Point of View: Riskless Capitalism

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The US government decision to cover uninsured deposits at Silicon Valley Bank (SVB) undermines free market discipline.
If large depositors are always protected in the name of financial stability, moral hazard increases and "riskless capitalism" is encouraged.

Deposits over "$250,000" were known to be uninsured.
Streaming device maker Roku had "more than $450 million in deposits at SVB."
Based on past FDIC interventions, a haircut imposed on SVB’s large depositors would have cost uninsured depositors "about 10 percent of their balances."
The FDIC could have saved "$20 billion" while preserving the principle that some who take risks pay the consequences.
SVB was described by the Federal Reserve’s investigation as failing “because of a textbook case of mismanagement by the bank.”
SVB was the "16th" largest bank in the United States.

Powerful, politically connected depositors and venture capitalists lobbied for government protection; cited voices include David Sacks and Bill Ackman (as reported).
Political connections are illustrated by the involvement of a bank executive on the board of a governor’s spouse’s charity and the governor’s wineries being clients of SVB (as reported).
Regulatory changes in 2019 allowed banks like SVB to operate with less transparency and fewer checks, per the Fed’s post-mortem report.
When regulation can be captured, property rights and the rules of the market can be redefined to favor vested interests, converting pro-market rhetoric into pro-business outcomes.

Free enterprise capitalism requires government to set up and maintain the infrastructure that enables participants to trade freely and with confidence.
Because collective benefits of competitive markets do not produce concentrated private incentives to defend them, markets are politically fragile and subject to capture.
Periodic bailouts (after 2008 and during the pandemic) have made bank bailouts seem inevitable and to have gained intellectual respectability, weakening market discipline.
Reduced international competition and rising protectionism lessen the disciplining effect of foreign competition.
Political fear of electorate backlash over distributional outcomes discourages allowing market failures to play out, entrenching inefficient firms.

No incumbent businesses that are very powerful; each business must have only modest power so the state can act as an impartial enforcer.
An effective welfare system to reduce the political pressure to protect failing firms and to ensure that "Firms should go bust; people should not."
Reduce the power of incumbents by forcing them to compete with firms from other countries that do not protect the inefficient; maintain domestic markets open to international competition.
Persuade the public of the imperative for free, competitive markets so the wider public will resist narrow interest groups’ agendas.

Allow flighty uninsured demand deposits to function as a market discipline: if uninsured depositors pay attention, they can shut down incompetent bank management quickly, saving taxpayers money.
Impose haircuts on large uninsured depositors in cases like SVB to preserve market penalties for incompetence and deter future risky behavior.
If contagion risks materialize, consider announcing a blanket implicit guarantee for all deposits only as a last resort, not as a first response.
Develop metrics based on political influence (not only traditional market-dominance metrics) to limit firms’ political power.

Free-market outcomes are not an inevitable product of minimalist government; instead, markets are a political creation requiring specific conditions and active defense against vested interests.
Left unchecked, the natural tendency of political economy is toward cronyism or pro-business capitalism rather than pro-market capitalism.

Source: Point of View: Riskless Capitalism, F&D Magazine, Raghuram Rajan and Luigi Zingales, June 2023.

Riskless Capitalism
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