Are cost-benefit analyses exploited?

Cost-benefit analyses are either being productively used or abused in financial regulation, depending on your point of view.

Those stances are embroiled in intensive debate, as highlighted by two recent events.

The first is the introduction of a bill by Sens. Susan Collins, R-Maine, Rob Portman, R-Ohio, and Mark Warner, D-Va., to authorize the president to require independent agencies to conduct cost-benefit analyses of proposed new rules.

The bill, known as the Independent Agency Analysis Act of 2012, or S 3468, would, according to Mr. Portman, “minimize unnecessary burdens on the economy … by bringing independent agencies under the same burden-reducing requirements that apply to other regulators.”

The bill has garnered some bipartisan interest among legislators and has won the support of former administrators of the Office of Information and Regulatory Affairs under both Democratic and Republican administrations. OIRA is the agency within the Office of Management and Budget that handles oversight of the cost-benefit analysis requirements that apply to other, non-independent agencies.

At the forefront of opposition to S 3468 is the Consumer Federation of America.

The CFA argues that the bill would “singlehandedly eliminate [the] independence [of the agencies involved] and hand special interests another tool that they can use to stop or delay urgently needed protections.”

The second event is a provocative report from Better Markets, a nonprofit, nonpartisan organization that promotes the public interest in financial reform, that lends credence to the concerns raised by the CFA.

ALLEGED MISUSE

The Peterson Institute for International Economics released the report, “Setting the Record Straight on Cost-Benefit Analysis and Financial Reform at the SEC,” on July 30. It makes the case that the financial services industry is misusing cost-benefit analyses, especially as applied to Dodd-Frank rule making, as an intentional strategy to delay or defeat needed financial regulatory reforms through paralysis by analysis.

Although intent is difficult to prove, the limitations of cost-benefit analyses are real and are well-delineated in the Better Markets report. Costs of regulations generally are much easier to estimate than benefits because they are well-defined and likely to be incurred as soon as regulations are implemented.

Conversely, benefits are often not as easily quantified, nor even monetary, and are achieved only over the long term.

Though the source of costs might be relatively easy to identify, the amounts used can be inaccurate. Estimates commonly are drawn from data supplied by the regulated industry, which has an inherent incentive to maximize cost estimates to make the case for minimal regulation.

Experience has shown that once regulations are imposed, industry players are quite adept at finding ways to minimize compliance costs beyond what was assumed for projection purposes.

Moreover, though costs of regulations are borne by the regulated, benefits generally are realized in the form of harms not inflicted on clients of those companies or on broader segments of society. In economic terms, costs are internalized, while benefits are externalized.

Thus regulated industries not only have incentives to overestimate costs that they may incur, they have reason to discount or deny expected benefits as they attempt to deter stricter regulations.

Compounding the problem of internalized/inflated costs and externalized/understated benefits is the complexity induced when multiple regulations are intended to provide an integrated solution to a systemic problem. In such cases, a rule requiring a separate cost-benefit analysis for each separate regulation would be ill-advised because the benefits of a comprehensive regulatory strategy can be overlooked.

The real issue in the debate that is raging is whether, in this era of ultrapolarized politics, cost-benefit analyses can be used as weighted, objective measures to aid in the regulatory process or if they will be exploited through the political process as a cost minimization tool for the financial services industry. This debate is one that is worth the attention and active participation of anyone concerned about good government and the future success of regulatory reform.

Blaine F. Aikin is chief executive of fi360 Inc. and a member of the steering committee for the Committee for the Fiduciary Standard.