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Vincent DiLorenzo*

Introduction................................................ 322 R

I. Cost-Benefit Analysis in the Legislative Arena........ 324 R A. The Embrace of Cost-Benefit Analysis as a Principle........................................ 324 R B. The Reality of Cost-Benefit Analysis in the Legislative Arena............................... 327 R

1. Evidence from the Committee Reports....... 328 R

2. Evidence from the Committee Hearings...... 332 R a. Enhanced Competition.................. 333 R b. Increased Efficiency..................... 335 R c. Lower Costs for Consumers............. 336 R d. Improved Access........................ 339 R e. New Products and Services.............. 342 R II. Legislative Deregulation as Benefit to Consumers..... 345 R A. Policy Makers and Assumed Consumer Benefit... 345 R B. The Evidence—Financial Services Deregulation Two Years Later................................ 346 R

1. Competition................................ 346 R a. Bank Entry Into Insurance and Securities. 348 R b. Insurance Company Entry Into Banking and Securities........................... 351 R c. Security Company Entry Into Banking and Insurance............................... 355 R

2. Efficiency.................................. 360 R

3. Lower Costs for Consumers................. 361 R a. Home Mortgage Rates.................

–  –  –


[Citigroup] is facing three types of risk.... The first is legal risk, related to [Enron] securities that the firm underwrote and sold to investors.... Then there is the regulatory risk, as Congress could try to restrict Citigroup’s activities.... The final concern is reputational.1 Cost-benefit analysis and a renewed embrace of deregulated markets are two legacies of the last decades of the twentieth century. This Article examines these two principles through a study of the 1999 financial services deregulation initiative—the last major deregulatory initiative of the twentieth century. It explores whether deregulation produces substantial consumer benefits. Part I of this Article examines cost-benefit analysis as a means to legislative decision-making. It examines whether Congress sought and received adequate explanation and documentation of the stated benefits of financial services deregulation to consumers. I conclude that while Congress has embraced cost-benefit analysis as a means of decision-making by regulatory agencies, it has paid only lip service to the principle in its own deliberations. Benefits frequently went unexplained, unchallenged, and undocumented. In essence, benefits were assumed.

1. Riva D. Atlas, Sinking Feeling Is Now Settling Over Citigroup, N.Y. TIMES, July 24, 2002, at C1 (paraphrasing views of Michael Mayo, analyst with Prudential Securities).

2003] COST-BENEFIT ANALYSIS 323 Part II explores the most frequently touted benefit of the legislative decision to deregulate particular markets—the benefit to consumers. The deregulated financial services industry—banks, insurance companies and securities firms—serve as the test case. Part II examines the outcome two years after enactment of the legislation. Were the congressional assumptions regarding consumer benefits justified?

I find that while consumer benefits were assumed to exist and to be significant, in reality, benefits have been modest or even nonexistent.

Part III of this Article explores possible explanations for the findings that Congress does not choose to employ a rigorous cost-benefit review of legislative proposals, such as the proposal to deregulate the financial services industry, and that experience has revealed little or no consumer benefit to the deregulation initiative. One explanation is political advantage. Endorsing consumer benefits has electoral advantages and therefore such benefits are stated or overstated based on little or no evidence. A second explanation is complexity and resultant unpredictability. A legislative change becomes one factor in a complex and dynamic mix that determines outcomes. Thus, unrelated, post-legislative changes in the business environment may have prevented expected consumer benefits from being realized. Both of these factors may play a role.

But I posit a more fundamental explanation: that the customary, generally accepted model of likely outcomes in deregulated markets must be reexamined. In this model, firms compete by seeking to capture a broad market of customers, products, and geographic areas— primarily on the basis of price. In some industries, however, substantial consumer benefits from deregulation cannot be reasonably expected to accrue, because providing consumer benefits across a wide spectrum of customers and products is not viewed as the best means to maximize profits or stock prices. Yet, legislators continue to assume the contrary.

This Article explores the stated and the realized benefits, if any, of deregulation. Adverse consequences of the 1999 deregulation initiative in the financial services market have recently surfaced. One consequence has been possible anticompetitive practices manifested through attempts to tie loans to investment services.2 Another conseSee ASS’N FOR FIN. PROF’LS, CREDIT ACCESS SURVEY: LINKING CORPORATE CREDIT TO THE AWARDING OF OTHER FINANCIAL SERVICES (2003) (reporting results of survey of senior corporate financial professionals, which revealed ties between short-term credit provided by commercial banks and other financial services, such as cash management services, underwriting services, and strategic advisory services), http://www.afponline.org/Information_Center/News/Credit_Access_Survey.pdf.

324 LEGISLATION AND PUBLIC POLICY [Vol. 6:321 quence has been possible conflicts of interest and subsequent poor decision-making resulting from deregulated companies’ engagement in both corporate lending and investment banking.3 These and other costs of deregulation must be weighed against the realized benefits of deregulation, and not against assumed benefits.

This is not to say necessarily that the 1999 deregulation initiative should be reversed. Pushing back the clock is always difficult. Additional safety measures might be required, however, and additional incentives or requirements to provide consumer benefits might be necessary. Moreover, experience now cautions that if an adequate cost-benefit analysis had been done initially, a wiser legislative initiative might have been an alternative to cross-industry competition.



IN THE Mr. TOOMEY: [O]ne of the primary objectives of H.R. 10 is to allow different kinds of financial institutions to offer different financial services with fewer obstacles, fewer impediments imposed by the regulatory structure. To the extent that some version of H.R. 10 succeeds in accomplishing that, would you feel safe in saying that this will almost certainly benefit consumers in the long-run by lowering the cost to these institutions in providing these services?

Mr. GREENSPAN: Oh, most certainly. In fact, at the end of the day, the whole purpose of the capitalist market system is effectively to help consumers.4 A. The Embrace of Cost-Benefit Analysis as a Principle Cost-benefit analysis has been increasingly embraced as a tool for decision-making at the federal level. Executive orders dating back

3. See, e.g., Gretchen Morgenson, Banks Are Havens (And Other Myths), N.Y.

TIMES, July 28, 2002, § 3 (Money & Business), at 1 (describing investors’ concerns with sufficiency of due diligence conducted by banks underwriting or dealing in WorldCom’s $12 billion bond offering, which was managed by Citigroup; analysts believe commercial banks were eager to teach companies how to skirt tax rules and accounting regulations so banks could capture lucrative securities underwriting deals);

see also Kurt Eichenwald & Michael Brick, Enron Investors Say Lenders Took Part in Fraud Scheme, N.Y. TIMES, Apr. 8, 2002, at A15 (reporting on lawsuit alleging that nine financial institutions participated in deals that disguised Enron’s true financial health); Emily Thornton & Wendy Zellner, Too Close For Comfort, BUS. WK., Mar.

18, 2002, at 78, 78–79 (reporting that firms that invested in Enron partnerships took part in investment banking business).

4. H.R. 10—The Financial Services Modernization Act of 1999: Hearings Before the House Comm. on Banking and Fin. Servs., 106th Cong. 143 (1999) [hereinafter House Banking Hearings] (exchange between Rep. Patrick J. Toomey and Alan Greenspan, Chairman, Federal Reserve System).

2003] COST-BENEFIT ANALYSIS 325 to 1981 have directed regulatory agencies to employ cost-benefit analysis.5 Some federal regulatory statutes have been interpreted by the courts as requiring cost-benefit analysis.6 The 1995 Unfunded Mandate Reform Act explicitly requires a written statement containing a qualitative and quantitative assessment of anticipated costs and benefits of any federal mandate imposed on state and local governments.7 Analyzing the benefits and costs of a legislative proposal has a long history as a suggested tool for legislative decisions. Long before the law and economics movement touted the need for cost-benefit analysis, legislative analysts spoke of the need for the legislature to consider the expected positive and negative effects of a legislative proposal before its enactment. This is an aspect of deliberative democracy that seeks collective decision-making by means of open debate among all who will be affected by a decision or by their representatives.8 In a deliberative democracy, political debate is organized around concepts of the public good and not around narrow self-interest.9 Open discussion is thought to be beneficial since it, among other things, reveals private information, lessens or overcomes the impact of bounded rationality, forces or encourages justification beyond pure self-interest, and legitimizes the ultimate choice.10 A bit of clarification is necessary here. The term cost-benefit analysis has been used to describe two distinct principles. First, it has been used to describe a standard that determines proper decisions.

This standard comes from the law and economics movement and posits that the best outcome is that which leads to the most efficient allocation of resources.11 This aspect of cost-benefit analysis has been

5. See Eric A. Posner, Controlling Agencies with Cost-Benefit Analysis: A Positive Political Theory Perspective, 68 U. CHI. L. REV. 1137, 1139 (2001); Edward R. Morrison, Comment, Judicial Review of Discount Rates Used in Regulatory Cost-Benefit Analysis, 65 U. CHI. L. REV. 1333, 1333 n.2 (1998).

6. See Posner, supra note 5, at 1139 n.17. R

7. See 2 U.S.C. § 1532(a) (2000).

8. See, e.g., Jon Elster, Introduction to DELIBERATIVE DEMOCRACY 1, 8 (Jon Elster ed., 1998); Joshua Cohen, Deliberation and Democratic Legitimacy, in DELIBERATIVE DEMOCRACY: ESSAYS ON REASON AND POLITICS 67 (James Bohman & William Rehg eds., 1997).

9. See Cohen, supra note 8, at 68. R

10. See James D. Fearon, Deliberation as Discussion, in DELIBERATIVE DEMOCRACY, supra note 8, at 45; Thomas Christiano, The Significance of Public Delibera- R tion, in DELIBERATIVE DEMOCRACY: ESSAYS ON REASON AND POLITICS, supra note 8, R at 243 (arguing that public deliberation leads to results that are more just and viewed as rationally justified by citizenry).

11. See RICHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 13 (4th ed. 1998); see also Matthew D. Adler & Eric A. Posner, Implementing Cost-Benefit Analysis When Preferences are Distorted, 29 J. LEGAL STUD. 1105, 1108 (2000) (linking cost-benefit analysis with efficiency).

326 LEGISLATION AND PUBLIC POLICY [Vol. 6:321 subject to a great deal of criticism.12 It is not the aspect of cost-benefit analysis explored in this Article.

A second manner in which the term cost-benefit analysis has been used is to describe a tool in the decision-making process. This tool requires the decision maker to explore in depth the expected or likely benefits and costs of a proposal before making a choice.13 As a process of decision-making, cost-benefit analysis does not prescribe a particular outcome. Benefits need not exceed costs for a decision to be proper. Rather, costs and benefits must be made explicit before a choice is made. This process has been widely accepted by academics because, among other things, it serves a democracy principle.14 Public policy considerations are forced into every legislative debate, and hopefully help to determine decisions. This is because a discussion of public benefits and costs becomes a necessary component of every decision-making process, and that discussion is publicly reported.

Such a process may help to avoid decisions based solely on interest group pressure or back-room political trades.

Even as a process for decision-making, some manifestations of the process have been controversial. At times, the cost-benefit process has been described as requiring the monetizing of all costs and benefits.15 Such monetization has been criticized.16 The process has also been criticized as requiring frequent comparisons of types of benefits

12. See, e.g., Richard Whisnant & Diane DeWitt Cherry, Economic Analysis of Rules: Devolution, Evolution, and Realism, 31 WAKE FOREST L. REV. 693, 725 (1996); see also Robert W. Hahn, Achieving Real Regulatory Reform, 1997 U. CHI.

LEGAL F. 143, 150 (1997) (listing various criticisms of cost-benefit analysis).

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