## Riskless Capitalism

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**Canonical URL:** [Riskless Capitalism](https://www.imf.org/-/media/files/publications/fandd/article/2023/june/rajan-june23.pdf)

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### Main findings on the SVB intervention
- The US government covered uninsured deposits at Silicon Valley Bank (SVB), undermining free market discipline.
- Deposits over $250,000 were uninsured under existing rules.
- Many firms failed to practice elementary risk management; example cited: Roku had more than $450 million in deposits at SVB.
- Shareholders and management of SVB were wiped out, but large depositors were protected by the government changing the rules—“riskless capitalism.”
- Based on past FDIC interventions, a haircut of about 10 percent on uninsured depositors would have been typical.
- An alternative strategy: impose a haircut on large depositors and, if contagion appeared, announce a blanket implicit guarantee for all deposits.
- The FDIC would have saved $20 billion under the haircut approach while preserving the principle that some who took risks pay the consequences.
- The Federal Reserve’s investigation described SVB as failing “because of a textbook case of mismanagement by the bank.”
- SVB was the 16th largest bank in the United States, but its clientele included very powerful and politically connected venture capitalists and firms.

### Analysis of moral hazard and political capture
- If large depositors are always protected in the name of financial stability, they should at least be charged the insurance fee that insured deposits bear.
- Repeated government bailouts reduce credibility when authorities claim future restraint: “A government that repeatedly shows its willingness to bail out has little credibility when it says next time will be different.”
- Immense lobbying influenced the government decision; examples cited include venture capitalists and tweets urging intervention.
- The ability to bend insurance rules for large depositors highlights an intrinsic contradiction in the Chicago tradition: the need for well-defined and well-enforced property rights versus the risk of regulatory capture by vested interests.
- If vested interests can redefine uninsured deposits as insured by invoking a larger public good, free enterprise capitalism becomes a political creation vulnerable to cronyism rather than an outcome of minimalist government.

### Conditions necessary to sustain pro-market capitalism (as identified by the authors)
- First: No incumbent businesses should be very powerful; each business must have only modest power so the state can act as an impartial enforcer.
- Second: An effective welfare system to prevent politicization of relief when competition triggers painful failures; “Firms should go bust; people should not.”
- Third: Reduce incumbent firms’ power by forcing them to compete with firms from other countries that do not protect the inefficient; maintain domestic markets open to international competition.
- Fourth: Persuade the public of the benefits and political fragility of free, competitive markets so the wider public will defend the system against narrow interests.

### Current threats to competitive markets and implications
- Massive direct bailouts during the global financial crisis beginning in 2008, and indirect bailouts during the pandemic, have normalized periodic bank bailouts and given them intellectual respectability.
- Competition between systems is increasingly threatened by old-style protectionism, often hiding behind geopolitical concerns; when trading is restricted to like-minded countries, inefficiencies persist and pressure for change falls.
- Political fear of electorate backlash (perceived unfair distribution of gains from capitalism and unfair competition) makes industrial countries reluctant to allow market losses to play out, entrenching inefficient practices.
- Standard antitrust metrics may miss political influence; there is a need to develop better metrics based on political influence to limit the political power of firms.

### Policy recommendations and implications
- Preserve market discipline by not automatically protecting uninsured depositors; consider imposing haircuts in line with past FDIC practice (about 10 percent).
- If systemic risk appears, accompany targeted discipline with a clear, time-bound blanket guarantee to contain contagion.
- Charge large depositors appropriate insurance fees if they are to be treated as effectively insured.
- Strengthen the four structural conditions for market competitiveness: limit incumbent power, provide effective welfare, maintain international competition, and build public support for free markets.
- Develop metrics to measure and constrain firms’ political influence, beyond conventional market-dominance measures.

*Raghuram Rajan and Luigi Zingales, Finance & Development, June 2023*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2023/june/rajan-june23.pdf_