Essay on Cost Benefit Posner Weyl

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CHICAGO
COASE-SANDOR INSTITUTE FOR LAW AND ECONOMICS WORKING PAPER NO. 683
(2D SERIES)
PUBLIC LAW AND LEGAL THEORY WORKING PAPER NO. 473

COST-BENEFIT ANALYSIS OF FINANCIAL REGULATIONS: A
RESPONSE TO CRITICISMS
Eric A. Posner and E. Glen Weyl

THE LAW SCHOOL
THE UNIVERSITY OF CHICAGO
May 2014
This paper can be downloaded without charge at the Institute for Law and Economics Working Paper
Series: http://www.law.uchicago.edu/Lawecon/index.html and at the Public Law and Legal Theory
Working Paper Series: http://www.law.uchicago.edu/academics/publiclaw/index.html and The Social Science Research Network Electronic Paper Collection.

Electronic copy available at: http://ssrn.com/abstract=2436538

Cost-Benefit Analysis of Financial Regulations: A Response to Criticisms
Eric A. Posner & E. Glen Weyl 1
May 14, 2014

Abstract. Financial regulators should use cost-benefit analysis (CBA) to evaluate financial regulations. Finance is an ideal domain for CBA because the direct costs and benefits of financial activity can be easily monetized, and a huge amount of data exists for calculating the relevant valuations. John Coates and others have argued that in fact the valuations are too difficult to determine because of unique features of financial markets that distinguish them from other types of markets where CBA is used. We respond that these features are present in other markets, and that financial valuations are difficult to determine at present only because academic research on them is at an early stage.

In two recent articles, we urged financial regulators to use cost-benefit analysis (CBA) to evaluate financial regulations. 2 John Coates has emerged as a leading critic of this view. 3 Doubts can also be found in a recent paper by Jeffrey Gordon. 4 In this Essay, we survey their objections and respond to them.
We make several points. First, Coates conflates two separate issues: the advisability of
CBA and the uncertainty of valuations. He argues that because scholars have so far disagreed about relevant valuations, regulators should not engage in CBA. However, he exaggerates the difficulty of determining valuations. The current level of uncertainty justifies greater investment in academic research, not abandonment of CBA.
Second, Coates makes a series of theoretical arguments that valuation difficulties do not arise merely from the paucity of academic research but from the nature of financial markets. He argues that financial markets are “central,” “social,” and “non-stationary” in a way that other markets are not, and this explains why valuation problems cannot be surmounted. Gordon makes a similar argument that CBA of financial regulations cannot work because financial markets are
“constructed” or artificial. We argue the opposite: that because financial markets generate a huge amount of data, and because most of the relevant valuations are monetary in nature, financial
1

Kirkland & Ellis Distinguished Service Professor, University of Chicago Law School; Assistant Professor,
Department of Economics, University of Chicago. Thanks to Cass Sunstein for comments, and to Jullia Park for research assistance.
2
Eric A. Posner & E. Glen Weyl, Benefit-Cost Analysis for Financial Regulation, 103 AM. ECON. REV (PAPERS &
PROC.) 393 (2013), available at http://ssrn.com/abstract=2188990; Eric A. Posner & E. Glen Weyl, Benefit-Cost
Paradigms in Financial Regulation, J. LEGAL STUD. (forthcoming, 2014), available at http://chicagounbound.uchicago.edu/cgi/viewcontent.cgi?article=1647&context=law_and_economics. 3
John C. Coates, IV, Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications (Harvard Law
Sch. Eur. Corp. Governance Inst. Law Working Paper No. 234, 2014 ), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2375396. 4
Jeffrey N. Gordon, The Empty Call for Benefit-Cost Analysis in Financial Regulation (Colum. Law & Econ.
Working Paper No. 464, 2013), available at…