Thursday, October 15, 2009

Too Big to Fail, Too Big Not to Know

Corporate Justice Blog Posting 10/15/09

Too Big to Fail, Too Big Not to Know[i]

We are all more than familiar with the financial crisis in the fall of 2008 where the US and global economies experienced a financial crisis of cataclysmic proportions. Beginning with the failure of several Wall Street financial firms, the financial markets reacted to the crisis by freezing the credit markets leading to a US and global recession.

The underlying cause of the financial crisis is widely attributed to the risky bets of many Wall Street firms on the financing and selling of financial instruments tied to consumer mortgages.[ii] In addressing the financial crisis, the Treasury Department and the Federal Reserve began unprecedented efforts to inject capital into financial markets (by providing loans and other equity capital to banks in order for the institutions to avoid bankruptcy), and to assess the underlying causes of the financial crisis.[iii] The federal government also began a multi-agency investigation into the conditions, which caused the financial crisis.[iv]

The Treasury Department concluded there were several reasons for the financial crisis.[v] Citing a lack of regulatory oversight and transparency in the selling of collaterized debt obligations and mortgage-backed securities by banks, investment banks, and other financial firms, the federal government began a regulatory overhaul of financial firms.[vi]

The assessment of systemic risks in the financial markets was determined to be a regulatory priority. The Treasury Department began to identify institutions it deemed “too big to fail” and establish procedures for applying a “stress test” to these institutions.[vii]

Two key initiatives are noteworthy. One calls for increased transparency, accountability, and monitoring of firms receiving federal funds.[viii] The second calls for housing support and foreclosure prevention for consumer mortgages.[ix] While both initiatives potentially improve the accountability of financial firms in their use of government funds, the government requirements for risk assessment do not require financial firms to put in place reasonable procedures to assess the effects of mortgage lending on communities of color.

The financial crisis caused by risky bets on Wall Street has had more dramatic effects on communities of color in the form of mortgage foreclosures.[x]
Communities of color were more likely to be the victims of fraudulent and unscrupulous mortgage broker practices.[xi] While Wall Street appears to be headed for new record profits and bonuses for employees, the downstream communities harmed by the financial instruments fueling Wall Street growth continue to receive little attention.[xii]

Federal Regulators must mandate that Wall Street financial firms deemed too big to fail develop a corporate social responsibility agenda for corporate governance. Corporate social responsibility requires firms to consider the consequences of business decisions on society.[xiii]
Financial firms deemed too big to fail by the federal government should be required to develop a corporate governance process in which a corporate social responsibility agenda assesses the potential negative consequences of loan products derived from consumer lending, particularly on low income or communities of color.

Requiring a corporate social responsibility agenda that seeks to understand the downside risk of financial products on communities of color, serves two important goals.
First, financial firms deemed critical to the economic stability of US and global economies and requiring government funding in the event of financial instability should be required to know the effect of their financial products, which are derived from consumer mortgages, on the communities served. Second, financial firms critical to the flow of capital should be required to assess the future economic consequences of the mortgaged based products they sell on the communities they serve.

If a financial firm is too big to fail, it is also too big not to know the consequences of its financial decisions on the communities it needs to drive its financial success.

[i] Comments of Z. Jill Barclift, Associate Professor of Law, Hamline University School of Law. These comments are based on a forthcoming presentation and essay.

[ii] See generally THE TRILLION DOLLAR MELTDOWN (Charles R. Morris 2008)

[iii] See generally (last accessed 10/15/09) Statements by Secretary Henry M. Paulson, Jr. on Financial Markets Update, October , 2008

[iv] See generally (last accessed 10/15/09) Joint Economic Committee: Shelting Neighborhoods from the Subprime Foreclosure Storm

[v] See generally (last accessed 10/15/09)

[vi] Id.

[vii] Id.

[viii] Id.

[ix] Id.

[x] See generally (last accessed 10/15/09) Worl Economic Forum, Partnering to Strengthen Public Governance (January, 2008)

[xi] Id.

[xiii] Id.


  1. professor barclift:

    news yesterday reports that foreclosures hit a record three month high in the period of the last three months where hundreds of thousands of homes were foreclosed on by banks.

    news today indicates that goldman sachs is reporting record profits and plans to set aside dozens of billions of dollars for bonuses for its employees and executives.

    the wall street journal says that the crisis is "ebbing." what evidence is there that anything is going to change? the crisis may be ebbing for the elite, but it seems to be continuing unabaited for the taxpayers?

  2. You would do more with a much smaller expenditure of time, effort and resources (financial or otherwise) by ending the nonsensical concept of "too big to fail" and its resulting over-incentivizing of risk than you would by mandating "social consciousness" on corporations.