Commissioner Paredes, the SEC, and the Subterfuge of Cost Benefit Analysis

With all of the turmoil surrounding the SEC these days, Commissioner Paredes at the SEC gave a very curious speech at SEC Speaks on Friday, Feb. 6.  It did two things.  First, it was an apology for his vote to ban short selling last Fall.  As we noted on this Blog, the SEC used its emergency authority under Section 12 of the Exchange Act to ban all short selling.  It was an extraordinary step and possibly a violation of the emergency authority.  Paredes, as a Republican appointee (he replaced Paul Atkins), felt the need to justify his vote to interfere with the markets in such a dramatic way.  As he noted:

• For me, it boiled down to determining that if the ban might help stabilize the situation, the ban's potential benefits justified its costs, particularly given that the ban was temporary. Put differently, given the chance that the temporary ban would help stem the financial tumult, the cost of Commission inaction would have been too high. More to the point, as events stood, it was apparent that the private sector was not well-positioned to address the present systemic risk. Ensuring a sound, well-functioning financial system — a "public good" — called for a limited and temporary government response.

The remainder of the speech was a call for the application of rigorous cost-benefit analysis.  As he said:  "Simply put, regulatory decision making at the SEC — and throughout government generally — should be based on rigorous cost-benefit analysis, including sound economics."  No one would disagree that in assessing regulation, some analysis of costs and benefits needs to occur. 

But this call for "rigorous cost benefit analysis" is really a call for less regulation.  Those who promote the approach have an easy time finding costs.  All regulatory changes engender some costs.  Companies need to change the way they do things and that often results in additional expenses.  At the same time, the benefits are usually amorphous, focusing on things like investor confidence and the integrity of the financial markets.  Those who want a "rigorous" application of cost benefit analysis typically discount these benefits.  As a result, the costs of any regulation almost always outweigh the benefits. 

The irony in Paredes speech is that he apparently didn't undertake a cost benefit analysis in connection with the ban on short selling.  Where intervention in the market suited him, it was enough to conclude that the intervention might have some benefit. 

It is the "rigorous cost benefit analysis" that largely got us into the trouble we are in now.  It was an approach to regulation that hypothesized that the costs almost always outweighed the benefits.  Fortunately, while that philosophy was in the majority under the old Commission, regime change has transformed it into a minority view.

Comments

[ruralcounsel]

In what way did cost-benefit analysis contribute to the sub-prime implosion? That is the trouble we're in now, isn't it?

The detractors of cost-benefit analysis dislike that the costs or benefits as the case may be (depends if they are for or against the action the cba is evaluating) are difficult to make quantitative.

Often the cost or benefit is diffuse and theoretically spread out over long time periods. This is classicaly the case in environmental or health issues. the cost of smoking a cigarette today is miniscule, but continued for the next 40 years may be great. Of course, that same risk over the next 100 years is immaterial, because the smoker will be dead anyway, whether from smoking or something else.

Those are not valid criticisms of cost-benefit analysis; those are criticisms of how society as a whole values things differently than certain individuals value them. The critics like an analysis approach that is more malleable and distortable to give them the result they want.

Perhaps Congressional Democrats did a cost-benefit analysis regarding efforts to boost home ownership among those unlikely to be able to meet their obligations, and the resultant bubble in real estate prices? And decided that the immediate benefit to their political careers was worth the long term cost to the nations economy and to the financial situations of those being foreclosed upon after losing what little savings they may have had?

Perhaps Congressional Republicans did a cost-benefit analysis of the muckraking they would have to endure to bring a halt to the social engineering, and decided that since it wasn't their constituency, why bother?


Cost-benefit isn't a call for less regulation. It's a call for decision-making by something other than gut-feel and wishful thinking. It's a call for respecting the science, such as it is ... something the Bush administration was pilloried for not doing, and Obama said he'd correct.

People that don't like to put prices on things they want someone else to pay for ... those are the people that don't like cost-benefit analysis.