Economic Analysis by Federal Financial Regulators

November 15, 2012

Since the current economic crisis, financial markets have been subjected to expansive regulatory overhaul. For example, the Wall Street Reform and Consumer Protection Act ("Dodd-Frank") gave the financial regulators a long list of regulations to engineer and enact, says Hester Peirce is a senior research fellow at the Mercatus Center.

While the swift exercise of the Dodd-Frank agenda is to quell the problems in finance, it does not necessarily follow that this theoretical frame will be empirically effective, especially if the constructs are not subject to intensive economic analysis. Indeed, the failure to routinely conduct economic analysis on financial regulatory initiatives undercuts the pursuit for optimal results.

Peirce's investigation reveals the following:

  • The federal regulators charged with implementing Dodd-Frank and regulating the financial markets perform very little high-quality economic analysis.
  • Although each regulator has a unique approach to economic analysis, all approaches fall short of the standard to which executive agencies are held.
  • Furthermore, regulators responsible for the Dodd-Frank implementation are subject to relatively few explicit, statutory requirements to conduct economic analysis in connection with their rulemaking.
  • In most cases, regulators have been inept in conducting thorough regulatory analysis designed to identify the problems necessitating regulation and the best solution to achieve the best result.

Peirce says that an in-depth economic analysis should be part of the reform making process; it is vital for successful reforms. By avoiding substantive economic reflection, lawmakers deprive themselves of instrumental tools in the rulemaking process.

Indeed, federal financial lawmakers have a responsibility for monitoring the foundation of particular institutions or the financial system as a whole. A deep understanding of economics is paramount for the task.

  • Cost-benefit analysis is one such tool of economics.
  • Cost-benefit analysis is a way for identifying, targeting and checking the impacts of regulatory measures on the underlying causes.
  • It is imperative to understand what those root causes are and how targeted solutions will affect the financial institutions, their customers, and the economy as a whole.
  • Economic investigation improves regulatory analysis by providing concrete guideposts.

Source: Hester Pierce, "Economic Analysis by Federal Financial Regulators," Mercatus Center, October 23, 2012.

 

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