Douglas Diamond of University of Chicago wins Nobel in economics

The University of Chicago’s Douglas Diamond has spent his academic career researching short- and long-term financial assets. All the while, his work was building its own value, for him and society.

Monday, he got the news that extremely deferred compensation was headed his way. Diamond, finance professor at the University of Chicago Booth School of Business, won the Nobel Prize for economic sciences, recognition for research into the banking system that goes back to the 1980s.

It’s been a career of applying theory to the real world of lending, addressing when banks need to take risks and why they might need help during a crisis. They can be well-capitalized but still susceptible to “the fear of fear itself,” Diamond said.

His papers have influenced top policymakers, including former Federal Reserve Chairman Ben Bernanke, also awarded a Nobel on Monday for parallel research into the banking system. Bernanke is now with the Brookings Institution.

Diamond also shares the Nobel with Philip Dybvig of Washington University of St. Louis for papers they co-authored. The three men divide a financial award of about $900,000.

“A well-structured financial system, it’s very vulnerable to the fear of fear itself, a self-fulfilling prophecy that it might go down,” Diamond said at a U. of C. news conference.

He said banks are so crucial to the way money moves that intervention, whether from the Federal Reserve or the healthiest banks, is needed when the system is under extreme stress because a perceived threat is as important as the threat itself. He said the Fed, which has hiked interest rates to cool an inflationary economy, has been an effective steward. It responded well to the financial crisis of 2008 and regulations enacted afterward have made for a stronger banking system, Diamond said.

Banks are pivotal because they connect savers, who want instant access to their money, to businesses who have borrowed for success down the road. “If you borrow short term and finance with something long term [i.e. business loans] you can’t sell very well, you better be able to keep rolling over that debt or you’re dead,” he said.

His work with Dybvig, including a seminal 1983 paper called “Bank Runs, Deposit Insurance, and Liquidity,” is considered central to modern banking theory. Because of their shared research interests, Diamond said he was in touch frequently with Bernanke during the latter’s time at the Fed.

Diamond, 68, said the award surprised him, although he quickly caught on when a call from Sweden woke him from a sound sleep and informed him he had won. He figured it wasn’t a prank because he recognized the voices of two Nobel committee members on the call.

He insisted there was no voice within him wishing the Nobel had come earlier in his career. “We don’t want to get it too young. It sort of goes to your head,” Diamond said.

He joins a scholastic lineup of heavy hitters at the U. of C. The school lists seven other Nobel laureates in economics on its current faculty. Counting economics and other fields, Diamond is the 97^th U. of C. scholar to earn a Nobel.

In his remarks, Diamond said the award honors the collaborative nature of the U. of C. He said colleagues have helped him write papers that were academically rigorous while still talking directly to central bankers dealing with everyday practicalities.

U. of C. President Paul Alivisatos spoke to that culture in congratulating Diamond, saying his work exemplifies a tradition of encouraging researchers to ask the right questions. “This is a community of individuals that really questions assumptions and who care about the power of ideas and the freedom to engage in open debate,” he said.

Asked what he’ll do with his share of the prize money, Diamond said he’ll probably put it in a total market index fund, taking care to keep his investments well-diversified. He said he hopes to continue teaching a few more years.

Diamond has been affiliated with the U. of C. since 1979. He earned his bachelor’s at Brown University and his master’s and doctorate, all in economics, at Yale University. He is a research associate at the National Bureau of Economic Research and visiting scholar at the Federal Reserve Bank of Richmond.

The award led to a day of congratulations on the Hyde Park campus. Asked what he plans to do to kick up his heels, Diamond, with an economist’s cost-benefit attitude, said he and his wife would take advantage of warm October weather. They plan a dinner at a favorite restaurant with outdoor seating — location undisclosed.

Anthony Vazquez/Sun-Times

Editor’s note: This article was updated to say 97 University of Chicago scholars have received Nobel prizes.