In the modern financial architecture, financial services and products increasingly are provided outside of the traditional banking system—and thus without the need for bank intermediation between capital markets and the users of funds. Most corporate financing, for example, no longer is dependent on bank loans but is raised through special-purpose entities, money- market mutual funds, securiti es lenders, hedge funds, and investment banks. This shift, referred to as “disintermediation” and described as creating a “shadow banking” system, is transforming finance so radically that regulatory scholars need to rethink their assumptions. Two of the fundamental market failures underlying shadow banking—information failure and agency failure—were also prevalent in the bank-intermediated financial system. By amplifying systemic risk, however, disintermediation greatly increases the importance of what scholars long have viewed as a third market-failure category: externalities. Viewing externalities as a distinct category of market failure, though, is misleading. Externalities are fundamentally consequences, not causes, of failures, and all market failures can result in externalities. Focusing on externalities also obscures who should be responsible for causing the externalities. This Article argues that the third market-failure category should be reconceptualized as a “responsibility failure”: a firm’s ability to externalize a significant portion of the costs of taking a risky action. This reconceptualization would not only more precisely describe the market failure but also help to illuminate that sometimes the government itself, not merely individual firms, should bear responsibility for causing externalities, and that exercising this responsibility may require the government to enact laws that require firms to internalize those costs.



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