/US: A Macroeconomic Model of the United States
(Flint
Brayton
& Peter Tinsley eds
.,
Oct. 1996),
.gov/pubs/feds/1996/199642/199642pap.pdf [http://perma.cc/H6LF-TC2Q].
197
Graham et al,
supra
note 197, at 5.
198
Id
at 6.
199
The sensitivity of estimates of social harms to assumptions in similar macroeconomic models is discussed more in connection with the Basel III rules in Part IIIC,
infra
200
For overviews, see John J Donohue III,
Assessing the Relative Benefits of Incarceration
Overall Changes and the Benefits on the Margin
in
Do Prisons Make Us Safer? The Benefits and Costs of The Prison Boom 269, 270-341
(Steven Raphael & Michael A. Stoll eds
.,
2009); and Jens Ludwig,
The Costs of Crime
, 9
Criminology & Pub.
Pol’y
307, 307-11 (2010).
201
See
John P
Hoehn
et al.,
A Hedonic Model of Interregional Wages, Rents and Amenity Values
, 27
J. Regional Sci
. 605 (1987); Richard
Thaler
A Note on the Value of Crime Control: Evidence from the Property Market
, 5
J.
Urb
. Econ
137 (1978).
202
See
Mark A Cohen et al.,
Willingness-to-Pay for Crime Control Programs
42
Criminology
89
(2004); Daniel S.
Nagin
et al.,
Public Preferences for Rehabilitation Versus Incarceration of Juvenile Offenders: Evidence from a Contingent Valuation Survey
, 5
Criminology & Pub.
Pol’y
627 (2006).
203
See
Anderson,
supra
note 183, at 616-29
204
See
Simon Moore & Jonathan P Shepherd,
The Cost of Fear: Shadow Pricing the Intangible Costs of Crime
, 38
Applied Econ.
293 (2006).
205
These methods are probably best used in combination, as described in Donohue,
supra
note 202, at 321 (“Instead of trying to resolve these normative questions, this chapter illustrates their importance by presenting various estimates of the cost of crime based on different assumptions The effort to highlight the underlying assumptions and methodologies will enable readers to implement their own normative choices in conducting cost-benefit analyses of incarceration.”).
206
Peter A Diamond & Jerry A.
Hausman
Contingent Valuation: Is Some Number Better than No Number
J. Econ.
Persp
45, 63 (1994) (concluding that “survey responses [in contingent valuation surveys] are not satisfactory bases for policy” because they are internally inconsistent, unreliable and biased by such factors as the “warm glow” from answering questions in particular ways);
see also
John
Bronsteen
et al.,
Well-Being Analysis vs. Cost-Benefit Analysis
, 62
Duke L.J
. 1603 (2013) (advocating use of hedonic surveys as more reliable than willingness-to-pay surveys, which are conventionally used in CBA in the non-financial regulatory context).
207
See
Coates &
Srinivasan
supra
note 155, at 17
208
See, eg.
, Ehud
Kamar
et al.,
Going-Private Decisions and the Sarbanes-Oxley Act of 2002: A Cross-Country Analysis
, 25
J.L. Econ. & Org.
107 (2009) (studying whether SOX drove firms out of the public capital market)
; see
also
Coates &
Srinivasan
supra
note 155, at 55 (touting difference-in-difference studies).
209
This seems to have been true in some of the earliest studies of the effects of SOX, which found differences in US. firms after SOX compared to Canadian or U.K. firms. For a selection of these studies, see Coates &
Srinivasan
supra
note 155, at 29-31. Those differences, however, either started well before SOX, or affected U.S. firms not subject to SOX as much as they did U.S. firms subject to SOX, such that no consensus has emerged as to whether SOX had the studied effects.
Id.
210
See the studies reviewed in Coates and
Srinivasan
supra
note 155, at 27, 30, 56
211
One could imagine a law like SOX 404 applying to all firms with a past (and so not easily manipulated) market capitalization of between $75 million and $100 million, or between $100 million and $125 million, or between $150 million and $175 million, and so on all the way through the full distribution of market capitalizations Needless to say, even though it may be the only way to derive reliable estimates of the aggregate social costs and benefits of the rule,
sch
a novel regulatory design would likely generate protest from covered companies, who would rightly complain that they compete with the exempt companies in the product, labor, and capital markets and that they were being potentially disadvantaged by any regulatory costs the rule might impose.
212
Peter
Iliev
The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices
, 65
Fin
1163 (2010).
213
Coates &
Srinivasan
supra
note
153
214
Stefan
Arping
& Zacharias
Sautner
Did SOX Section 404 Make Firms Less Opaque?
Evidence from Cross-Listed Firms
, 30
Contemp Acct. Res.
1133 (2013); Christian
Leuz
et al.,
Why Do Firms Go Dark?
Causes and Economic Consequences of Voluntary SEC
Deregistrations
, 45
J. Acct. & Econ.
181 (2008).
215
At first pass, it might seem that the dual effects of this choice on both costs and benefits would cancel out as long as the choices were consistent, but in fact that would require a further debatable assumption—that is, that the functional relationship between actual legal compliance on the rule’s effects is the same for both costs and benefits That assumption seems at least possibly mistaken, because (for example) the extra costs from assuming a realistic baseline should be larger for larger companies, but they should increase at a decreasing rate in relation to firm size. On the other hand, the extra benefits might not follow that pattern, and in fact might increase at an increasing rate, if (for example) large firm frauds (as at Enron) have externalities that are not only larger than externalities of smaller firms, but also larger by a multiple greater than one due to informational cascades and threshold effects in how the media report on frauds.
216
Another open issue for CBA/FR is whether to use a national or supranational unit of analysis for purposes of estimating welfare effects If, for example, SOX 404 prevented fraud by U.S.-listed but foreign-based companies that harms foreign investors, should that count as a social gain? What if, as some studies suggest,
e.g.
, Coates &
Srinivasan
supra
note 155, SOX 404 reduced cross-listings in the U.S. of foreign firms but with an effect that was concentrated among the most fraud-prone firms? If the result was to shift sales of stock by fraud-prone companies from the U.S. to other countries but not to reduce the total amount of fraud, should that count as a “benefit” for CBA/FR purposes under U.S. law? A similar unresolved issue concerns the costs of the rule: if the shift of firms from the U.S. to foreign stock markets harmed the New York economy but benefited the London or Hong Kong economies, should the losses count in a CBA/FR of the rule? The authors of the CCMR report seem to think such losses to the U.S. economy should count as “costs” under CBA.
CCMR Report
supra
note 4, at 10 (criticizing the SEC for not attempting to measure whether new rules “would . . . deter foreign companies from tapping U.S. capital markets”). But that report does not defend the position and does not take the correlative position that an increase in larger company cross-listings (for example, by lowering the cost of capital relative to foreign jurisdictions by reducing information asymmetries) should count as a benefit (and if a benefit, whether it should be a gross benefit to the United States or net of lower benefits to the issuers’ home countries). Neither the CFTC’s nor the SEC’s governing statutes specify the United States as the governing unit when commanding those agencies to consider “costs and benefits” or “efficiency,” respectively.
See
sources cited
supra
note 6.
217
See Harrington et al,
supra
note 34, for evidence of this outside the financial context.
218
See
FEI/FERF Survey
supra
note 166
219
See
Coates &
Srinivasan
supra
note 155, at 25-29
220
SOX 404, for example, generates higher costs for larger firms, as well as for firms with less centralized decision making and more dispersed or fragmented assets
Id.
To some extent, the RFA and analyses thereunder have produced useful methods of breaking down costs by firm size, but some of the more important differences may have less to do with size and more to do with industry, complexity, or geographic dispersion.
221
Office of Chief Accountant,
Study and Recommendations on Sections 404(b) of the Sarbanes-Oxley Act of 2002 for Issuers with Public Float Between $75 and $250 Million
Sec & Exch. Commission
2011) [hereinafter SEC,
Study and Recommendations
],
/news/studies/2011/404bfloat-study.pdf
[http://perma.cc/L5P7-PSHX]; Office of Econ. Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64.
222
See
Leonce
Bargeron
et al.,
Sarbanes-Oxley and Corporate Risk-Taking
, 49
J. Acct. & Econ.
34 (2010) (finding reduced risk-taking by U.S. companies subject to SOX compared to non-U.S. companies not subject to SOX).
But see
Ana M. Albuquerque & Julie L. Zhu,
Has Section 404 of the Sarbanes-Oxley Act Discouraged Corporate Risk-Taking? New Evidence from a Natural Experiment
Bos
. Univ. Sch. of Mgmt. Research Paper Series, Working Paper No. 2013-6, 2013),
[http://perma.cc/J88G-TTN9] (finding a trend towards reduced risk-taking by U.S. companies prior to SOX).
223
The cost estimates range from more than $44 million per year on average (firms with an average of $6 billion in revenues in 2004, based on a FEI/FERF survey) to $350,000 (firms with market capitalizations under $10 billion in 2012, based on a GAO survey).
See
FEI/FERF Survey,
supra
note 166;
U.S. Gov’t Accountability Office
, GAO-13-582,
Internal Controls: SEC Should Consider Requiring Companies To Disclose Whether They Obtained an Auditor Attestation 23
(2013).
224
For one economist’s highly skeptical assessment of IAMs in the environmental context, see Robert S
Pindyck
Climate Change Policy: What Do the Models Tell Us
51
J. Econ. Lit.
860 (2013).
Pindyck
calls for environmental policymaking to be informed by research, including empirical research, but ultimately based not on IAMs or guesstimated CBA but on “simpler” policy approaches that use a “plausible” range of outcomes and probabilities, where “plausible” is what is acceptable to a range of economists and subject matter experts (in his analysis, climate scientists).
Id.
at 869-70.
225
PV=C/R
, where
PV
is the present value,
is the annual cost, and
is the discount rate
226
This is a rough range of per-year, per-firm direct cost estimates reflected in the SEC’s comprehensive survey of such costs in 2007 and 2008
See
Office of Econ. Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64, at 46 tbl.9 (2009). The estimates were reduced by an arbitrary thirty percent to reflect increases that would have occurred without SOX, due to market pressures reacting to Enron and related scandals.
227
The Office of Management and Budget suggests these discount rates OMB Guidance,
supra
note 20, at 18. Whether they are appropriate at all, or for assessing financial regulation, is unclear.
See
Martin L. Weitzman,
Tail-Hedge Discounting and the Social Cost of Carbon
, 51
J. Econ. Lit.
873 (2013) (critiquing the current discount rate of three percent recommended by OMB and suggesting one percent instead, based on current yields on U.S. Treasuries).
If a discount rate of one percent were used instead of three percent, the sensitivity to the net costs and benefits reported in Table 3 below for discount rates would increase by another 852%. One can also argue for discount rates higher than seven percent, depending on what time period one uses to average returns on equity investments. As discussed in Part III.C, two further discount rates (2.5% and 5%) are used by the Bank for International Settlements in its CBA/FR of the Basel III capital rules discussed below, and yet another (3.5%) is used by the FSA in its CBA/FR of the mortgage reforms discussed in Part III.E below. That six different discount rates (1%, 2.5%, 3%, 3.5%, 5%, 7%) are plausible is itself a source of concern about CBA/FR.
228
See
Office of Econ Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64, at 27 tbl.1 (showing 2205 companies subject to 404(b) that did not answer the survey and 2081 companies subject to 404(b) that did answer the survey, totaling 4286, grossed up to 4400 to reflect growth in the number of listed companies since 2009).
229
See supra
text accompanying
note 180
230
This range is roughly equivalent at the high end to reductions in the shares of US. public companies that were meeting or just beating analyst estimates in the post-SOX period, with the low end being motivated by the likelihood that SOX’s effects on fraud are diminishing over time and/or caused by changes other than SOX 404.
Eli
Bartov
& Daniel A. Cohen,
The “Numbers Game” in the Pre- and Post-Sarbanes-Oxley Eras
, 24
J. Acct. Auditing & Fin.
505, 517 fig.2 (2009).
231
This range extends from 50% to 200% of the point estimate of the relationship between transfers and externalities of crime from
Anderson,
supra
note 183, at 629 tbl7.
232
SEC,
Study and Recommendations
supra
note 223, at
53-55
; Office of Econ
Analysis,
Study of the Sarbanes-Oxley Act
supra
note 64.
233
Another method for estimating the net costs and benefits of a financial regulation is the “event study,” which examines market reactions to events leading up to a regulation’s enactment One estimate of the negative effects of SOX overall, based on stock market reactions to events leading to its passage, was roughly -0.07% of the U.S. equity market capitalization. Ivy
Xiying
Zhang,
Economic Consequences of the Sarbanes-Oxley Act of 2002
44 J. Acct. & Econ
74, 92 tbl.2 (2007).
That represented a net effect of more than negative $980 billion, based on U.S. equity market capitalization in 2003 (when SOX § 404 was adopted) of roughly $14 trillion.
Market Capitalization of Listed Companies
World Bank
[http://perma.cc/8FYT-9CNM]. By contrast, other studies of the stock market reaction to SOX produced results ranging from positive $420 billion to $1.7 trillion.
Aigbe
Akhigbe
& Anna D. Martin,
Valuation Impact of Sarbanes-Oxley: Evidence from Disclosure and Governance Within the Financial Services Industry
, 30
J. Banking & Fin. 989
(2006);
Pankaj
K.
Jain &
Zabihollah
Rezaee
The Sarbanes-Oxley Act of 2002 and Capital-Market Behavior: Early Evidence
23 Contemp. Acct. Res
629
(2006)
Haidan
Li et al.,
Market Reaction to Events Surrounding the Sarbanes-Oxley Act of 2002
and Earnings Management
51 J.L. & Econ.
111
(2008).
The studies were
published in peer-reviewed journals, and they included plausible cross-sectional tests of the validity of the estimates. For example, each contrasted differing market reactions to firms that theory would predict to be more or less benefited or harmed by SOX and found results consistent with at least some of those theories.
234
Fidelity turned out not to be a target of the investigations, but Spitzer did not let that get in the way of a dramatic moment
235
2006 Performance and Accountability Report
Sec & Exch.
Comm’n
23 (2006),
[http://perma.cc/A474-TGZ4] (noting that “fair funds” were established pursuant to SEC enforcement actions concerning market timing and late trading); John C. Coates IV,
Reforming the Taxation and Regulation of Mutual Funds: A Comparative Legal and Economic Analysis
1 J. Legal Analysis
591, 592-93 & n.3 (2009). I served as an independent distribution consultant in connection with one of the Fair Funds created as a result of the SEC’s investigations of the fund industry that came in the wake of Spitzer’s announcement.
See
Order Approving Modified Distribution Plan, Mass. Fin.
Servs
. Co., S.E.C. 56122 (2007),
-56122.pdf [http://perma.cc/G36G-JK3F].
236
See, eg.
, Complaint at
¶¶
9, 20, New York v. Canary Capital Partners, LLC, No. 2003-402830, 2003 WL 25691660 (N.Y. Sup. Ct. Sept. 3, 2003),
/default/files/press-releases/archived/canary_complaint.pdf [http://perma.cc/9GLR-VXG8] (alleging that Bank of America agreed to let a hedge fund place illegal late trades in return for keeping investments in funds sponsored by Bank of America). For a good analysis of the market reaction to the revelation of the scandals, see Stephen Choi & Marcel
Kahan
The Market Penalty for Mutual Fund Scandals
, 87
B.U. L. Rev.
1021 (2007).
237
Various sections of the ICA govern conflict of interest transactions
See, e.g.
, Investment Company Act of 1940, Pub. L. No. 76-768, § 17, 54 Stat. 815 (codified as amended at 15 U.S.C. § 80a-17 (2012)) (banning purchases, sales, borrowing, and loans to or from a fund by “any affiliated person”). The exemptions adopted by the SEC under the ICA are numerous and collected at Investment Company Governance, 69 Fed.
Reg. 46,378, 46,379 n.9 (Aug. 2, 2004) (to be codified at 17 C.F.R. pt. 270).
238
Investment Company Governance, 69 Fed
Reg. at 46,582-82.
The SEC also added requirements for fund boards to perform self-assessments at least annually, hold executive sessions for independent directors at least quarterly, and give independent directors authority to hire their own staff.
Id
. at 46,381.
None of these requirements were the focus of subsequent litigation, although each plausibly contributes to both the overall benefits and overall costs of the combined package of conditions, by enhancing the power of independent directors, for both good and ill.
239
Amy
Borrus
& Paula Dwyer,
Who’s Right, the SEC or Ned Johnson
Bloomberg
Businessweek
, June 27, 2004,
-the-sec-or-ned-johnson [http://perma.cc/9YVJ-76ED].
240
See
Letter from Eric D Router, Senior Vice President and Gen. Counsel, Fidelity Mgmt. & Research Co. to Jonathan G. Katz,
Sec’y
, U.S. Sec. & Exch.
Comm’n
(Mar. 18, 2004),
[http://perma.cc/UF86-8JGK].
241
Investment Company Governance, 69 Fed
Reg. at 46,386-87 (applying cost-benefit analysis);
id.
at
46,381-86 (discussing conditions, including qualitative assessment of benefits).
242
Id
at 46,386.
243
Id
at 46,380.
244
The SEC noted that “[
e]
ven
accepted at face value, Fidelity’s data constitute muddy and unpersuasive evidence for continuing to allow senior management company officials to sit in the fund chairman’s chair”
Id.
at 46,383 n.52 (citing John C.
Bogle
, Founder and Former CEO, Vanguard Group, Remarks Before the Institutional Investor Magazine Mutual Fund Regulation and Compliance Conference (May 5, 2004)).
245
As noted by Sherwin, this rider was first introduced in S 2908, 108th Cong. (2004), by Senator Gregg on September 15, 2004, and was later incorporated into H.R. 4818, 108th Cong. (2004), the version of the spending bill passed into law, during the House-Senate conference. Sherwin,
supra
note
15
, at 27 n.159. For Fidelity’s role, see Carrie Johnson,
Trade Groups,
Firms
Push to Ease Tough Federal Scrutiny
Wash.
Post
, Jan. 3, 2005,
].
246
412 F3d 133, 144 (D.C. Cir. 2005).
247
Chamber of Commerce v SEC, 443 F.3d 890 (D.C. Cir. 2006).
248
The SEC’s Chief Economist was Chester S
Spatt
, who had been a Professor of Finance at Carnegie-Mellon.
249
See
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir. from Chester
Spatt
, Chief Economist, Sec. & Exch.
Comm’n
, to the Inv. Co. File S7-03-04 (Dec. 29, 2006),
[http://perma.cc/XF8H-FXYE]; OEA Memorandum re: Power Study as Related to
Indep
Mut
. Fund Chairs from Chester S.
Spatt
, Chief Economist, Sec. & Exch.
Comm’n
, to the Inv. Co. Governance File S7-03-04 (Dec. 29, 2006),
[http://perma.cc/4PXD-F42K].
250
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir.,
supra
note
249
, at 1. While the Chief Economist did not spell out the point, “structural model” here presumably refers to a model in which potential causal relationships among exogenous and endogenous variables needed to measure fund value or fund performance are specified—in other words, a theoretical model of fund value or performance.
See, e.g.
, Peter C. Reiss & Frank A.
Wolak
Structural Econometric Modeling: Rationales and Examples from Industrial Organization
in
6A Handbook of Econometrics
4277, 4363 (James J. Heckman & Edward E.
Leamer
eds
.,
2007) (contrasting structural models with non-structural “descriptive” empirical models). Most empirical corporate governance research, including research relevant to mutual funds, remains closer to the “descriptive” than to the “structural.”
251
OEA Memorandum re: Literature Review on
Indep
Mutual Funds and Dir.,
supra
note
249
, at 2.
252
Eg.
Sanjai
Bhagat
& Bernard Black,
The Non-Correlation Between Board Independence and Long-Term Firm Performance
, 27
J. Corp. L.
231 (2002); Benjamin E.
Hermalin
& Michael S.
Weisbach
The Effects of Board Composition and Direct Incentives on Firm Performance
, 20
Fin. Mgmt
. 101 (1991); Eugene Kang &
Asghar
Zardkoohi
Board Leadership Structure and Firm Performance
, 13
Corp. Gov.: Int’l Rev
. 785 (2005); April Klein,
Firm Performance and Board Committee Structure
, 41
J.L. & Econ.
275 (1998); Hamid
Mehran
Executive Compensation Structure, Ownership, and Firm Performance
, 38
J.
Fin
. Econ
163 (1995); M.
Babajide
Wintoki
et al.,
Endogeneity
and the Dynamics of Internal Corporate Governance
, 105
J. Fin.
Econ
581 (2012).
253
Eg.
Sanjai
Bhagat
& Richard H.
Jefferis
, Jr., The Econometrics of Corporate Governance Studies
(2002); Michael R. Roberts & Toni M. Whited,
Endogeneity
in Empirical Corporate Finance
in
Handbook of the Economics of Finance 493
(George M.
Constantinides
et al. eds
.,
2013);
Yair
Listokin
Interpreting Empirical Estimates of the Effect of Corporate Governance
, 10
Am.
L. & Econ.
Rev.
90 (2008).
This does not mean empirical studies of governance are useless. Such studies are essential sources of descriptive information about important organizations, without which neither social scientists nor practitioners can hope to understand them at all. For example, the fact of the extent and generality of variation in governance’s fine details emerged only from such studies. Such studies can provide partial, weak, and provisional evidence about the effects of governance arrangements, and when replicated with sufficient frequency in a variety of settings by a variety of researchers, they may allow tentative inferences to augment raw experience-based judgment in tentative evaluations. They can reject certain theories about governance, prompt refinements in theory, and provide a basis for more serious experimentation. At least over short time frames, they can allow for useful out-of-sample predictions even without reliable proof of causal mechanisms.
254
Compare, for example, the effect of financial collapse (as in 2008), accounting scandals (as in 2002), a market crash (as in 1987 and 1989), or war (shooting or trade), pandemic, or drought
255
Thus, as with SOX, a valid criticism of the SEC’s CBA/FR is that the SEC failed to adequately explain why quantitative analysis was not feasible, and that it failed to present an adequate conceptual CBA/FR—not, as argued by others, that it failed to conduct adequate quantitative analysis
See
e.g.
, Chamber of Commerce v. SEC, 412 F.3d 133, 144 (D.C. Cir. 2005);
CCMR Report
supra
note
, at 9; Edward Sherwin, The Cost-Benefit Analysis of Financial Regulation: What the SEC Ignores in the Rulemaking Process, Why It Matters, and What To Do About It 53, 65 (Working Paper, 2005),
[http://perma.cc/7TWL-8GNR]. For example, the SEC never noted in its rule release that heightened independence requirements could result in less informed and more cumbersome boards or divisiveness and conflict on boards, undermine board culture, and dilute the effectiveness of board decision making.
Investment Company Governance, 69 Fed.
Reg. at 46,386-87.
These costs seem likely to swamp the short-term compliance costs on which the SEC, the D.C. Circuit, and commentators have focused.
See
Letter from John C. Coates IV, Professor of Law and Econ
.,
to Nancy M. Morris,
Sec’y
, Sec. & Exch.
Comm’n
(Mar. 1, 2007),
[http://perma.cc/8R5X-F38D] (discussing the costs of an independent board chair).
256
Chamber of Commerce v SEC, 443 F.3d 890 (D.C. Cir. 2006) (nowhere discussing these costs); Chamber of Commerce v. SEC, 412 F.3d 133 (D.C. Cir. 2005) (same);
CCMR Report
supra
note
, at 4; CCMC
Report,
supra
note
at 29-30; Sherwin,
supra
note
15
, at 32-33.
257
See
Letter from John C Coates IV
supra
note
255
258
I also argued that “[
]f
[CBA/FR] is to assist the regulatory process, the minimum one would expect before adding regulations is at least some economic evidence that the regulations will provide some benefit”
Id.
at 2
I continue to hold that view. But a desire for “evidence” is not the same as a mandate to conduct
quantified
CBA/FR. One can believe financial regulations aimed at improving or constraining governance are not susceptible to quantified CBA/FR without giving up on the goal of obtaining “evidence” that can inform consideration of the rules and their alternatives. Evidence is commonly adduced in court and in other contexts that do not admit of quantification, reliable causal inference, or anything approaching “science.”
259
Cf
Robert A.
Kagan
Adversarial Legalism and American Government
in
The New Politics of Public Policy
88 (Marc K.
Landy
& Martin A. Levin eds
.,
1995) (litigation drains agency resources, causing agencies to alter their behavior in an effort to avoid it).
260
Letter from Warren Buffett, Chairman, Berkshire Hathaway Inc, to Shareholders (Feb. 28, 2002),
[http://perma.cc/S7WA-BH85].
261
See
Capital Purchase Program: Program Purpose and Overview
US. Dep’t of Treasury
(Jan. 15, 2014, 3:10 PM),
[http://perma.cc/YY5Y-M5RN].
262
Wells Fargo’s then-CEO has criticized what he viewed as US. government efforts to pressure his company to accept a bailout under the Emergency Economic Stabilization Act (also known as the Troubled Asset Relief Program), and Wells Fargo repaid the investment as soon as it was permitted under the terms of the investment. Mark
Calvey
Former Wells Fargo CEO Dick
Kovacevich
Blasts TARP: An
Unmitigated Disaster
S.F. Bus. Times
, June 13, 2012,
[http://perma.cc/86D4-5NW4];
Wells’ TARP Plan Brings End to Bailout Era
N.Y. Times:
DealBook
(Dec. 14, 2009, 6:33 PM),
[http://perma.cc/ZMA2-N7VD]. However, Wells Fargo was found to need more capital in the course of the “stress tests” conducted during the crisis, in circumstances in which not all banks were required to raise capital. Wells Fargo & Co., Annual Report (Form 10-K) 8 (Feb. 26, 2010),
[http://perma.cc/YW49-8TJE] (“[
I]n
2009, the [Federal Reserve] conducted a test under the [Supervisory Capital Assessment Program, i.e., the stress test program] to forecast capital levels . . . in an adverse economic scenario. Following . . . that stress test, the [Federal Reserve] required [Wells Fargo] to generate a $13.7 billion regulatory capital buffer . .
. .
[Wells Fargo] exceeded this requirement through an $8.6 billion . . . common stock offering . .
. .
”).
263
See
Brett W
Fawley
& Christopher J. Neely,
Four Stories of Quantitative Easing
, 95
Fed. Reserve Bank St. Louis Rev
. 51 (2013),
/Fawley.pdf [http://perma.cc/EV39-BRNT].
264
See
Jennifer G Hill,
Why Did Australia Fare So Well in the Global Financial Crisis
in
The Regulatory Aftermath of the Global Financial Crisis
203, 287 (
Eilís
Ferran
et al. eds., 2012) (reporting that no bailouts occurred in Australia or Canada, and noting that “[b]
etween
2003 and 2005, [Australia’s financial services regulator] created a new regulatory framework, which was focused on close supervision, effective risk management, governance, and strong, well-enforced, capital adequacy rules”); Michael D.
Bordo
et al.,
Why Didn’t Canada Have A Banking Crisis in 2008 (or in 1930, or 1907, or . . . )?
25 (Nat’l Bureau of Econ. Research, Working Paper No. 17312, 2011),
[http://perma.cc/ZYUs-CMTD] (“Canadian regulation under OSFI proved tougher than in the United States, mandating higher capital requirements, lower leverage, less securitization, the curtailment of off balance sheet vehicles, and restricting the assets that banks could purchase.”).
265
See
Andrea
Beltratti
& René M
Stulz
The Credit Crisis Around the Globe: Why Did Some Banks Perform Better
105
J. Fin. Econ
1, 8-10 (2012).
266
See
Basel Committee on Banking Supervision
Bank for Int’l Settlements
[http://perma.cc/7YUX-FQPA].
267
The Federal Reserve supervises systemically important financial institutions and other bank and financial holding companies, as well as state banks that are members of the Federal Reserve System (FRS) The OCC supervises national banks and federal thrifts. The FDIC supervises state FDIC-insured banks that are not members of the FRS and has back-up authority over other insured banks.
See
Edward V. Murphy, Cong. Research Serv., R43087, Who Regulates Whom and How?
An Overview of U.S. Financial Regulatory Policy for Banking and Securities Markets
13, 16 (2013).
268
See Basel Committee Membership
Bank for Int’l Settlements
[http://perma.cc/69B3-76LZ].
269
Basel Comm on Banking Supervision,
Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems
Bank for Int’l Settlements
1 (June 2011),
[http://perma.cc/7D9U-YM8F].
270
See
Basel Comm on Banking Supervision,
Basel III: The Liquidity Coverage Ratio and Liquidity Risk Monitoring Tools
Bank
for Int’l Settlements
paras
1-3
, at 1 (Jan. 2013),
[http://perma.cc/DU8G-YDLM].
The new requirements include a liquidity coverage ratio, which requires banks to have enough high quality liquid resources to survive an acute stress scenario lasting for one month, and a net stable funding ratio, designed to address liquidity risk by creating incentives for banks to rely on funding with maturities of a year or longer.
Id
paras
14-17, at 4.
In general terms, liquidity is the amount of cash or other assets readily convertible to cash on a timely basis, to meet withdrawal demands or other cash requirements. The Basel Committee also circulated an earlier discussion paper related to liquidity.
See
Basel Comm. on Banking Supervision,
Basel III: International Framework for Liquidity Risk Measurement, Standards and Monitoring
Bank for Int’l Settlements
(Dec. 2010),
[http://perma.cc/6J2Y-64BE].
271
Under prior capital rules, securitized assets with high credit ratings were given a low risk weighting and so required less capital than other kinds of assets
See
Basel Comm. on Banking Supervision,
Revisions to the Basel
Securitisation
Framework
Bank for Int’l Settlements
4 (Dec. 2012),
[http://perma.cc/QF6Z-RBCL] (“The recent financial crisis revealed that external credit ratings often did not adequately reflect the risk of certain structured finance asset classes, such as mortgage backed securities, including but not limited to
resecuritisation
exposures.”).
272
See
Basel Comm on Banking Supervision,
Basel III Counterparty Credit Risk and Exposures to Central Counterparties - Frequently Asked Questions
Bank for Int’l Settlements
(Dec. 2012),
[http://perma.cc/9329-V35D]; Basel Comm. on Banking Supervision,
Basel Committee on Banking Supervision Reforms - Basel III
Bank for Int’l Settlements
[http://perma.cc/D6KL-V4A7]; Basel Comm. on Banking Supervision,
Global Systemically Important Banks: Assessment Methodology and the Additional Loss Absorbency Requirement
Bank for Int’l Settlements
(July 2011),
[http://perma.cc/TQH2-UCXP].
273
See
Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-Weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 78 Fed Reg. 62,018, 62,023 (Oct. 11, 2013) (to be codified at 12 C.F.R. pts. 208, 217, 225) (final rule, consolidating three proposed rules, and noting that there were over 2,500 comments for these proposed rules); Liquidity Coverage Ratio: Liquidity Risk Measurement, Standards and Monitoring, 78 Fed. Reg. 71,818 (proposed Nov. 29, 2013) (to be codified at 12 C.F.R. pt. 249); Regulatory Capital Rules: Advanced Approaches Risk-Based Capital Rule; Market Risk Capital Rule, 77 Fed. Reg. 52,978 (proposed Aug. 30, 2012) (to be codified at 12 C.F.R. pts. 3, 217, 324); Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy, Transition Provisions, and Prompt Corrective Action, 77 Fed. Reg. 52,792 (proposed Aug. 30, 2012) (to be codified at 12 C.F.R. pts. 208, 217, 225); Regulatory Capital Rules: Standardized Approach for Risk-Weighted Assets; Market Discipline and Disclosure Requirements, 77 Fed.
Reg. 52,888 (proposed Aug. 30, 2012) (to be codified at 12 C.F.R. pt. 217).
274
Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-Weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 78 Fed
Reg. at 62,024.
275
See
Basel Comm on Banking Supervision,
An Assessment of the Long-Term Economic Impact of Stronger Capital and Liquidity Requirements
Bank for Int’l Settlements (
Aug.
2010)
[hereinafter BCBS 173],
[http://perma.cc/JL5H-4PU6] (estimating both costs and benefits of higher capital requirements); Macroeconomic Assessment
Grp
.,
Final Report: Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements
Bank for Int’l Settlements (
Dec.
2010),
[http://perma.cc/FZ45-39XB] (estimating the effects of higher capital requirements).
276
Basel Comm on Banking Supervision,
Results of the Comprehensive Quantitative Impact Study
Bank for Int’l Settlements 1, 4 (
Dec.
2010),
[http://perma.cc/BY4F-QSE8]. The Basel Committee compiled those inputs and analyzed the results in a “quantitative impact study,”
id
and the results are reflected in the Committee’s final CBA/FR, Macroeconomic Assessment
Grp
.,
supra
note
275
. This consultation was confidential, at both agency and bank levels, and individual bank or national regulator inputs to the Basel Committee process are not available to the public.
Id.
277
The FSA was required to conduct CBA/FR
See supra
text accompanying note
81
278
Ray
Barrell
et al,
Optimal Regulation of Bank Capital and Liquidity: How To Calibrate New International Standards
Fin. Services Authority
(Occasional Paper Series No. 38, July 2009) [hereinafter FSA 38], [http://www.fsa.gov.uk/pubs/occpapers/op38.pdf [http://perma.cc/G7JM-2ZTH]; Sebastian de-Ramon et al.,
Measuring the Impact of Prudential Policy on the
Macroeconomy
: A Practical Application to Basel III and Other Responses to the Financial Crisis
Fin.
Servs
Auth.
(Occasional Paper Series No. 42, May 2012) [hereinafter FSA 42],
].
279
Eric Posner & E Glen
Weyl
Benefit-Cost Analysis for Financial Regulation
, 103
Am
. Econ.
Rev.
, May 2013, at 393, 394 (citing
Carmen M. Reinhart & Kenneth S.
Rogoff
, This Time is Different: Eight Centuries of Financial Folly
(2009)).
280
Andrew G Haldane, Exec.
Dir., Fin.
Stability, Bank of Eng., Address at the Institute of Regulation & Risk in Hong Kong: The $100 Billion Question (Mar. 30, 2010),
[http://perma.cc/9SEQ-9KYK]; FSA 42,
supra
note 280, at 63 tbl.7;
Meilan
Yan et al., A Cost-Benefit Analysis of Basel III: Some Evidence from the UK 26 tbl.10 (Working Paper, Aug. 20, 2011),
[http://perma.cc/UAD5-64BB].
281
This date is from
Reinhart &
Rogoff
supra
note
279
, at 230 fig14.4. Posner and
Weyl
do not provide details on which of Reinhart and
Rogoff’s
estimates they used; in some of the latter’s datasets, for example,
id
at
295 app.A.1, they list datasets on crises dating back to 1800 or even 1258. I assume few would use data from the thirteenth century in modern CBA/FR.
282
See infra
Part IVA.1.
283
That a crisis could have zero social cost disconcerted the authors of BCBS
173,
supra
note
275
, who found the result driven by “definitions of what constitutes a systemic banking crisis For example, some studies assume that Canada had a banking crisis in 1983. While two small banks failed, experts at the Bank of Canada do not consider this event a systemic banking crisis. Unsurprisingly, most studies find zero output costs for this crisis.”
Id.
at 36 (citation omitted).
284
John H Boyd et al.,
The Real Output Losses Associated with Modern Banking Crises
, 37
J. Money, Credit & Banking
977, 978, 994 tbl.7 (2005).
285
BCBS 173,
supra
note
275
, at 34
286
Id
at 11.
287
Id
at 35 & tbl.A1.1.
288
Id
289
One prominent study asserts that the definitions used in it and in other cross-country studies are “qualitative” Glenn
Hoggarth
et al
.,
Costs of Banking System Instability: Some Empirical Evidence
, 26
J. Banking & Fin.
825, 829 (2002).
290
See, eg.
, Michael
Bordo
et al.,
Is the Crisis Problem Growing More Severe
16
Econ.
Pol’y
53, 55 (2001).
291
See, eg.
Reinhart &
Rogoff
supra
note
279
, at 8-11
FSA 38,
supra
note
278
, at 12.
292
See, eg.
Reinhart &
Rogoff
supra
note
279
, at 8-11;
Bordo
et al.,
supra
note
290
, at 55; FSA 38,
supra
note
278
, at 12.
293
See, eg.
Bordo
et al.,
supra
note
290
, at 55
FSA 38,
supra
note
278
, at 12.
294
See, eg.
, Boyd et al.,
supra
note
284
, at 980-81.
295
See, eg.
, FSA 38,
supra
note
278
, at 12.
296
See, eg.
Bordo
et al.,
supra
note
290
, at 55.
297
As the FSA noted, the use of binary crisis dummies (as is typical in the studies reviewed here) “inevitably mean[s] that the start and end dates are ambiguous” FSA 38,
supra
note
278
, at 12. The use of annual dummies allows for up to twenty-two months of variance in actual duration without affecting the data used (eleven months for the start date, eleven months for the end date), and, “[
s]
ince
the end-dates are to some extent subjectively chosen[,] there are potential
endogeneity
problems with estimation: the explanatory variables will be affected by ongoing crises.”
Id.
298
Eg.
Bordo
et al.,
supra
note
290
, at 68 tbl.3.
299
Boyd et al,
supra
note
284
, at 980 (comparing their choice of twenty-three crises with 160 “or so” identified by Gerard
Caprio
, Jr. & Daniela
Klingebiel
Bank Insolvency: Bad Luck, Bad Policy, or Bad Banking
in
Annual World Bank Conference on Development Economics
(Michael Bruno & Boris
Pleskovic
eds., 1997));
see also
BCBS 173,
supra
note
275
, at 9 (“Different authors classify crises differently. Reinhart and
Rogoff
(2008) find 34 crises over the 25 year period, while
Laeven
and Valencia (2008) report only 24.”).
300
If a stable or smooth relationship existed between the number of crises and the average losses caused by crises, then choices affecting size might be balanced by effects in the second component of the CBA/FR of capital rules, namely, the probability of a crisis, but no such relationship is evident from the studies
301
R&R concede the spreadsheet error,
see
Full Response from Reinhart and
Rogoff
NY. Times:
Economix
, Apr. 17, 2013,
[http://perma.cc/W5VJ-2GFA], but not other critiques of their estimates,
see id
Paul
Krugman
Reinhart-
Rogoff
Continued
N.Y. Times: Conscience of a Liberal
(Apr. 16, 2013, 7:31 PM),
[http://perma.cc/S6AW-476F].
Krugman
takes R&R to task for their response to their critics; R&R take
Krugman
to task for his taking them to task. Carmen M. Reinhart,
Letter to PK
Carmen M. Reinhart Author Website
(May 25, 2013),
[http://perma.cc/BLQ3-BM75].
302
The original R&R publication was a working paper released in early 2010
See
Carmen M. Reinhart & Kenneth S.
Rogoff
Growth in a Time of Debt
(Nat’l Bureau of Econ.
Research, Working Paper No. 15639, 2010),
[http://perma.cc/9QR3-2NGL].
The data flaw did not get noticed until 2013.
See
Thomas Herndon et al.,
Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and
Rogoff
(Political Econ.
Research Inst., Working Paper No. 322, 2013),
[http://perma.cc/W3TL-NX6B].
303
As noted in Herndon et al,
supra
note
302
, at 4, R&R’s 2010 paper “is the only evidence cited in the ‘Paul Ryan Budget’ on the consequences of high public debt for economic growth.” British politician George Osborne (later Chancellor of the Exchequer) relied on R&R to argue most financial crises are caused by excessive public debt in a speech quoted in an April 2013
New Yorker
article on the R&R kerfuffle. John Cassidy,
The Reinhart and
Rogoff
Controversy: A Summing Up
New Yorker: John Cassidy,
Apr. 26, 2013,
.html
[http://perma.cc/K33X-YCR5].
304
Herndon et al,
supra
note
302
, at 5.
305
Carmen M Reinhart & Kenneth S.
Rogoff
, Op-Ed,
Reinhart and
Rogoff
: Responding to Our Critics
N.Y. Times,
Apr. 25, 2013,
[http://perma.cc/46UB-RH8V].
306
BCBS 173,
supra
note
275
, at 3 (“Using the median estimate . . across all comparable studies . . . each 1 percentage point reduction in the annual probability of a crisis yields an expected benefit per year equal to 0.6% of output when banking crises are allowed to have a permanent effect on real activity. Using the median estimate . . . when crises are seen to have only a temporary effect . . . each 1 percentage point reduction . . . yields an expected benefit per year equal to 0.2% of output.”).
307
BCBS 173,
supra
note
275
, at 29 tbl8 (subtracting amounts in the column labeled “Net benefits (large permanent effect)” from amounts in the column labeled “Net benefits (no permanent effect),” adding back the amount in column labeled “Expected costs,” and comparing the difference).
308
BCBS 173,
supra
note
275
, at 36 (noting that “median losses are sensitive to the choice of discount rate,” and that “the median loss . . is 82% if a discount rate of 2.5% is used” but is 63% if 5% is assumed). On discount rates in CBA/FR,
see generally
Pindyck
supra
note
224
309
See generally
Tetlock
supra
note
64
310
Edward
Ashbee
, Fiscal Policy Responses to the Economic Crisis in the United Kingdom and the United States: A Comparative Assessment 1 (Am Political Sci.
Ass’n
, Annual Meeting Paper, 2011),
[http://perma.cc/Y8BN-8RNV].
311
See
Michael Joyce,
Quantitative Easing and Other Unconventional Monetary Policies: Bank of England Conference Summary
, 52
Bank Eng Q. Bull.
48, 49 (2012),
[http://perma.cc/NU62-CQ3V] (contrasting the U.S., U.K., and European Central Bank responses to the crisis); Leonardo
Gambacorta
et al.,
The Effectiveness of Unconventional Monetary Policy at the Zero Lower Bound: A Cross-Country Analysis
5-6 (Bank for Int’l Settlements, Working Paper No. 384, 2012),
[http://perma.cc/FU6G-LEVM].
312
Eg.
, James R. Lothian,
U.S. Monetary Policy and the Financial Crisis
, 6
J. Econ.
Asymmetries
25, 27-28 (2009).
313
Eg.
, Mariko
Fujii
& Masahiro Kawai,
Lessons from Japan’s Banking Crisis, 1991-2005
, at 4-8 (Asian Dev. Bank Inst., Working Paper No. 222, 2010),
[http://perma.cc/RT9B-S2UM].
314
Eg.
, Lothian,
supra
note
312
; Adam S. Posen, External Member of the Monetary Policy Comm., Bank of Eng. and Senior Fellow, Peterson Inst. for Int’l Econ
.,
Why Is Their Recovery Better Than Ours? (Even Though Neither Is Good Enough), Speech at the National Institute of Economic and Social Research, London 2 (Mar. 27, 2012),
[http://perma.cc/WK2L-U3LE] (“[
T]he
US has had significantly more GDP growth with somewhat lower inflation over the last thirty-two months than in the UK . . . [because, among other factors] there was significantly less net withdrawal of fiscal stimulus in the US than the UK.”); Jeremy C. Stein, Member, Bd. of Governors of the Fed. Reserve,
Evaluating Large-Scale Asset Purchases
, Remarks at the Brookings Institution (Oct. 11, 2012),
[http://perma.cc/P8FH-K6W4] (noting that large-scale asset purchases by the Federal Reserve “played a significant role in supporting economic activity and in preventing a worrisome undershoot of the Committee’s inflation objective”); Martin Feldstein,
Quantitative Easing and America’s Economic Rebound
Project Syndicate
(Feb. 24, 2011),
[http://perma.cc/N8WQ-JJ8S] (suggesting that the 2011 economic rebound in the United States was due to increases in stock prices and consumer spending driven by quantitative easing, which would not be sustainable beyond 2011).
315
It is tempting to suggest that CBA/FR could be made tractable by just ignoring future policy responses in modeling the costs of future crises But that is to make an implicit assumption, too, and one that is more likely to be counterfactual than an assumption based on past (or at least recent) policy responses. The assumption would tend to inflate the cost of future crises beyond reasonable levels because every crisis would tend, absent a policy response, to generate large and sustained reductions in GDP, as in the Great Depression. The result would be to expand greatly the range of defensible regulations and to eliminate any disciplining effect of CBA/FR while adding a great deal of camouflage to the regulatory process.
316
BCBS 173,
supra
note
275
, at 9 (citing Carmen M Reinhart & Kenneth S.
Rogoff
Banking Crises: An Equal Opportunity Menace
(Nat’l Bureau of Econ. Research, Working Paper No. 14587, 2008),
[http://perma.cc/BX8V-CD5F]); Luc
Laeven
& Fabian Valencia,
Systemic Banking Crises: A New Database
(Int’l Monetary Fund, Working Paper No. 08-224, 2008,
[http://perma.cc/FVC8-7XHY].
317
See
BCBS
173,
supra
note
275
, at 39 tblA1.4.
318
FSA 38,
supra
note
278
, at 12
319
BCBS 173,
supra
note
275
, at 9
320
FSA 38,
supra
note
278
, at 15 tbl2.
321
FSA 42,
supra
note
278
, at 38 & tbl5.1, adds current account balances to the
logit
model used in FSA 38, and adjusts the data for comparability across countries. The modest change “results in a significant improvement in” the model’s classification performance.
Id
. FSA 42 also examines a larger family of different crisis prediction models.
Id
. at 38-45.
The authors later present information on the overall uncertainty associated with their bottom-line estimates of the net benefits of higher capital requirements,
id.
at
60-64, but they do not break out the specific potential impact of different models of crisis frequency.
322
A fourth, equally difficult challenge is to anticipate and model the private market responses to the rule, particularly responses that include moving assets or activities outside of regulated banks into unregulated entities—that is, Basel III may shift risk into “shadow banks” If those assets or activities nevertheless create risks for the financial system as a whole, or otherwise generate external risks, such a response would represent an offset to the benefits of higher capital requirements, to be included on the cost side of the CBA/FR ledger.
323
FSA 42,
supra
note
278
, at 47
324
The Financial Crisis Response in Charts
US. Dep’t Treasury 12
(Apr. 2012),
[http://perma.cc/5HUD-ZBGN].
325
FSA 42,
supra
note
278
, at 47
326
Id
at 48.
327
Id
at 50-51.
328
BCBS
173,
supra
note
275
, at 21-22; FSA 38,
supra
note
278
, at 39 & tbl4.
329
BCBS 173,
supra
note
275
, at 22, notes that reducing the assumed cost of bank equity from the 1993 to 2007 average of 148% to 10.0% cuts the impact of higher capital requirements from a one-to-thirteen basis point impact to a one-to-seven basis point impact. The report goes on to note that “there are good reasons to believe that the cost of capital would
decline
in response to a reduction in bank leverage” due to increased bank capital requirements, and that “in the limit, the change in the cost of capital could reduce to tax effects.”
Id.
(citing Franco Modigliani & Merton H. Miller,
The Cost of Capital, Corporation Finance and the Theory of Investment
, 48
Am. Econ. Rev.
261 (1958) (finding that, under stylized assumptions, a firm’s returns are invariant to how it finances itself, but for taxes)). As BCBS 173 notes, prior research suggests that the long-run effect on banks’ funding costs of higher capital requirements is likely to be smaller than the numbers used in BCBS 173—a four percentage point increase is assumed to increase borrowing costs by fifty-two basis points in BCBS 173,
supra
note 277, at 23 tbl.6, versus only twenty basis points in Douglas J. Elliott,
A Further Exploration of Bank Capital Requirements: Effects of Competition from Other Financial Sectors and Effects of Size of Bank or Borrower and of Loan Type
Brookings Inst.
22 (Jan. 28, 2010),
[http://perma.cc/9C6R-5GPF], and ten to eighteen basis points in Anil K.
Kashyap
et al.,
An Analysis of the Impact of “Substantially Heightened” Capital Requirements on Large Financial Institutions
17 (May 2010) (unpublished manuscript),
[http://perma.cc/WY6E-GHRE]. For a discussion of some of the drivers of disagreements on the effect of capital requirements on lending costs, see Douglas J. Elliott,
Higher Bank Capital Requirements Would Come at a Price
Brookings Inst.
(Feb. 20, 2013)
[http://perma.cc/GJ7J-LRDL].
330
Anat
Admati
et al.,
Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity Is Not Socially Expensive
, at
(Stanford Graduate Sch. of Bus.
Working Paper No. 2065, 2013),
[http://perma.cc/4LR5-97HX].
These authors
also rely on Modigliani & Miller
supra
note
329
331
Admati
et al,
supra
note
330
, at 19-20.
332
Id
at 21-23.
333
BCBS 173,
supra
note
275
, at 27 tbl7.
334
Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub
L. No. 111-203, § 619, 124 Stat. 1376, 1620 (2010) (codified at 12 U.S.C. § 1851 (2012)).
Section 619 is called the “Volcker Rule” because former Federal Reserve Board Chairman Paul Volcker was a prominent backer of the law.
335
The banking agencies and the SEC issued a joint final rule Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, 79 Fed. Reg. 5,536 (Jan. 31, 2014) (to be codified at 12 C.F.R. pt. 44 (OCC); 12 C.F.R. pt. 248 (Fed. Reserve); 12 C.F.R. pt. 351 (FDIC); 17 C.F.R. pt. 255 (SEC)). The CFTC issued a final rule separately. Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds,
79 F
ed.
Reg
. 5,808 (
Jan. 31, 2014) (to be codified at
17 C.F.R. pt. 75).
336
Bank Holding Company Act of 1956, Pub
L. No. 84-511, 70 Stat. 133 (codified as amended in scattered sections of
12 U.S.C.)
The Bank Holding Company Act of 1956 (BHCA) initially contained a broad regulatory delegation of authority to the Federal Reserve Board to “issue such regulations and orders as may be necessary to enable it to administer and carry out the purposes” of the Act and to “prevent evasions thereof.”
Id.
§ 5(b), 70 Stat. at 137.
That provision remains in 12 U.S.C. § 1844(b), with amendments to clarify that the authority includes the power to adopt capital requirements for bank holding companies.
337
See
7 US.C. § 19(a)(1) (2012) (requiring the CFTC to “consider the costs and benefits” of its regulatory actions). This is true even though the SEC and the CFTC were also required to adopt the Volcker Rule because their authority (and mandate) to do so is (unusually) in the BHCA, not the statutes that traditionally authorize them to act.
Office of the Comptroller of the Currency,
Analysis of 12 CFR Part 44
U.S. Dep’t Treasury
(Mar. 2014),
[http://perma.cc/BA7-R4PG].
338
The specific section that authorizes the Volcker Rule, 12 US.C. § 1851 (2012), added to the BHCA by the Dodd-Frank Act, contains a similarly broad grant of authority and does not condition rulemaking on any particular finding or process, other than (1) to “consider” a statutorily mandated January 2011 study of how to implement the section conducted by the Financial Stability Oversight Council,
see
12 U.S.C. § 1851(b)(1)-(2)(A) (2012);
Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationships with Hedge Funds & Private Equity Funds
Fin. Stability Oversight Council
(Jan. 2011),
[http://perma.cc/JFW4-E2XZ]; and (2) to coordinate rulemaking among the Federal Reserve Board, FDIC, OCC, SEC, and CFTC so as to “
assur
e], to the extent possible, that such regulations are comparable and provide for consistent application and implementation . . . to avoid providing advantages or imposing disadvantages to the companies affected . . . and to protect the safety and soundness of banking entities and nonbank financial companies supervised” by the Federal Reserve, 12 U.S.C. § 1851(b)(2)(B)(ii) (2012).
339
Prohibitions and Restrictions on Proprietary Trading, 79 Fed
Reg. at 65,744 (conducting analysis under the PRA);
id.
at
65,778 (conducting analysis under the RFA). The American Bankers Association (ABA) and other plaintiffs sued to enjoin enforcement of the Volcker Rule on the ground that the agencies’ RFA analysis failed to consider the rule’s “significant economic impact on a substantial number of community banks.”
See
Emergency Motion of Petitioners for Stay of Agency Action Pending Review at 15, Am. Bankers
Ass’n
v. Bd. of Governors of the Fed. Reserve Sys
.,
No. 13-1310 (D.C. Cir.
Dec. 24, 2013),
[http://perma.cc/6HSX-PNE8].
The Joint Volcker Rule Release specifically addressed potential impacts by exempting banks below various specified size thresholds from reporting and compliance burdens. The ABA suit focuses on one indirect effect of the rule, which is to ban “banking entities” (including all depository institutions, small or large) from holding “ownership interests” in hedge and private equity funds (Subpart C of the Volcker Rule), including
debt
instruments that give holders the right to remove a collateral manager for a collateralized debt obligation–an entity that holds multiple trust-preferred or other securities, which (as the ABA in its papers admits) collapsed in value during the financial crisis.
See id.
at
2, 7.
340
See
Office of the Comptroller of the Currency
supra
note
337
341
Id
at 18-22.
The FSOC also identified the benefit that the rule would reduce the risk that banks have effective liability for nominally off-balance sheet funds they sponsor.
Fin. Stability Oversight Council,
supra
note 340, at 56.
342
Office of the Comptroller of the Currency,
supra
note
337
, at 1
343
Id
at 15.
344
Cf
James D. Cox et al.,
A Better Path Forward on the Volcker Rule and the Lincoln Amendment
Bipartisan
Pol’y
Center
8 (Oct. 2013),
[http://perma.cc/4QPL-27Z9].
345
See
Office of the Comptroller of the Currency,
supra
note
337
, at 1, 23
346
Shanny
Basar
Paul Volcker Fights for Volcker Rule
Fin.
News
(Feb. 14, 2012),
[http://perma.cc/8R2E-5PZ2]; Bill Moyers,
Paul Volcker on the Volcker Rule
Moyers & Co.
(Apr. 5, 2012),
].
347
Office of the Comptroller of the Currency,
supra
note
337
, at 17 (citing Joel Hasbrouck,
Trading Costs and Returns for US. Equities: Estimating Effective Costs from Daily Data
, 64
J. Fin.
1445 (2009)).
348
Id
at
1, 23
349
See
CCMR
Report
supra
note 4, at 13-16
350
Cross-Border Security-Based Swap Activities, 78 Fed
Reg. 30,968 (proposed May 23, 2013) (to be codified at 17 C.F.R. pts. 240, 242, 249) [hereinafter Cross-Border Swap Release].
351
The
gap was cemented by the Commodity Futures Modernization Act of 2000, Pub
L. No. 106-554, 114 Stat. 2763, 2763A-365. The 262-page bill, attached as an appendix to a budget bill, barred the SEC from regulating OTC derivatives as “securities” and the CFTC from regulating them as “futures,” leaving regulation only through general (and much less specific) “safety and soundness” oversight by regulatory supervisors of OTC issuers and users (which was non-existent for companies that did not accept deposits, invest or deal in securities or futures, or underwrite or sell insurance, including companies that were affiliated with regulated entities, such as AIG).
See
Sheila Bair, Bull by the Horns: Fighting To Save Main Street from Wall Street and Wall Street from Itself
333 (2012);
Simon Johnson & James
Kwak
13 Bankers: The Wall Street Takeover and the Next Financial Meltdown
7-11, 78-82, 92, 121-26, 134-37, 169-70, 202 (2010).
352
See
Report Pursuant to Section 129 of the Emergency Economic Stabilization Act of 2008: Restructuring of the Government’s Financial Support to the American International Group, Inc
on March 2, 2009
Fed.
Reserve
Sys.
(2009)
[http://perma.cc/V6J8-HNLW].
353
The CFTC now regulates “swaps,” the SEC now regulates “security-based swaps,” and both have authority over “mixed swaps” Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 721, 761, 124 Stat. 1376, 1658-72, 1754-59 (2010). A “swap” is a contract that requires conditional payments between counterparties derived from changes in specified prices or events, generally related to financial markets, such as interest or currency exchange rates, but can also include “credit” events, such as the default by a borrower on an unrelated “reference” security or loan.
354
Regulated entities include swap dealers, major swap participants, data repositories, clearing agencies, and execution facilities
Id.
Where regulated by the SEC, relevant entities have the phrase “security-based” added to qualify “swap,” but otherwise the definitions are identical to those applicable to the CFTC for other swaps.
Id.
§ 761.
For definitions of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant,” “Major Security-Based Swap Participant” and “Eligible Contract Participant,” see 77 Fed.
Reg. 30,596, 30,751-53 (May 23, 2012) (to be codified at 17 C.F.R. pts. 1, 240).
355
Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed
Reg. 48,208 (Aug. 13, 2012) (to be codified at 17 C.F.R. pts. 1, 230, 240, 241) (adopting product definitions); Further Definition of “Swap Dealer,” 77 Fed.
Reg. at 30,596 (adopting intermediary definitions);
see also
Further Definition of “Swap Dealer,” “Security-Based Swap Dealer,” “Major Swap Participant” and “Eligible Contract Participant,” 75 Fed.
Reg. 80,174 (proposed Dec. 21, 2010) (to be codified at 17 C.F.R. pts. 1, 240) (proposing intermediary definitions).
356
Capital Margin and Segregation Requirements for Security-Based Swap Dealers and Major Security-Based Swap Participants and Capital Requirements for Broker-Dealers, 77 Fed
Reg. 70,214 (Nov. 23, 2012) (to be codified at 17 C.F.R. pt. 240) (proposing capital, margin, and segregation rules); Clearing Agency Standards, 77 Fed.
Reg. 66,220 (Nov. 2, 2012) (to be codified at 17 C.F.R. pt. 240) (adopting clearing agency standards); Process for Submissions for Review of Security-Based Swaps for Mandatory Clearing and Notice Filing Requirements for Clearing Agencies; Technical Amendments to Rule 19b-4 and Form 19b-4 Applicable to All Self-Regulatory Organizations, 77 Fed.
Reg. 41,602 (July 13, 2012) (to be codified at 17 C.F.R. pts. 240, 249) (adopting clearing procedures); Registration of Security-Based Swap Dealers and Major Security-Based Swap Participants, 76 Fed.
Reg. 65,784 (Oct. 24, 2011) (to be codified at 17 C.F.R. pts. 240, 249) (proposing registration rules for dealers and major swap participants); Business Conduct Standards for Security-Based Swap Dealers and Major Security-Based Swap Participants, 76 Fed.
Reg. 42,396 (July 18, 2011) (to be codified at 17 C.F.R. pt. 240) (proposing standards for external business conduct); Registration and Regulation of Security-Based Swap Execution Facilities, 76 Fed.
Reg. 10,948 (Feb. 29, 2011) (to be codified at 17 C.F.R. pts. 240, 242, 249) (proposing registration framework for execution facilities); Trade Acknowledgment and Verification of Security-Based Swap Transactions, 76 Fed.
Reg. 3,859 (Jan. 21, 2011) (to be codified at 17 C.F.R. pt. 240) (proposing trade acknowledgement rules); End-User Exception to Mandatory Clearing of Security-Based Swaps, 75 Fed.
Reg. 79,992 (Dec. 21, 2010) (to be codified at 17 C.F.R. pt. 240) (proposing end-user exceptions); Security-Based Swap Data Repository Registration, Duties, and Core Principles, 75 Fed.
Reg. 77,306 (Dec. 10, 2010) (to be codified at 17 C.F.R. pts. 240, 249),
corrected at
75 Fed.
Reg. 79,320 (Dec. 20, 2010) (to be codified at 17 C.F.R. pts. 240, 249)
and
76 Fed.
Reg. 2,287 (Jan. 13, 2011) (to be codified at 17 C.F.R. pts. 240, 249) (proposing data repository rules); Regulation SBSR-Reporting and Dissemination of Security-Based Swap Information, 75 Fed.
Reg. 75,208 (Dec. 2, 2010) (to be codified at 17 C.F.R. pts. 240, 242) (proposing reporting rules).
357
Dodd-Frank Act § 752.
358
See
77 Fed
Reg. 70,214, 70,299-328 (Nov. 23, 2012) (to be codified at 17 C.F.R. pt. 240) (showing that economic analysis takes up roughly 20% of the total release); 77 Fed.
Reg. 66,220, 66,263-84 (Nov. 2, 2012) (to be codified at 17 C.F.R. pt. 240) (showing that economic analysis takes up roughly 30% of the total release); 77 Fed.
Reg. 30,596, 30,722-42 (May 23, 2012) (to be codified at 17 C.F.R. pt. 240) (showing that economic analysis takes up roughly 12% of the total release).
359
See
CCMR
Report
supra
note 4, at 14
360
Id
(emphasis added). The CCMR Report does not provide any specific cites or examples from within the Cross-Border Swap Release to back up this characterization, instead citing to the release as a whole.
Id.
361
Cross-Border Swap Release,
supra
note 352, at 386
362
Id.
363
Id
at 413-16.
364
Id
at 416-18.
365
Id
at 509-10.
In the discussion of the benefits of the rules covering swap executive facilities, there is no quantification, nor does the release quantify major potential non-compliance costs of such rules, which are noted in qualitative terms in the release and include the possibility that disclosure obligations will drive swap participants from the market, reducing liquidity, or force participants to fragment trades to discourage front-running, resulting in greater transaction costs.
Id
. at 505-08 (benefits), 510-12 (non-quantifiable costs).
366
See
CCMR
Report
supra
note 4, at 13-16.
367
Eg.
, Cross-Border Swap Release,
supra
note 352 at 16 n.5, 34 n.76, 356 & n.1218, 359 & n.1226, 364-66, 365 nn.1245-46, 366 n.1251, 371, 373, 388 n.1301, 392-93. All of these estimates relate to the less important assessment costs, the scope of or changes in relevant markets, or other data, and none are estimates of the more important programmatic costs or programmatic benefits.
368
Id.
369
For example, in assessing how much voluntary swap clearing is already occurring, the release notes that “if the counterparties choose to transact in a reference entity that is accepted for clearing in a currency other than US. dollars, the transaction is no longer eligible for clearing.”
Id.
at 486 n.1618.
This fact would be of significance for assessing the rules, since one would expect many cross-border swaps to be denominated in other currencies. No data on the currency profile of cross-border swaps is provided. As another example, the release states in another footnote the fact that less than five percent of margin received by swaps association members was segregated with a third-party custodian.
Id.
at 467 n.1549.
This fact directly bears on the potential gross benefits of a rule requiring segregation.
370
Cross-Border Swap Release,
supra
note 352, at 467-68 (footnotes omitted)
371
I think thirty-five words could preserve the meaning: “Segregation may protect customers, depending on US. and foreign laws, and if so may increase market confidence and the value of swaps, consistent with our experience with broker-dealer segregation, but those benefits cannot be quantified.”
372
George Parker & Brooke Masters,
Osborne Abolishes FSA and Boosts Bank
Fin
Times,
June 16, 2010,
].
The theory of the split-up of the FSA was that it had neglected systemic issues due to a “pre-occupation with consumer protection matters.”
Eilis
Ferran
Regulatory Lessons from the Payment Protection Insurance
Mis
-selling Scandal in the UK
, 13
Eur.
Bus. Org. L. Rev
. 247, 248 (2012). Going forward, the Prudential Regulation Authority is meant to engage in prudential supervision, while the Financial Conduct Authority will govern consumer finance.
Id.
373
Mortgage Market Review: Proposed Package of Reforms
Consultation Paper CP11/31
Fin
Servs
Auth
. 7 (Dec. 2011),
[https://perma.cc/K3YW-VWUN].
374
Id
375
See
supra
note 83
376
Mortgage Market Review
supra
note 375, at A1
:1
377
Id
at A1
:3
. The FSA’s conceptual CBA/FR is much more complex than depicted in the text. In one figure alone, it identifies four channels for reforms to affect welfare by cutting both affordable and unaffordable loans and increasing the suitability of loans made: (1) reducing resources spent on loans in arrears or repossession; (2) changing welfare from fewer loans; (3) changes in the buy-to-let mortgage market; and (4) lower home prices.
Id
. at A1
:11
. The reforms also affect competition and raise compliance costs, increasing mortgage prices and contributing to lower home prices. Lower home prices would cut the odds of a new crisis, benefiting the economy, and would also affect the economy through the rental, savings, and pension markets. All this would be happening simultaneously with changes in the identified baseline, such as market corrections in the home loan market; stricter prudential requirements, such as those imposed under Basel III; the collapse and re-launch of a new securitization market; and changes in the supply and demand for housing due to government policy changes, partly driven in turn by the macroeconomic loss. The FSA’s efforts to guesstimate the costs and benefits of the reforms aim at a subset of these channels. Other effects (e.g., changes in monetary or fiscal policy, effects on the “buy-to-let” market, effects on competition) are not quantified “because they are unlikely to be significant or because data constraints prevent us from providing any meaningful estimate.”
Id
. Also not quantified were benefits from reduced transfers of homes from borrowers to mortgagors, because although reducing transfers “is likely to be regarded as socially beneficial . . . it is difficult to assess the size of the benefit relative to the size of the transfer.”
Id
. at A1
:27
. Nevertheless, despite this complexity, the bottom line of the FSA’s CBA is driven by what is described in the text.
Id
. at A1
:8
-9 (noting that “[o]
verall
CBA balance” is dominated by net well-being benefit).
378
Impairment was defined as either being in arrears (that is, paying late) or having a home repossessed
Id
. at A1
:27
. The breakdown between these types was roughly 85%/15%.
See id.
379
Id
at A1
:32
. For the other two reforms, the FSA used a separate “model” that simply identified a subset of loans that passed the affordability test but were made to borrowers with high debt-service ratios (mortgage payments to after-tax income), which was taken as a proxy for loan non-affordability.
Id
. at 141.
380
Id
at A1
:4
. This cut-off point was identified by looking visually at a plot of the average underwriting risk scores by the lenders in its sample, identifying a region in which the scores increased at an increasing rate, selecting the midpoint of the visually identified range, and usually the average underwriting score for the lender so identified.
Id
. at A1
:35
. It then arbitrarily chose a range that bracketed this score by a round +/- 0.1.
Id
. at A1
:36
381
Id
at A1
:4
. The FSA broke its sample into two sub-periods—2005 to 2007 and 2009 to 2010—to “construct different estimates of the impacts the affordability assessment would have in boom and subdued periods” of lending.
Id
. at A1
:39
. The FSA does note that this period experienced generally low (by historical standards) and falling interest rates, which likely means its estimates of loan defaults are low by historical standards; this may have led it to underestimate the benefits of its rules.
Id
. at A1
:32
382
Id
at A1
:8
. To do this, the FSA estimated the likely impact of the reforms on the size of loans that would be made, breaking down loans into those of new buyers, home movers, and re-mortgagors.
Id
. at A1
:69
-71. For new buyers, loans were reduced until they “
compli
ed
]” with the rules under the FSA’s model, unless the reduction exceeded an arbitrarily chosen 30%, at which point the FSA assumed (absent data) the loan would be foregone.
Id.
at 70-71.
For other borrowers, they estimated the impact on the marginal increased loan of the new rules.
Id
. Of these, the FSA estimated that 75,000 would obtain a smaller mortgage while the rest would be pushed to delay their borrowing.
Id
. at A1
:79
383
Id
at A1
:76
. The FSA partly motivates this strong pair of assumptions by further assuming that “most borrowers would prefer to borrow affordably.”
Id
384
Id
at A1
:26
. “Others whose borrowing is affected by the [rules] would in any case not have experienced mortgage impairment. These consumers experience
only
a reduction in well-being (a cost), for example from having to buy a less desirable property, from delaying their property purchase or, in the case of some re-mortgagors, from not obtaining desired additional lending to support consumption.”
Id
. (emphasis added). The FSA implicitly defends this assumption with the claim that “some of these [borrowers] would have been willing and able to deal with high repayment burdens without much stress.”
Id
. at A1
:78
385
Id
at A1
:76
386
Id
at A1
:80
387
Id
at A1
:82
-84. The FSA refers to them as “weights.”
Id
. at A1
:83
388
The FSA generated a variety of comparative statics for different subgroups of borrowers and different types of housing-related events
Id
. at A1
:82
-84. Because of the variety of comparisons possible, there is no single ratio that emerges from the analysis, other than the general qualitative conclusion that effects of payment problems and defaults are “much greater” than the effects of delayed or foregone housing improvements.
Id.
at A1
:83
389
Id
at A1
:84
. Positive effects were larger during housing booms, with slightly negative effects in subdued markets.
Id
390
Id
at A1
:85
-86.
391
Id
at A1
:8
, A1:86.
392
Id
at A1
:8
393
Id
at A1
:8
, A1:102-09.
394
Id
at A1
:112
395
The National Institute for Economic and Social Research created the model, and describes it as using “a ‘New-Keynesian’ framework in that agents are presumed to be forward-looking but nominal rigidities slow the process of adjustment to external events”
See
Model Overview
Nat’l Inst. Global Econ. Model
-intro/nigemintro.php?t=2&b=1 [http://perma.cc/8VXH-6QP6].
396
Mortgage Market Review
supra
note 375, at A1
:72
This modeling was off a baseline that took into account the effects of Basel III estimated by the FSA,
id
at
A1:72 n.37, and so builds in all of the uncertainties and assumptions of that exercise,
see
infra
Part III.C, along with a variety of other assumptions used to calibrate the
NiGEM
model, including assumptions about economic growth, inflation, and home prices, and how those macroeconomic forces interact.
Id.
at A1
:72
-74.
397
These categories were (1) a reduction in home lending due to increased lending costs from the rules, (2) reduced home prices, which lower household expectations of capital gains from investments in homes, (3) increased household savings and reduced consumption to offset the reduction in expected home investments, (4) decreased inflation and lower central and interbank borrowing rates due to reduced consumption, increased savings, and lower household borrowing, (5) increased business lending as banks use funds freed up by reduced household and mortgage borrowing, and because of the lower bank rate, and (6) increased business investment due to additional business lending, which adds to productive capacity and increases overall output
Id.
at A1
:72
-74.
398
Id
at A1
:74
399
This discount rate is mentioned in passing in another part of the FSA’s CBA/FR, without explanation of how it was derived
Id
. at A1
:112
. The FSA does not translate its macroeconomic impact estimates into present values.
400
Id
at A1
:9
401
This may suggest that if new CBA/FR mandates are to be adopted, which Part IV below argues against, they should be confined to the consumer protection context
402
Mortgage Market Review
supra
note 375, at A1
:85
403
Id
at A1
:70
n.33. The FSA defends thirty percent as more realistic than zero or 100%, which seems right, but better would have been to present a sensitivity analysis for this assumption.
404
Id
at A1
:79
n.42. As the FSA laconically notes, “it is therefore likely that over the long run we are over-estimating the impacts of the [rules] on lending volumes in the market.”
Id.
405
Id
at A1
:83
. This means that benefits are likely understated.
406
Id
at A1
:82
. This assumption seems implausible because borrowers will tend to “stretch” in their borrowing for housing in response to career developments, which will correlate with time, so any time trends in well-being reports will be reflected in the implicit before-and-after comparisons.
407
Id
at A1
:93
. Better would have been to include some data from periods of high or rising interest rates, but the FSA faced data limitations similar to those faced by all financial regulators.
408
Id.
at A1
:87
409
Cf id
at
A1:8 n.3, A1:27. The FSA noted this assumption was likely counterfactual, although it did not elaborate on why—presumably because the non-market value of a home to the defaulting borrower exceeds the value of the home to the lender and/or a new buyer, on average.
410
Compare with OMB
Guidance,
supra
note 20, at 2 (“It is usually necessary to provide a sensitivity analysis to reveal whether, and to what extent, the results of the analysis are sensitive to plausible changes in the main assumptions and numeric inputs”).
411
Mortgage Market Review
supra
note 375, at A1
:40
This estimate is for the affordability component of the reforms alone; for the package of reforms, the results were similar.
Id.
at A1
:62
. The FSA also showed breakdowns by borrower type in the
subperiods
Id.
at A1
:41
-42, A1:63-64.
412
Id
at A1
:65
413
Id
at A1
:2
. Another disclaimer: “No amount of quantification would remove the need to make such a
judgement
. We illustrate, however, our quantification of the tradeoff. This should not be interpreted as providing a precise measure of well-being effects, but rather as supporting some reasonable assumptions about the relative weight attached to different positive and negative effects, and illustrating that such relative weights might support different
judgements
.”
Id.
at A1
:80
414
Id
at A1
:5
. While the FSA believed those judgments “are best informed” by its CBA/FR, it presented no evidence to show that was true, or if so, how.
Id.
415
Id
at A1
:3
416
Eg.
CCMR Report
supra
note 4, at 13 (rebutting the belief that “quantifying the expected benefits of a regulation is impossible,” instead claiming that “rigorous cost-benefit analysis is not only feasible but has been successfully employed by regulators both in the United States and abroad”).
417
John Y Campbell et al.,
Consumer Financial Protection
, 25
J. Econ.
Persp
91, 98-99 (2011).
418
Luigi
Zingales
The Future of Securities Regulation
, 47 J
Acct. Res
. 391, 393-401 (2009).
419
Using partially quantified CBA to generate bounds is sometimes offered as a solution to the problematic output of CBA
See, e.g
.,
Sunstein
supra
note 19, at 2 (describing that estimates of expected value are useful to identifying regulatory benefits). But bounds do not generally make quantified CBA/FR useful, for two reasons. First, estimates of bounds themselves are highly imprecise. For example, even the “easily” quantified subsets of costs for many financial rules, such as the direct costs of SOX 404, have wide confidence intervals; for SOX 404, they range from $400,000 to $4 million per firm per year, and that range has changed over time.
See
supra
text accompanying notes 164-
167
. The lower bound on a lower bound (here, that is, $400,000) is all that partial quantified CBA can typically produce to guide policy judgment. Second, and more importantly, also as shown in Part III, when estimates of costs and benefits are
both
highly uncertain and imprecise, as is common in CBA/FR, the lower bound on the lower bound that can emerge from partial quantified CBA may not be a meaningful aid to policy judgment. If we know, for example, that a subset of costs can be estimated at $2.2 billion, plus or minus $1.8 billion, but we do know the benefits, a CBA advocate would argue that we have advanced the analysis because now we know that unless the benefits exceed the lower bound of the lower bound (that is, $400 million), the rule is not justified. But if any expert would have already had a prior judgment that the
unquantifiable
costs are likely to be an order of magnitude larger than $400 million, we have not significantly advanced the analysis, because we already knew benefits would have to be more than $400 million (indeed, more than $4 billion—an order of magnitude larger than $400 million). Quantification of the lower bound of the lower bound of the subset of costs may look precise (it produces a number), but it has not in fact improved our bottom-line estimate of the net benefits and costs, because our rough estimate of the benefits would already have had to be far higher before considering the rule. Put differently, only when partial quantification produces a lower bound on a lower bound on
costs that is
surprisingly
high (or vice versa, in the case of bounds on benefits) will the exercise aid policymaking judgment.
420
Compare, eg.
Sunstein
The Cost-Benefit State
supra
note 11, at 20-21 (advocating a “suitably devised system of CBA,” albeit with caveats),
with
Sinden
supra
note 42, at 191-95 (critiquing the use of cost-benefit analysis).
421
See, eg.
Sunstein
supra
note 36, at 2289 (“A skeptic might conclude that because the range of uncertainty [about the net costs and benefits of a regulation designed to reduce arsenic intake] is so large, any number at all could be justified and the ultimate decision is essentially political or based on ‘values.’ This view is not exactly wrong, but it should not be taken as a convincing challenge to CBA.”). Even the arsenic rule had considerably simpler potential effects on welfare than several of the case studies reviewed in Part III (for example, SOX 404 or the Volcker Rule).
422
See
supra
text accompanying notes 373-375
423
Compare
Cliff
Asness
et al,
Open Letter to Ben Bernanke
Wall St. J.
Real Time Econ.
(Nov. 15, 2010, 12:01 AM),
[http://perma.cc/3VKA-UL8W] (posting an open letter from multiple economists, including former Chairman of Council of Economic Advisors, former Director of the Congressional Budget Office, former Senior Economist of the Board of Governors of the Federal Reserve, and former Deputy Assistant Treasury Secretary, among others, stating that “[
w]e
believe the Federal Reserve’s large-scale asset purchase plan (so-called ‘quantitative easing’) . . . risk[s] currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment”),
with Reply to Open Letter to Ben Bernanke from Federal Reserve Spokeswoman
Wall St. J.
Real Time Econ.
(Nov. 15, 2010, 12:01 AM)
[http://perma.cc/3VKA-UL8W] (defending the Federal Open Market Committee’s “recent actions”—that is, “quantitative easing”—as reflecting the Federal Reserve’s “Congressionally-mandated objectives [of]
promot
ing
] increased employment and price stability”).
See also
supra
notes 330-335 (noting disagreements among economists over whether an increase in bank capital requirements will reduce socially beneficial lending).
424
See
Cass R
Sunstein
The Real World of Cost-Benefit Analysis: Thirty-Six Questions (and Almost as Many Answers)
, 114
Colum. L. Rev. 167, 185
(2014) (citing 75 Fed.
Reg. 76,186, 76,238).
The proposed rule was adopted on March 31, 2014.
See
NHTSA Announces Final Rule Requiring Rear Visibility Technology
Nat’l Highway Traffic & Safety Admin.
(Mar. 31, 2014)
].
425
The DOT’s CBA is confusing (and perhaps in error) in its presentation of cost estimates, 75 Fed
Reg. 76,237 (Table 15 and text); 75 Fed.
Reg. 76,240 (Table 19 and text), in that it presents both a “primary estimate” and a “high estimate” of costs that are higher when using a 7% discount rate than when using a 3% discount rate, and the text of the rule does not refer to the numbers in the tables. It is also of note that rather than monetizing a cost of a child’s life differently from that of an adult, and then using the numbers so estimated in its analysis, it used a conventional value of an adult life, concluded that its quantified CBA produced a net cost, but then adopted the rule anyway based on what it determined was the non-quantifiable additional value of a child’s life.
Id.
at 76,238-39.
426
Marsili
Toy Models and Stylized Realities
, 55
Eur.
Physical J.
169, 173 (2007).
427
An exception is climate change, where the effects of US. regulations will depend upon how other governments cope with climate change. Quantitative CBA may for that and other reasons be less useful for coping with climate change than for regulations responding to less world-threatening problems.
See
Pindyck
supra
note 226
428
Paul A
Tipler
Physics
or Scientists and Engineers
336-37
(4th ed. 1999) (relating gravitational constant to the force of gravity at various depths).
429
Other physical constants relevant to non-financial domains include the magnetic constant, the electric constant, the mass of a proton, the gas constant, the speed of light, Planck’s constant, etc
430
Eugene F
Fama
& Kenneth R. French,
Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay
60
J. Fin. Econ.
3 (2001);
Zingales
supra
note 420, at 392. More companies are now paying dividends again, following the financial crisis, partly as a result of the extremely low interest rate environment created by quantitative easing by the Fed.
431
Fin Crisis Inquiry
Comm’n
The Financial Crisis Inquiry Report
38-51 (2011).
432
Marsili
supra
note
426
, at 173
433
Larry Tribe made the same point in this journal forty years ago when discussing CBA of environmental regulation Laurence H. Tribe,
Ways Not To Think About Plastic Trees: New Foundations for Environmental Law
, 83
Yale L.J.
1315, 1322 (1974) (“[
E]
ven
before anyone is very good at the task of attaching shadow prices to varying levels of constraints as elusive as ecological diversity, the
attempt
to attach them rather than simply incorporating such constraints in an all-or-nothing fashion should lead to better decision processes even if not better outcomes.”). I thank Duncan Kennedy for the reference.
434
See
Chamber of Commerce v SEC
, 443 F.3d 890 (D.C. Cir. 2006);
Chamber of Commerce v. SEC
, 412 F.3d 133 (D.C. Cir. 2005);
see also
CCMC
Report
supra
note 6, at 30 (characterizing the costs as “minor”);
supra
notes 18, 89-102 and accompanying text.
435
This was the view of none other than Douglas Ginsburg (now on the DC. Circuit, author of the
Business Roundtable
decision,
see
supra
notes 103-126 and accompanying text), writing about his experience as the first head of OIRA from 1984 to 1985.
See
Christopher C.
DeMuth
& Douglas H. Ginsburg,
White House Review of Agency Rulemaking
, 99
Harv
. L. Rev.
1075, 1085-86 (1986) (“The private nature of the regulatory review process [i.e., OIRA’s review of executive agency rulemaking] has been a strength . . . because . . . it can flourish only if the agency head or his delegate, and OMB as the president’s delegate, are free to discuss frankly the merits of a regulatory
proposal.
. . . The administration’s deliberative process would be significantly compromised if the preliminary rounds in any [interagency] disagreement were routinely publicized.”).
DeMuth
and Ginsburg acknowledge that private interagency review suffers from a legitimacy problem—it makes it hard for OIRA to rebut allegations that it acts to smuggle politics or private interests into the review process, out of the public’s eye—but they go on to argue that the problem is more apparent than real and in any event justified by the benefits of the process.
Id.
at 1086-87.
436
See
supra
note 134 and accompanying text
437
See
Alan B Morrison,
The Administrative Procedure Act: A Living and Responsive Law
, 72
Va. L. Rev.
253, 256 (1986) (“[
R]
ulemakings
are often more controversial than adjudications [under the APA], whose very processes are hidden from outsiders.”).
438
Eg.
, Nat’l
Ass’n
of Mfrs. v. SEC, 956 F. Supp. 2d 43, 46 (D.D.C. 2013) (upholding an SEC rule promulgated under section 1502 of the Dodd-Frank Act, which directed the agency “to develop and promulgate a rule requiring greater transparency and disclosure regarding the use of ‘conflict minerals’ coming out of the DRC and its neighboring countries”),
aff’d
in part
, 748 F.3d 359 (D.C. Cir. 2014). This consequence appears to be a novel or at least recent dysfunction in the administrative state.
See
Jacob E.
Gersen
& Anne Joseph O’Connell,
Deadlines in Administrative Law
, 156
U. Pa. L. Rev.
923, 926 (2008) (“Because narrow delegations with extensive substantive restrictions would eliminate agency discretion and expertise in policymaking, it is rare that Congress specifies the actual content or substance of agency decisions.”);
cf.
Michael
Herz
Judicial
Textualism
Meets Congressional Micromanagement: A Potential Collision in Clean Air Interpretation
, 16
Harv
Envtl
. L. Rev. 175, 179
(1992) (arguing that in environmental regulation, judicial deference to regulatory discretion absent statutory specificity had created incentives for Congress to impose specific mandates as the best way to control agencies).
439
Cf
Vermeule
supra
note 9 (critiquing judicial review of agency decisions under conditions of uncertainty).
440
See
id
at
2-3 for a different but complementary argument that courts should be more deferential to agencies in contexts requiring arbitrary decisions.
441
For evidence that judicial review of agency action outside the financial regulatory context is motivated by politics and judicial ideology, despite nominal legal standards requiring deference and permitting court intervention only if the agency acts “arbitrarily” or “capriciously,” see
supra
note 127 and accompanying text
442
Kraus &
Raso
supra
note 12, at 338-42;
see also
Fisch
supra
note 116, at 718-21 (discussing the application of the Government in the Sunshine Act, 5 US.C. § 522(b) (2012), to the SEC).
443
Freedom of Information Act, 5 US.C. § 552 (2012).
444
Id
445
See
sources cited
supra
note 81
446
See
sources cited
supra
note 82
447
See
supra
text accompanying notes 86-87
448
Kraus &
Raso
supra
note 12, at 341
449
See
OMB
Guidance,
supra
note 20, at 4-15
450
CBA/FR advocates,
see,
eg.
CCMR Report
supra
note 4, at 14, rightly point to the SEC’s pilot program on short sale rules, which randomly exempted a stratified sample from new rules for purposes of evaluating the rules’ effects in a statistically reliable way.
See
Office of Econ.
Analysis
Economic Analysis of the Short Sale Price Restrictions Under the Regulation SHO Pilot
, Sec. & Exch.
Comm’n
(2007),
[http://perma.cc/EE3U-VAUD].
451
CCMR Report
supra
note 4, at 9
452
I take up the task of making such proposals in a related paper
See
Coates
supra
note 10