Corporate Governance

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

By J. Robert Brown

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.

Full post as published by The Race to the Bottom on February 10, 2009 (boomark / email).