Streetwise Professor

February 4, 2017

The Regulatory Road to Hell

One of the most encouraging aspects of the new administration is its apparent commitment to rollback a good deal of regulation. Pretty much the entire gamut of regulation is under examination, and even Trump’s nominee for the Supreme Court, Neil Gorsuch, represents a threat to the administrative state due to his criticism of Chevron Deference (under which federal courts are loath to question the substance of regulations issued by US agencies).

The coverage of the impending regulatory rollback is less that informative, however. Virtually every story about a regulation under threat frames the issue around the regulation’s intent. The Fiduciary Rule “requires financial advisers to act in the best interests of their clients.” The Stream Protection Rule prevents companies from “dumping mining waste into streams and waterways.” The SEC rule on reporting of payments to foreign governments by energy and minerals firms “aim[s] to address the ‘resource curse,’ in which oil and mineral wealth in resource-rich countries flows to government officials and the upper classes, rather than to low-income people.” Dodd-Frank is intended prevent another financial crisis. And on and on.

Who could be against any of these things, right? This sort of framing therefore makes those questioning the regulations out to be ogres, or worse, favoring financial skullduggery, rampant pollution, bribery and corruption, and reckless behavior that threatens the entire economy.

But as the old saying goes, the road to hell is paved with good intentions, and that is definitely true of regulation. Regulations often have unintended consequences–many of which are directly contrary to the stated intent. Furthermore, regulations entail costs as well as benefits, and just focusing on the benefits gives a completely warped understanding of the desirability of a regulation.

Take Frankendodd. It is bursting with unintended consequences. Most notably, quite predictably (and predicted here, early and often) the huge increase in regulatory overhead actually favors consolidation in the financial sector, and reinforces the TBTF problem. It also has been devastating to smaller community banks.

DFA also works at cross purposes. Consider the interaction between the leverage ratio, which is intended to insure that banks are sufficiently capitalized, and the clearing mandate, which is intended to reduce systemic risk arising from the derivatives markets. The interpretation of the leverage ratio (notably, treating customer margins held by FCMs as an FCM asset which increases the amount of capital it must hold due to the leverage ratio) makes offering clearing services more expensive. This is exacerbating the marked consolidation among FCMs, which is contrary to the stated purpose of Dodd-Frank. Moreover, it means that some customers will not be able to find clearing firms, or will find using derivatives to manage risk prohibitively expensive. This undermines the ability of the derivatives markets to allocate risk efficiently.

Therefore, to describe regulations by their intentions, rather than their effects, is highly misleading. Many of the effects are unintended, and directly contrary to the explicit intent.

One of the effects of regulation is that they impose costs, both direct and indirect.  A realistic appraisal of regulation requires a thorough evaluation of both benefits and costs. Such evaluations are almost completely lacking in the media coverage, except to cite some industry source complaining about the cost burden. But in the context of most articles, this comes off as special pleading, and therefore suspect.

Unfortunately, much cost benefit analysis–especially that carried out by the regulatory agencies themselves–is a bad joke. Indeed, since the agencies in question often have an institutional or ideological interest in their regulations, their “analyses” should be treated as a form of special pleading of little more reliability than the complaints of the regulated. The proposed position limits regulation provides one good example of this. Costs are defined extremely narrowly, benefits very broadly. Indirect impacts are almost completely ignored.

As another example, Tyler Cowen takes a look into the risible cost benefit analysis behind the Stream Protection Rule, and finds it seriously wanting. Even though he is sympathetic to the goals of the regulation, and even to the largely tacit but very real meta-intent (reducing the use of coal in order to advance  the climate change agenda), he is repelled by the shoddiness of the analysis.

Most agency cost benefit analysis is analogous to asking pupils to grade their own work, and gosh darn it, wouldn’t you know, everybody’s an A student!

This is particularly problematic under Chevron Deference, because courts seldom evaluate the substance of the regulations or the regulators’ analyses. There is no real judicial check and balance on regulators.

The metastasizing regulatory and administrative state is a very real threat to economic prosperity and growth, and to individual freedom. The lazy habit of describing regulations and regulators by their intent, rather than their effects, shields them from the skeptical scrutiny that they deserve, and facilitates this dangerous growth. If the Trump administration and Congress proceed with their stated plans to pare back the Obama administration’s myriad and massive regulatory expansion, this intent-focused coverage will be one of the biggest obstacles that they will face.  The media is the regulators’ most reliable paving contractor  for the highway to hell.

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  1. So, if you nix Dodd-Frank, get rid of leverage ratio requirements, let the derivative markets do what they will. Then how do you prevent the next 2008? What is the better way?

    Comment by Howard Seth Miller — February 4, 2017 @ 9:43 pm

  2. @Howard Seth. Contrary to the received narrative, derivatives markets had a peripheral role at best in the financial crisis. And as I have written here extensively since the immediate aftermath of the crisis, the regulations themselves–especially clearing and collateral mandates–have not reduced systemic risk, but have merely redistributed systemic risks.

    The ProfessorComment by The Professor — February 4, 2017 @ 9:52 pm

  3. This could get real interesting depending on the scope of any roll back of US regulations. What is under appreciated is the extent, for better or worse, of harmonisation of regulatory regimes across jurisdictions and the amount of effort expended in getting the US, Europe and others to agree to a common framework. Protecting that are onerous requirements that apply when dealing with a counterparty located in a materially non compliant jurisdiction.

    An unintended consequence of significant US deregulation may be an increase in capital requirements and/or further concentration of clearing.

    Ah, the joy of global markets.

    Comment by noir — February 5, 2017 @ 7:46 am

  4. Chevron deference is a recipe for lazy government. Lazy courts won’t hold the Deep State to the limits of statute, so lazy bureaucrats don’t do the hard work of making solutions in compliance with the law. It didn’t take long for lazy legislatures to learn how to avoid the hard political choices that come with writing clear and concise law, and we get fuzzy good-intentionism like the Americans with Disabilities Act, and delegate-whatever-it-takes-to-make-this-brick-fly Obamacare, effectively pushing the blame for any costs on the executive, and the hard work of clarifying policy onto the judiciary. Now the courts have accumulated a giant tangle of made-it-up-as-we-went-along case law that makes every case harder to decide. So now maybe the courts have learned that laziness doesn’t pay in the long run, eh?

    Comment by M. Rad. — February 5, 2017 @ 9:35 pm

  5. Seth needs to read John Allison’s book.

    Comment by @pointsnfigures — February 7, 2017 @ 7:28 am

  6. When i discuss such matters with Liberals, i usually just point them to the McGovern Op Ed in the WSJ where he tells the story of how he essentially was bankrupted by the ADA in the B&B he opened after losing the presidential election of 1972. And how laws with good intentions even pave the road to hell for democrats.

    Comment by Jeffrey — February 8, 2017 @ 1:15 pm

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