The Institutional Framework for Cost Benefit Analysis in Financial Regulation

Four years after the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), the use of cost benefit analysis (CBA) in financial regulation has come to play a critical role in an increasingly heated debate concerning the statute’s implementation. Requiring nearly three hundred rule-makings across twenty agencies, Dodd-Frank’s enormous regulatory mandate represents for many an especially dangerous risk of the typical “drift” and “slack” problems long associated with administrative rule-making. The fact that Dodd-Frank was enacted in the midst of an economic recession only heightens these fears, particularly the concern that overworked and/or overzealous agencies might discharge their regulatory mandate by promulgating cost-insensitive regulations. In light of these concerns, a number of Congressional proposals now exist that would subject financial rule-making to more formal CBA reflecting the conventional belief that rigorous CBA can provide much-needed accountability over regulatory agencies.

Juxtaposed against this generally positive assessment of CBA, however, stands a less sanguine, even sinister view of these proposals. Under this view, the challenge of imposing CBA on financial reforms whose benefits may be difficult to quantity—but whose costs are often easy to estimate—bodes ill for Dodd-Frank regulations. At best, the difficulty of the process will add delay to rule-making as regulators scramble to quantify the unquantifiable. At worse, the expectation of rigorous, quantified CBA will (in the words of Better Markets) “stop financial reform, as all financial regulatory agencies … grind to a halt trying to do all this burdensome analysis.”

My paper, which is forthcoming in the Journal of Legal Studies, argues that the ultimate effect of imposing CBA on financial reform rules hinges critically on the institutional framework in which agencies engage in it. While popular calls for imposing CBA on financial regulation often suggest financial agencies are currently immune from CBA, virtually all of the principal agencies in charge of Dodd-Frank rule-making have come to adopt CBA processes as key components of their deliberative processes. What sets these agencies apart in their use of CBA is instead the institutional context in which they engage in it. It is these differences that shape in important ways the rigor with which agencies conduct CBA (e.g., how seriously an agency seeks to quantify regulatory benefits) as well as how likely it is that CBA might result in undermining an agency’s regulatory agenda. For these reasons, the current debate over CBA in financial reform can be viewed as reflecting not so much a debate over whether agencies should engage in CBA at all (indeed, as argued in the paper, there are reasons to believe that agencies themselves will continue to conduct it), but rather, differences over the institutional framework in which this analysis should occur.

To advance this argument, I begin by surveying the current use of CBA within U.S. financial rule-making and the different institutional frameworks in which it is conducted across financial regulators. Using examples from recent regulatory initiatives, I illustrate how CBA is used by financial regulators in four principal institutional contexts. First, financial regulators are shown to differ in whether their CBA analysis is subject to review by the Office of Information and Regulatory Affairs (OIRA). Situated within the White House Office of Management and Budget (OMB), OIRA has required for over three decades substantive CBA for all rules proposed by Cabinet departments and executive agencies. However, because most U.S. financial regulators exist as independent regulatory agencies, OIRA has been denied the authority to review their CBA analyses. The primary exception relates to rules promulgated by the Financial Stability Oversight Council (FSOC) and, for the period prior to Dodd-Frank, rules promulgated by the Office of the Comptroller of the Currency (OCC).

While OIRA review constitutes the first institutional dividing line for agencies using CBA, a second, independent dividing line appears in the form of judicial review of an agency’s CBA. As reflected in cases such as Business Roundtable v. SEC, the statutory authority under which a U.S. financial regulator engages in rule-making has frequently been construed by courts to require a formal CBA. Separate and distinct from the type of CBA review associated with OIRA, this form of CBA review has occasionally resulted in rules being remanded to agencies for insufficient analysis. Other agencies, however, have been determined by courts to be free of a statutory requirement of CBA, freeing these agencies to use, or not use, CBA as they deem appropriate—unless they happen to be required to conduct CBA for OIRA.

The following two-by-two table summarizes how these two institutional features work in tandem to define the context in which financial regulators engage in CBA, along with examples of agencies that fit within each paradigm:

Appreciating the critical role of institutional design in shaping financial regulator’s use of CBA has important implications for the current debate about the proper role of CBA in financial regulation. Perhaps most importantly, the fact that so many financial regulators officially use CBA highlights that a formal requirement of CBA need not lead to regulatory paralysis as CBA detractors so often contend. As I argue in the paper, nor would this result necessarily change if Congress were to require that agencies engage in more rigorous, quantifiable CBA as has been proposed in several pending bills. At the same time, however, the uneven application of CBA engendered by the four paradigms raises a number of concerns that suggest this institutional framework would itself fail a cost benefit analysis, providing a compelling case for encouraging a more uniform system of CBA through greater institutional oversight. However, in contrast to currently-pending proposals to find this oversight in judicial review, analysis of the unique challenges of financial rule-making suggests the advisability of moving towards a system similar to what applied to the OCC prior to Dodd-Frank. This system, which eschews judicial review in favor of an effectively unenforceable obligation to comply with an interagency review of CBA mandates, may hold the greatest promise for encouraging a more uniform and transparent application of CBA across financial regulators while avoiding the critique that CBA leads to regulatory paralysis and delay.

The full paper is available for download here.