Two family traditions
Douglas Warren Diamond was born in Chicago on October 25, 1953. His family joined two very different American stories. His mother’s parents were Catholics from Madison, Wisconsin: his grandmother, Ethel Houlehan Gunkel, was of Irish descent, and his grandfather, Frederick Gunkel, the chief hog buyer for Oscar Mayer, was of Austrian and German descent. His father’s parents were Jewish. His grandfather, Harry Diamond, had emigrated from Austria at 14 and ran a family business making rabbinical wine in New York City, founded by the family of his grandmother, Hattie Wirklich Diamond. The firm failed in the Great Depression, and Harry, Diamond writes, never recovered emotionally.
His father, Leon Diamond, grew up in Bensonhurst, Brooklyn, trained as a doctor through the Navy’s wartime programme and became a psychiatrist on the faculty of Northwestern University. His mother, Margaret Gunkel, had been widowed young before meeting Leon; she later became a social worker, deputy director of the Illinois Department of Mental Health and a professor of social work. Diamond’s parents divorced before he was two, and he was raised by his mother in Hyde Park, near the University of Chicago, while seeing his father regularly. His Jewish grandmother, he recalls, never forgave his father for marrying outside the faith, and he met her only a few times.
From a poor student to economics
Diamond describes himself as a terrible student until high school; his mother privately told relatives she would be happy if he managed to graduate from junior college. At the Latin School of Chicago he became serious, discovering social science through a course on constitutional law and a seminar on capitalism that read Milton Friedman, and helping to teach a class using Paul Samuelson’s textbook. Even so, he went to Brown University planning to become a molecular biologist.
Two weeks into his first biology course he dropped it and took intermediate microeconomics instead. A summer job at an investment bank, collecting data on what companies paid to borrow through bank loans versus directly issued debt, introduced him to a question he would study for years. In his senior year a course on Friedman and Anna Schwartz’s Monetary History of the United States, which spends much of its length on the bank failures of the 1930s, convinced him that bank failures damage the economy in more ways than Friedman and Schwartz described. His final exam book from that course is now in the Nobel Prize Museum.
Yale and the Federal Reserve
Diamond went to Yale for his doctorate in 1975, drawn by James Tobin. Summer jobs at the Federal Reserve Board gave him a practical education in banking. Asked to fix a simulation model of savings and loan associations, he built a new one, which showed that these institutions, borrowing short-term to fund 30-year fixed-rate mortgages, would become insolvent if interest rates rose sharply, a prediction that the savings and loan crisis of the 1980s bore out.
At Yale his adviser was Stephen Ross, who taught him to strip a model down until it was no longer a model and then add back one element at a time. Diamond says he would still be in graduate school without him. Among Ross’s students was Philip Dybvig, who would become his most famous collaborator. Diamond earned his Ph.D. in 1980 and joined the University of Chicago’s business school, now Chicago Booth, in 1979, where he has taught ever since apart from a year at Yale. He is the Merton H. Miller Distinguished Service Professor of Finance.
Why banks exist, and why they are fragile
In 1983 Diamond and Dybvig published “Bank Runs, Deposit Insurance, and Liquidity” in the Journal of Political Economy. It explains something everyone relies on but few think about. Savers want to be able to get their money whenever they need it, while productive projects need long-term funding. A bank solves this by taking deposits that can be withdrawn at any time and lending them for years, a process called maturity transformation. That is how banks create liquidity for savers while financing homes, businesses and investment.
The same structure makes banks vulnerable. A bank never holds enough cash to repay all its depositors at once. If depositors start to fear that others will withdraw, it becomes rational for each of them to rush to the bank first, and the fear becomes self-fulfilling: even a perfectly sound bank can collapse. Diamond and Dybvig showed that the remedy is a government guarantee. If depositors know their money is insured, they have no reason to run, and the run never starts. As the Royal Swedish Academy of Sciences put it, deposit insurance in theory never needs to be used, which explains why most countries now have such schemes.
Banks as monitors
A year later, in “Financial Intermediation and Delegated Monitoring,” Diamond explained another reason banks exist. Checking that borrowers use loans properly is costly, and it would be wasteful for thousands of small savers to do it separately. A bank does the monitoring on everyone’s behalf, and because it lends to many borrowers, its depositors do not need to monitor the bank in turn. The Nobel committee called this the first truly micro-founded theory of financial intermediation.
The theory also explains why bank failures are so damaging. The knowledge a bank builds up about its borrowers disappears when it fails and takes time to rebuild, so credit dries up and the economy suffers long after the crisis. That insight, alongside Ben Bernanke’s research on the Great Depression, showed why preventing widespread bank collapses matters so much.
Diamond kept returning to the question he first met in a summer job: why do some companies borrow from banks while others issue debt directly to investors? In a 1991 paper he showed that young firms without a track record benefit from a bank’s monitoring, while established firms with good reputations can borrow directly in the market. With Dybvig he wrote a second paper in 1986 applying their ideas to the regulation of banks and other financial intermediaries. Later, with Raghuram Rajan, he showed how the very fragility of banks disciplines them to lend wisely, and with Zhiguo He he studied how short-term debt can discourage firms from investing.
Protecting savers today
The committee said that Diamond and Dybvig’s insights form the foundation of modern bank regulation. Deposit insurance schemes, central banks acting as lenders of last resort, and rules requiring banks to hold liquid assets all address the vulnerability their model identified. When runs swept through shadow banks, institutions that borrowed short and lent long outside the regulated system, in the financial crisis of 2008 and 2009, the same framework explained what was happening, and its insights helped shape the emergency lending that kept the crisis from becoming a new depression. Economists have since used the model to study runs on money market funds and other non-bank institutions.
Diamond worked directly on policy during that crisis. He joined the Squam Lake group of economists that proposed reforms to financial regulation, served as an informal adviser to the U.S. Treasury and presented policy ideas to the Federal Reserve Board. With Raghuram Rajan, later Governor of the Reserve Bank of India, he wrote influential papers on liquidity, financial fragility and the credit freeze caused by fear of fire sales, and with Anil Kashyap he worked on how regulators should set banks’ liquidity requirements. The committee also noted the limits: deposit insurance can encourage risky behaviour, so other rules on bank capital and borrowing may be needed.
His work with Kashyap extended the original model to partial runs, in which only some depositors withdraw, and showed that this has surprising implications for how much cash and other liquid assets regulators should require banks to hold. Diamond has been careful to separate banks that are insolvent, whose loans are bad, from banks that are merely illiquid, sound but short of cash, a distinction his 1983 model with Dybvig made precise.
Teacher and family man
Diamond has advised 62 Ph.D. students at Chicago, passing on Ross’s philosophy of listening to what each student is trying to do. He served as president of the American Finance Association in 2003 and was elected to the National Academy of Sciences in 2017. For thirty years he was a regular visiting scholar at the Federal Reserve Bank of Richmond.
He married Elizabeth (Elee) Cammack, an economist in empirical finance, in 1982. Their children, Rebecca and William, are both economists; the family, he jokes, does not have a well-diversified portfolio of human capital, but enjoys economics jokes at the dinner table. His Jewish heritage comes through his father’s side of the family, and he is listed among Jewish Nobel laureates on Wikipedia’s list; he has not written about religious practice. In 2022 he shared the Nobel Memorial Prize in Economic Sciences with Bernanke and Dybvig for research on banks and financial crises.
Legacy
Diamond’s work is the reason economists can explain, in a few simple steps, both what banks do for society and why they can fail overnight. Every time a government reassures depositors that their savings are insured, or a central bank lends to a sound bank facing a sudden run, it is acting on the logic he and Dybvig set out in 1983. Their model has helped make bank runs, once a regular source of economic disaster, far rarer and far less damaging for ordinary savers.
Sources & further reading
Douglas Diamond, Biographical, NobelPrize.org · Popular information: The Prize in Economic Sciences 2022, NobelPrize.org · Press release: The Prize in Economic Sciences 2022, NobelPrize.org · Douglas Diamond, Wikipedia · Researched from the sources above and checked against them. Spotted an error? Tell us.
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