The following post comes to us from Omri Ben-Shahar, Professor at the University of Chicago Law School and Carl E. Schneider, Professor at the University of Michigan Law School. It is based on their recent paper entitled “The Futility of Cost Benefit Analysis in Financial Disclosure Regulation” and is available here.
A fascinating debate is emerging: should financial regulations be subject to Cost-Benefit Analysis (CBA) just as, say, environmental regulations are? In a recent article for the Journal of Legal Studies (here), we examined financial regulation’s crown jewel—mandated disclosure—and asked what would happen if CBA were applied to it.
Mandated disclosure is American law’s most common regulatory technique, nowhere more prominently than in financial regulation. Financial crises breed disclosure mandates, from the Securities Act of 1933, the Truth-in-Lending laws of the 60s and 70s, Sarbanes-Oxley in 2002, and now the Dodd-Frank Act. Disclosure is also favored in vast stretches of consumer-protection law, health law, privacy law, campaign finance law, conflicts of interest regulation, and much more.
Almost as striking as mandated disclosure’s ubiquity is the absence of evidence that its benefits outweigh its costs. Lawmakers require disclosure without serious CBA because it looks superfluous. Disclosure’s benefits seem obviously great, its costs seem obviously small, especially relative to other regulations.
Is real CBA of disclosure regulation possible? What would it show? We argue that only a slivery fraction of the thousands of mandates would survive. For two reasons. First, mandated disclosure’s proved benefits are significantly lower than often assumed. We wrote a book explaining this in detail (here) and documenting disclosure’s recurring failures. The prolonged effort to reform, improve, and simplify financial disclosure shows how elusive benefits are. Second, disclosures fail because of an unrecognized but significant cost that even systematic CBA cannot capture. In the remainder of this piece, we explain this overlooked cost, likely to dwarf any perceived benefit. With our more complete account of mandated disclosure’s costs, we conclude that even disciplined CBA of any disclosure regulation is likely to inspire false regulatory hopes.
The Uncounted Cost
Disclosures usually tax disclosers and recipients only modestly. But they impose a potentially devastating cost on each other—on other disclosures competing for the same audience’s eyeballs. To people so deluged by disclosures, attention given one necessarily comes at the expense of others. To illustrate, consider another regulatory behemoth: consumer loan disclosures.
Regulators have been mandating numerous disclosures of consumer-credit information. Loans—even simple mortgages—have many moving parts, many risks and pitfalls, and mistakes can be disastrous. Over the years, statutes, regulations, and court decisions have added to the clutter of disclosures consumers get at loan closings.
The Consumer Financial Protection Bureau recently tried to simplify this. Dodd-Frank required the Bureau to unify and redesign two confusing Federal disclosures into a single integrated form. The Bureau used sophisticated empirical methods in trying to produce one simple and effective disclosure. It used advance cognitive sciences to design an appealing format and hired a research company to test multiple versions of the disclosure. This produced a new and distinctively clear form, a fine improvement on its predecessors (here). This comes as close as possible to cost-benefit analysis of a disclosure mandate.
Is this a regulatory success? The revised disclosures were drafted and tested in isolation, without resolving the problem of accumulation. In the real world of mortgage borrowing, people cannot focus their attention with the intensity achieved in laboratory experiments because they receive much more than the improved form. As many as fifty disclosures may be mandated even for a simple mortgage. The Bureau’s new form is only one. Other federal agencies, state legislatures, municipal ordinances, and court decisions mandate disclosures. There are disclosures about the loan’s taxation; the appraisal; the credit-reporting practices; conflicts of interests; the right to cancel the transaction; non-discrimination; privacy; payment options; escrow choices; and much more. There is even—wonderfully—the Paperwork Reduction Act disclosure.
So instead of getting a single form in a CBA laboratory study, borrowers get a stack easily exceeding one hundred pages and needing dozens of signatures. Even if each disclosure were superbly designed, their accumulation would defeat their purpose.
Disclosures, that is, graze a public commons—people’s attention. Each draws a bit of this resource, degrading the others. Since disclosures are regulated piecemeal, this negative externality is not counted and cannot possibly be measured. No agency can abolish old disclosures mandated by another agency. Different agencies have jurisdiction over different aspects of a transaction. Pressure is constant to add new disclosures for new problems, but rarely is pressure to erase obsolete disclosures. Even Dodd-Frank, which was launched to the beat of the “smart and simplified disclosure” drum made things worse by adding a host of new disclosure items.
Many lawmakers now recognize a different problem with excess information—overload. But even if they recognize that too much information within a disclosure is counterproductive, they do not see that too much information across disclosures is just as harmful. Unfortunately, no method of measuring disclosure’s cost-effectiveness can account for the accumulation problem. The externality each disclosure imposes on others cannot be measured. And while individual disclosures can be re-engineered, the ever-mounting accumulation of disclosures cannot be stopped.
The risk we identified is “tunnel vision”—a narrow perspective that encourages regulators to exaggerate the benefits of a proposed regulation. Tunnel vision comes from the ways a regulation may interact with other regulations, including those issued by other federal, state, and local agencies. In some areas, these interactions can be solved by a coordinator like OIRA—the White House Office of Information and Regulatory Affairs. OIRA reviews regulation from different agencies and can be a repository of institutional knowledge and of coordination. It can guide regulators and discourage them from going down blind alleys and reproducing old errors. But even OIRA might not be able to overcome the excessive accumulation of legislative disclosure mandates. At best, it ought to teach agencies the limited utility of the disclosure device.