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Professors Henderson and Ribstein touch on two theoretical failures of the behavioralist movement which both reveal the prematurity of ‘behaviorally-informed’ regulatory proposals: the behavioralist assumptions that (1) behavioral biases theoretically necessitate, or at least enable, public intervention, and (2) governmental entities can net improve individual outcomes over the status quo of unfettered, if limited, human capabilities.  I think both of these observations highlight the shocking dearth of theoretical exploration amongst behavioralists thus far.  I want to focus on connecting these assumptions to the connection between behavioral economics and administrative regulation.

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Behavioral law and economics (“BLE”) can influence legal policy analysis and regulation in many ways.  On balance, it is not at all clear that this new paradigm undermines a policy commitment to markets.  From one vantage point, the BLE movement can be said to help preserve markets. Importantly, those using the paradigm often start with an underlying assumption that markets are good and that regulations are appropriate only to help correct market defects.  Of course, if “defects” are defined too broadly, the default state of market activity is indeed threatened.  However, the idea that the behavioral movement threatens to erode the primacy of markets that would be achieved without the paradigm erroneously assumes that a government would ever sign onto completely unfettered market behavior.  However desirable a free market state of the world might be, the unfettered markets baseline fails to comport with political realities.  Even setting aside insights from public choice theory (which predicts policy interference with markets), there is always the sense that people aren’t the purely informed rational actors that law and economics models might assume.  Too many people we know and love—our parents, kids, cousins, even ourselves—suffer harm from their decisions as a consequence of a failure to investigate, overcome biases, properly value options etc.  Most people carry an intuition that some market taming/correcting mechanisms are appropriate, and BLE at least helps that discussion proceed rigorously. If so, behavioral law and economics might help to ensure that regulatory actions are market preserving relative to the state of government without those insights.

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Few academic publications have had as much direct public influence on the law as the 2008 article by my NYU colleague Oren Bar-Gill and then Harvard Law Professor Elizabeth Warren.  In “Making Credit Safer,” they seek to combine two strands of academic thought in support of one great cause—more regulation of financial markets.  They start with the central claim of behavioral economics that sophisticated entrepreneurs are able to take advantage of the systematic foibles of ordinary people, by rigging their products in ways that work systematically to their own advantage.  By plying ordinary individuals will carefully packaged payment contracts, firms can undercut the central postulate of rational choice economics that all voluntary transactions produce mutual gains for the parties.  In its stead we get the wreckage of families and fortunes brought about by unscrupulous bankers in search of a buck.  Warren and Bar-Gill repeatedly talk about the importance of empirical evidence.  Her own work, however, is exceptionally shoddy, as Todd Zywicki has recently pointed out in the Wall Street Journal.

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The idea that the regularity of behavioral departures from full rationality justifies regulatory intervention has rarely gained more credence than in the context of consumer finance.  The Credit CARD Act of 2009 rests on nothing so much as the supposition that cardholder decisions about spending and repayment reflect systematic misapprehension of the likely patterns of future behavior.  And given Elizabeth Warren’s prior writings with Oren Bar-Gill, we can expect the new CFPB to rely heavily on such regulation.

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The problem with behavioral law and economics (and its behavioral economics cousin) is not that it has nothing interesting to say, but rather that the interesting things it has to say do not mean what its proponents think they mean.  It is one thing to claim that people are less rational than we thought.  It even one thing to claim that people are systematically less rational than we thought, in predictable and important ways.  But it is entirely another to presume that the implication of this is a larger scope for government regulation to protect the market and market actors from the depredations of this irrationality.

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The Wall Street Journal is reporting that the Feds (the SEC, the FBI, and federal prosecutors in New York) are about to bring a host of insider trading charges “that could ensnare consultants, investment bankers, hedge-fund and mutual-fund traders and analysts across the nation.”  The authorities, which have been investigating the situation for three years, are boasting that their criminal and civil probes “could eclipse the impact on the financial industry of any previous such investigation.”

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In a front-page article entitled Congress Staffers Gain from Trading in Stocks, the Wall Street Journal reports that “72 aides on both sides of the aisle traded shares of companies that their bosses help oversee.” That finding was based on an “analysis of more than 3,000 disclosure forms covering trading activity by Capitol Hill staffers for 2008 and 2009.”

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The Obama administration has promised that the Federal Reserve’s new Consumer Financial Protection Bureau will be independent from politics, a model of regulatory expertise grounded in sound data and economics. Naming Harvard Law Prof. Elizabeth Warren as de facto agency head undermines both goals.

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Todd mentions Elizabeth Warren’s “kick off” speech for the CFPB, in which she accepts the new “President and Special Advisor to the Secretary of the Treasury” gig, and tells us what the new Bureau is all about…

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