(John Kemp is a Reuters market analyst. The views expressed are his own)
By John Kemp
LONDON, Feb 24 (Reuters) - ”I have reached a tipping point,“ Commissioner Scott O‘Malia told an open meeting of the U.S. Commodity Futures Trading Commission (CFTC) on Feb. 23, ”and can no longer tolerate the application of such weak standards to analysing the costs and benefits of our rulemakings.
”Our inability to develop a quantitative analysis, or develop a reasonable comparative analysis of legitimate options, hurts the credibility of this Commission and undermines the quality of our rules.
“I believe it is time for professional help,” O‘Malia told his fellow commissioners. He warned that he would be writing to the president’s Office and Management and Budget to seek an independent review of certain rules and to ask for “recommendations as to how the Commission can improve its cost-benefit analysis and analytical capabilities”.
O‘Malia’s passionate but carefully scripted comments mark the latest stage in his evolution from cautious supporter to chief internal opponent of CFTC Chairman Gary Gensler’s efforts to rewrite derivatives rules and implement roughly 60 new regulations required by the Dodd-Frank Act.
The commissioner’s personal journey mirrors the mounting pushback from the financial services industry, business groups, conservative lawyers, free-market thinkers and Republicans in Congress against the changes mandated by Dodd-Frank as memories of the crisis fade and attention turns to the burden of complying with regulations.
Demanding that federal rules be subject to strict, quantified cost-benefit analysis (CBA) has become a rallying cry for business groups and conservative scholars seeking to roll back government.
O‘Malia cited with approval a recent article on “Over-regulated America” in the “Economist” magazine. The Economist singled out the Dodd-Frank Act and complained, “Red tape in America is no laughing matter. The problem is not the rules that are self-evidently absurd. It is the ones that sound reasonable on their own but impose a huge burden collectively.”
The magazine recommended “all important rules should be subjected to cost-benefit analysis by an independent watchdog. The results should be made public before the rule is enacted.”
Last year, O‘Malia complained about the lack of quantitative cost-benefit analysis behind the CFTC’s decision to impose position limits in commodity derivatives. This lack of quantitative evidence is central to the legal challenge to position limits being mounted by the International Swaps and Derivatives Association (ISDA) and the Securities and Financial Markets Association (SIFMA).
ISDA and SIFMA are represented by the same lawyers who have already successfully struck down two securities rules on the grounds the Securities and Exchange Commission failed to perform and adequate cost-benefit assessments before implementing them.
It seems obvious federal agencies such as the CFTC should have to prove that the benefits of new regulations outweigh the costs before introducing them. But the reality is more complicated as even some of the proponents of cost-benefit analysis acknowledge, and it does not necessarily yield easy answers.
O‘Malia cited a paper on “Cost-Benefit Analysis and the Commodity Futures Trading Commission,” written by William Albrecht, a former acting chairman of the CFTC, given to a conference in April 2011.
Albrecht noted current law does not require the Commission to determine whether the benefits exceed the costs nor whether proposed rules are the most cost effective way to achieve the stated goals. Section 15(a) of the Commodity Exchange Act (7 USC 19(a)) simply requires the CFTC to consider the costs and benefits of its actions and evaluate them in five broad areas. Quantification is not required.
Albrecht concluded that more emphasis on cost-benefit analysis would, on balance, lead to a more efficient regulatory regime and that regulators should be required to undertake more rigorous analysis than they currently do. But he also highlighted some of the problems that make cost-benefit analysis more of an art than a science.
“A vast majority of CFTC staff and of the Commission itself would argue that any detailed CBA of the proposed Dodd-Frank rules is impossible. They would also argue that it would be pointless to evaluate rules that are required by the law. And they would argue that a serious effort at CBA would require vastly more staff ... to undertake mission impossible,” he wrote.
“There is a great deal of truth in these concerns. Certainly to undertake serious CBA of all the Dodd-Frank rules could be as monumental a task as writing all 60 sets of rules.”
In many cases rules are required by law, and the language mirrors the statute; the CFTC has therefore not subjected the requirements to a detailed CBA test.
O‘Malia complains that even in such cases, “the Commission always has some level of discretion in determining the means to achieve mandates”. But that comes perilously close to suggesting the Commission should use its expert judgement to overturn the intention of elected representatives in Congress.
Proponents of cost-benefit analysis and smarter regulation seem confused about how rules should be written and by whom.
The Economist calls for rules to be much simpler: “When regulators try to write an all-purpose instruction manual, the truly important dos and don‘ts are lost in a sea of verbiage. Far better to lay down broad goals and prescribe only what is strictly necessary to achieve them. Legislators should pass simple rules and leave regulators to enforce them.”
But this is unfair. It is precisely what Congress did with the Dodd-Frank Act (passing broad principles and leaving officials to fill in the details).
Yet elsewhere in the same article the Economist complains, “Hardly anyone has read Dodd-Frank ... Those who have struggle to make sense of it, not least because so much detail has yet to be filled in: of the 400 rules it mandates, only 93 have been finalised. So financial firms in America must prepare to comply with a law that is partly unintelligible and partly unknowable.”
Legislators are criticised when they write overly prescriptive rules and criticised when they delegate the detail to bureaucrats.
As you would expect, the Economist is not terribly keen on handing “too much power to unelected bureaucrats” but says this would be acceptable “if they were made more accountable”. Unreasonable judgements should be subject to swift appeal, and poor decision-makers should be sacked, according to the magazine.
The Economist cites an essay by another proponent of regulatory reform, Philip Howard, calling for an end to “the core assumption that regulation should be an instruction manual. It is far more effective to give general instructions about the ends to be achieved, economist Friedrich Hayek observed, and leave it to the different individuals to fill in the details according to the circumstances.” (“Results-Based Regulation: A Blueprint for Starting Over”).
Unfortunately, discretionary application of the rules rarely suits business (or lawyers) who want stability and predictability. Much of the complexity and prescriptiveness of regulations in America is the result of business lobbying, which has sought to curtail the discretion of regulators and carve out a myriad of exemptions for special interests.
Presumably, the proponents of smart regulation would require unelected officials to be guided by CBA in fleshing out the rule book and exercising discretion in individual cases. But as Albrecht shows, many costs (and by extension benefits) are hard to quantify. The results of CBA exercises can be manipulated by making small changes in the assumptions to influence the outcomes.
Drafting more general laws, which entails subjecting implementing regulations to tougher, more quantitative cost-benefit analysis and trusting regulators with more discretion, is a superficially attractive model. But the reality would be messy and impractical.
Cost-benefit analyses would be disputed and open to manipulation. The process would be enormously costly and generate an even greater avalanche of documentation. It would hold regulators to an impossible standard (which often seems to be the purpose for conservative advocates). And enforcement would become even more unpredictable and arbitrary.
What is more important, responsibility for making policy would pass from elected representatives to unelected lawyers, lobbyists, economists and bureaucrats.
Cost-benefit analysis is seductive, but it is not the simple solution conservatives such as O‘Malia and the Economist seek. (editing by Jane Baird)