Changing Law to Address Changing Markets: A Consequence-Based Inquiry

Authors

Steven L. Schwarcz, Duke Law SchoolFollow

Document Type

Article

Publication Date

2017

Abstract

This essay uses consequence-based inquiry (“CBI”) to derive a normative framework for determining when financial market changes should drive legal changes. This framework can improve the current ad hoc and politically distorted lawmaking process, which often results in over- or under-reactive legal changes that are made too late, after harm has occurred. Under the framework, the extent to which financial market changes should drive legal changes should depend on the consequences of the market failures resulting from financial market changes and the consequences of changing the law to attempt to correct those market failures. CBI is broader in several ways than traditional cost-benefit analysis, addressing not only the “how” but also the “when” of regulation and also addressing the “how” more objectively than cost-benefit analysis. Whereas traditional cost-benefit analysis assumes a decision, which may well be politically motivated, to implement specific proposed regulation if its benefits exceed its costs, CBI begins by identifying a financial market change, determining whether any market failures result from the market change, and assessing the consequences of those failures. If those consequences are significantly negative, CBI gets to the next steps of considering legal changes that could correct the harmful failures, examining the consequences of making those changes, and finally balancing consequences to reach a course of action. Those next steps are more objective than cost-benefit analysis; they avoid confirmation bias because they do not necessarily start with any specific proposal, and they are less subject to political distortions.

Comments

When should financial market changes drive legal changes? The inquiry is important for many reasons, including that a normative framework could guide and add legitimacy to what is now a politically reactive lawmaking process. This essay hypothesizes that the extent to which financial market changes should drive legal changes should depend on consequences: consequences of the market failures resulting from financial market changes, and consequences of changing the law to attempt to correct those market failures. After showing why this consequence-based inquiry goes beyond traditional cost-benefit analysis, the essay tests the hypothesis under the literature on financial change and also by applying it to an actual financial market change—examining how the shift in corporate bond markets from holding-bonds-to-maturity to bond-trading should drive legal changes.

Citation

Steven L. Schwarcz, Changing Law to Address Changing Markets: A Consequence-Based Inquiry, 80 Law and Contemporary Problems 163-191 (2017)