OMB's constant thrust is to achieve the least burdensome rule rather than the most effective rule -- even when the issue is protecting consumers from being maimed and killed, saving over 10 million American jobs, or preventing over $21 trillion in losses in GDP.
The Madness of Econometrics and Financial Models
The refusal of OMB's theocrats, including Obama's theocrats, to learn even the most glaring answers demonstrated by the most recent crisis is demonstrated by the Primer's treatment of econometrics and financial models. The econometric tests of the desirability of proposed regulations designed to stem an epidemic of accounting control fraud will always be disastrously wrong. These tests evaluate a proposed rule, e.g., to ban fraudulent liar's loans, by looking at whether the lending practice is associated with increased reported profits (or higher stock prices, but they are largely driven by reported profits). The obvious problem, which we have known for 30 years -- but which OMB refuses to recognize -- is that whatever lending practices optimize accounting control fraud will have the strongest positive correlation with reported (fictional) profits.
The problem with models is that they assume there is an exogenous distribution of economic events. No one who knows anything about statistics (or economics or finance) believes this to be true. (The "Black Swan" author pretends that there is an exogenous distribution but that we have failed to count the really bad parts of distribution accurately. I am confident that if he was asked point blank whether he believes there is a fixed, exogenous distribution of economic events. The truth is that our policies shape the distribution of economic events.) If we continue to create ever more criminogenic environments we will suffer ever more catastrophic crises. In finance, the officers who develop and choose the economic models used to measure risk have powerful conflicts of interest. If they understate the risk of owing an asset -- dramatically -- the value of the model will assign a much higher "market" value to the asset. The officer, and his superiors', bonuses will be significantly larger if the model inflates the market value. These deliberate modeling errors are massive. The deliberate model errors led to "toxic waste" (CDOs "backed" largely by fraudulent liar's loans) being rated "AAA." A rough approximation is that the models claimed that the toxic assets were worth twice their true value, so they claimed that assets worth about $1 trillion were worth $2 trillion. The roughly $1 trillion overstatement of toxic securities was a primary driver of the crisis.
The Primer is oblivious to both of these methodological disasters and blithely demands that agencies go down the same failed road. Note the subtle manner ("central scenario for the baseline") in which OMB marginalizes financial crises -- the paramount risk that should be driving our highest priority financial regulatory actions. OMB's directives are (1) contrary to every principle of valuing costs and benefits and (2) systematically, and massively, understate the benefits of effective regulation.
"Calculate the benefits and costs associated with each scenario. Once the set of plausible scenarios has been specified, the agency can calculate the benefits and costs associated with each scenario. At this stage, the agency has all of the information it needs to conduct a sensitivity analysis. A sensitivity analysis examines how the benefits and costs of the rule change with key uncertain variables.
Construct a range of values. When the agency cannot specify probabilities for the relevant scenarios, the agency should develop a central scenario for the baseline and for each regulatory alternative that reflects the agency's best estimate of the likely consequences of each regulatory alternative. The agency should use the benefits and costs of these best estimates to approximate the expected value of the benefits and costs of each regulatory alternative to use in its regulatory decision-making. The agency should also characterize ranges of plausible benefits, costs, and net benefits of each regulatory alternative."
The fable that there is an exogenous distribution that would allow the (sensible) use of statistical techniques in financial regulation remains sacrosanct at OMB. The reality is that the agencies are forced to waste massive amounts of time producing faux econometric and statistical analyses that have crippling biases against effective regulation, which even more theocratic judges can then use to strike down any effective regulation.
Conclusion
Overall, the sick joke is that due to OMB's dominance of cost-benefit analysis the fact that theoclassical economists were the primary architects of our three modern financial crises has led to them gaining ever greater, and more destructive power. The more incompetently OMB behaves and performs and the more crises it causes; the more power it gains to screw up the world.
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