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This is the Cost of Protecting Investors From Their Own Decisions

Vernon L. Smith | On October 6, 2016

This paper offers several explanations of the decline in new-bank entry, which in recessions tends to be much less severe than it has been since 2007-8. A prominent cause mentioned is the increase in the regulatory burden for start-up banks.

https://www.richmondfed.org/~/media/richmondfedorg/publications/research/economic_brief/2015/pdf/eb_15-03.pdf

But I think it is missing the essence of the public policy failure. At the outset, policy confused protecting depositors with protecting investors.

The latter, by definition is a key buffer that maintains depositor value in the face of declining asset value. Large bank protection from bankruptcy meant that the influx of new banks was more important than ever.

Why? New capital flowing into new economic activity receives the entire (incentive compatible) earnings return. New capital flowing into existing banks shares the return with rescued incumbent investors, who did not have to take their hit.
Policy, focused on preventing bankruptcy, then required increased capital & oversight to avoid re-occurrence. That in turn, discouraged new bank entry at a time when it was most essential for recovery.

Conclusion: Let them fail; then leave them alone.
Can public policy better protect central bankers and the Treasury Secretary from cronyism?

Vernon L. Smith

Dr. Vernon L. Smith was awarded the Nobel Prize in Economic Sciences in 2002 for his groundbreaking work in experimental economics. Dr. Smith has joint appointments with the Argyros School of Business & Economics and the School of Law, and he is part of a team that will create and run the new Economic Science Institute at Chapman.

Dr. Smith has authored or co-authored more than 250 articles and books on capital theory, finance, natural resource economics and experimental economics. He serves or has served on the board of editors of the American Economic Review, The Cato Journal, Journal of Economic Behavior and Organization, the Journal of Risk and Uncertainty, Science, Economic Theory, Economic Design, Games and Economic Behavior, and the Journal of Economic Methodology. He is past president of the Public Choice Society, the Economic Science Association, the Western Economic Association and the Association for Private Enterprise Education. Previous faculty appointments include the University of Arizona, Purdue University, Brown University, the University of Massachusetts, and George Mason University, where he was a Professor of Economics and Law prior to joining the faculty at Chapman University. Dr. Smith has been a Ford Foundation Fellow, Fellow of the Center for Advanced Study in the Behavioral Sciences and a Sherman Fairchild Distinguished Scholar at the California Institute of Technology.

In 1991, the Cambridge University Press published Dr. Smith’s Papers in Experimental Economics, and in 2000, a second collection of more recent papers, Bargaining and Market Behavior. Cambridge published his Rationality in Economics: Constructivist and Ecological Forms in January 2008. Dr. Smith has received an honorary Doctor of Management degree from Purdue University, and is a Fellow of the Econometric Society, the American Association for the Advancement of Science, and the American Academy of Arts and Sciences.

Dr. Smith is a distinguished fellow of the American Economic Association, an Andersen Consulting Professor of the Year, and the 1995 Adam Smith Award recipient conferred by the Association for Private Enterprise Education. He was elected a member of the National Academy of Sciences in 1995, and received CalTech’s distinguished alumni award in 1996. He has served as a consultant on the privatization of electric power in Australia and New Zealand and participated in numerous private and public discussions of energy deregulation in the United States. In 1997 he served as a Blue Ribbon Panel Member, National Electric Reliability Council.

Dr. Smith completed his undergraduate degree in electrical engineering at the California Institute of Technology, his master’s degree in economics at the University of Kansas, and his Ph.D. in economics at Harvard University.