The Pie: An Economics Podcast Why Banks Exist and Why They Fail: Douglas Diamond on Runs, Regulation, and the Risks of Short-Term Debt
Jan 13, 2026
Douglas Diamond, a Nobel Prize-winning economist and finance professor at the University of Chicago Booth School, delves into the intricacies of banking and financial crises. He reveals how bank runs are often self-fulfilling prophecies, fueled by short-term debt's risks. Diamond shares his first-hand experience advising on the 2008 financial crisis and critiques the regulatory reforms that missed critical warning signs. He even likens the 30-year mortgage to Michael Corleone, cautioning that good ideas can go awry when they're poorly managed.
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Runs Are Self-Fulfilling Expectations
- Bank runs are self-fulfilling: if everyone believes a run will occur, it will, and vice versa.
- Visible signals (like a closed door) can flip expectations and trigger a run.
Short-Term Debt Creates Universal Run Risk
- Short-term liabilities funding long-term assets create identical run risk across institutions.
- Shadow banks face the same fragility even without traditional deposits or currency.
Why Banks Exist: Delegated Monitoring
- Banks exist to pool monitoring costs and diversify idiosyncratic loan risk.
- Delegated monitoring lets small depositors avoid costly individual oversight.
