When is profit justified? A market failures test on 2008 and DWS

In 2006 Moody's alone put its triple-A stamp on 30 mortgage-related securities every working day, and 83 per cent of the mortgage securities rated triple-A that year were later downgraded. The ratings were paid for by financial firms (Financial Crisis Inquiry Commission, 2011, p. xxv). If you own a business and are reviewing how it makes money, that raises a harder question than "are we profitable?": does the profit come from competition, or from a gap in the market that you happen to be standing in front of?

When does profit pass the market failures test?

As I read it: when the profit comes from competition in a market not distorted by four kinds of failure, and it becomes suspect when it lives off those failures. The library describes the market failures approach (MFA) as drawn from Heath (2014; 2006) and instructs the reader to list current profit strategies, map each to one condition, and drop any that exploit a breach Market Failures Approach (MFA).

Heath's 2006 paper starts from a common view of business ethics: moral problems as fiduciary obligations to stakeholder groups that have to be reconciled. He asks whether that is the most fruitful framing and outlines two alternatives, a narrow one anchored in obligations to shareholders and a broader one centred on market failure (Heath, 2006). The library adds two pitfalls: using the approach to justify every compliance cost, and forgetting that Heath does not impose direct duties to every stakeholder Market Failures Approach (MFA). In my reading, the test picks out suspect sources of profit. It does not draw up a list of what you owe each group.

What does the test say about US bank profits before 2008?

Several sources of profit in the 2007–09 US financial crisis fall under three of the four conditions, by my own mapping. Acharya, Cooley, Richardson and Walter (2011) name four failures: mispriced government guarantees, regulation that watched single institutions instead of the system, opaque derivatives positions, and runs on the unregulated banking sector (Acharya et al., 2011). They write about regulation, not managers' ethics, so the bridge to MFA is mine.

I could not fit the public goods condition without strain, and the test does not demand that every episode breach all four.

Where was the profit? Financial firms exploited gaps in regulatory capital rules to take a one-way bet of $2–3 trillion on the US economy, chiefly on housing (Acharya et al., 2011, p. 12). In 2004, after lobbying the SEC, the investment banks got the net capital rule amended, which roughly doubled their gearing (Acharya et al., 2011, p. 13). Large expected returns go hand in hand with large aggregate risk (Acharya et al., 2011, p. 16); in my reading, the return rewarded risk that others would pay for when things went wrong. But a failure only creates an opening: banks with cheap deposit insurance need not take excessive risk if their charter value outweighs the gain from shifting risk (Acharya et al., 2011, p. 12).

If the sources disagree on causes, can the test still be used?

Yes, because it asks what each profit rests on, not who caused the crisis. The library records two competing explanations, Acharya's and Tarr's; the Financial Crisis Inquiry Commission (FCIC) is a third voice.

The two authors stress different things about one event, the 2004 net capital rule: Acharya and colleagues describe it as the result of investment bank lobbying (Acharya et al., 2011, p. 13); Tarr calls it a regulatory failure rather than deregulation, because it applied Basel standards (Tarr, 2010).

What they share is how the profit was made. The FCIC says no one in the toxic mortgage pipeline had enough skin in the game, because each believed the risk could be passed on (Financial Crisis Inquiry Commission, 2011, p. xxiv); Tarr says originators collected fees without bearing the risk (Tarr, 2010). This post does not adjudicate the root cause: the FCIC conclusions are the majority's, and the dissents in the report were not used. The Commission also wrote that we expect businesses to pursue profits while producing quality products and conducting themselves well (Financial Crisis Inquiry Commission, 2011, p. xxii).

What does the DWS settlement show about information?

By my own mapping, the DWS case tests the information condition: a fund buyer can hardly check the investment process described in sales material, while the seller knows it. On 25 September 2023 the SEC announced that DWS Investment Management Americas, a Deutsche Bank subsidiary, had agreed to pay $25m in two separate actions, without admitting or denying the findings (US Securities and Exchange Commission, 2023).

On ESG, the SEC order found that DWS marketed itself as an ESG leader following specific policies but, from August 2018 until late 2021, did not fully implement some provisions as it had led clients to believe; the penalty was $19m. The other $6m was for failing to build an anti-money-laundering programme for its funds, a compliance failure I do not map to any condition (US Securities and Exchange Commission, 2023). The press release does not say what DWS earned from ESG products, so $19m does not measure the profit that rested on the claim. The post on sustainable marketing versus CSR covers how to keep evidence behind a claim before it is printed.

How should a small workshop sort its sources of profit?

List each source, map it to one condition, and ask: if this source disappeared, would the profit go because a rival did better, or because the person bearing the cost stopped bearing it? The example is entirely invented: "Workshop A", 40 staff, bottling fish sauce, every detail my own.

The test suits you if you can still choose between ways of earning and dropping one line will not sink the business. It does not suit you if the exploiting line is most of the profit, because that is then a question about the business model. The library also records a node on contextual judgement: fixing one failure on its own may not improve overall efficiency Market Failures Approach (MFA). If every other workshop keeps discharging into the ditch, dropping row three may push your prices up and lose orders; the table does not settle that.

Going deeper: what the post rests on, and what it does not

The post does not use Heath (2014) or Heath (2006) in full. The full texts sit behind a paywall or bot protection, and the open copies tried would not load. For the 2006 paper only the abstract was available. Whatever this post says about Heath's position rests on that and on the framework summary; the four conditions, the pitfalls and the contextual-judgement node are the library's.

For Acharya and colleagues (2011) the post uses the abstract, sections 1 to 3 and the first half of section 4, but not the transparency section or the part on emerging markets; page numbers follow the printed paper. For Tarr it uses the World Bank working paper (Policy Research Working Paper 5324, May 2010), not the version in the Journal of Financial Economic Policy, so it gives no page numbers and the published text may differ. For the FCIC it uses only the Commission's conclusions (pages xv to xxvii), not the body or the dissents. For the SEC it uses the whole press release but not the two orders it links to.

This post does not show that profit built on market failures caused the crisis, and it assesses no Vietnamese law or firm.