Regulators Must Think Before They Regulate

Last week, the Commodity Futures Trading Commission received a letter from a group of overseas regulators. The letter urged the CFTC to "ensure that rulemaking works not just domestically but also globally" before rules take effect. In other words, the CFTC should think before it regulates-not an outlandish request. If the CFTC were to take the formal steps to think through its rules that non-financial regulators are required to take, it would be a watershed event in the course of Dodd-Frank implementation.

Evaluating problems and solutions before regulating is critical, so a system is in place to ensure that regulatory agencies do so. Before adopting a regulation, agencies must pinpoint the problem they are trying to solve, think about whether a regulatory solution makes sense, identify alternative regulatory solutions, and rigorously analyze the costs and benefits of each of the alternatives. Agencies are required to make their analyses-and the assumptions underlying the analyses-transparent so that interested members of the public can comment on them. These analyses are reviewed by regulatory specialists in the President's Office of Management and Budget before a regulation is approved.

The problem is that independent regulatory agencies are not subject to any of these requirements. Because most financial regulators are independent regulatory agencies, almost all Dodd-Frank rulemaking is being done without the systematic analysis that other agencies are required to perform. In fact, Dodd-Frank changed the status of the Office of the Comptroller of the Currency, which was formerly subject to regulatory analysis requirements, so that it is now able to regulate analysis-free as its fellow financial regulators do.

Several of the financial regulators-including the Securities and Exchange Commission, the CFTC, and the Bureau of Consumer Financial Protection-have tailored analysis requirements in their organic statutes. Too often, however, these regulators have shirked their statutory responsibilities. Rather than engaging in thorough analysis, they have opted for compliance in name only. They have resorted to after-the-fact justifications of their regulations with a superficial nod to the language of cost-benefit analysis. This halfhearted approach to analysis could change, particularly as the track record of successful court challenges based on inadequate analysis is growing. In the meantime, however, Dodd-Frank rulemaking is proceeding, and its effects will be far-reaching. Because regulators are not conducting thorough analysis of regulations, the consequences-intended and unintended-are not well understood.

The lack of economic analysis is not attributable to the many, tight Dodd-Frank deadlines. Even before Dodd-Frank was a glimmer in Congress's eye, the SEC had lost several suits based on its paltry economic analysis. The absence of rigorous analysis is a persistent problem within these agencies, and we should demand better quality.

The resistance to conducting regulatory analysis extends beyond governmental financial regulators to quasi-governmental regulators such as FINRA, which regulates broker-dealers, and the PCAOB, which regulates auditors. These regulators have significant regulatory responsibilities over the securities and futures markets, but, as a general rule, are not performing economic analysis. As these regulators more aggressively push the bounds of their authority and lobby regulatory agencies and Congress for more power, their failure to conduct economic analysis will become an even more serious problem.

Foreign regulators were right to ask the CFTC to take a more deliberate approach to regulation. The problem of inadequate analysis, which I described in a recent paper, extends beyond the CFTC to all other financial regulators. We should not have to wait to find out how Dodd-Frank will affect the financial industry, consumers, manufacturers, farmers, small businesses, and the economy. We should encourage, or better yet mandate, our financial regulators to think before they regulate.