OK, some notes on the classic Diamond-Dybvig paper on bank runs, which exemplified the kind of economic analysis I've always loved: a (relatively) simple model that transforms your understanding, so that you'll never see things the same way again 1/ bu.edu/econ/files/201…
If you're a normal human being, the paper might not look simple or even comprehensible. But trust me: they wrote down more or less the simplest possible model of what banking does, why it serves a useful purpose, but why it's vulnerable to self-fulfilling panics 2/
The idea is that people want liquidity — ready access to their wealth if needed — but that productive investment requires tying up a lot of wealth in illiquid assets that can't be quickly converted into cash 3/
Banks square this circle by offering people deposits that can be withdrawn at will, but investing most of the funds in illiquid loans to businesses etc. This normally works because not everyone needs cash at the same time 4/
By reconciling the need for liquidity with the need for illiquid investments, banking makes society richer. But ... it creates the risk of crisis. If, for whatever reason, people lose confidence in banks, they will all try to withdraw funds at once 5/
This can force banks into fire sales, and make fundamentally solvent institutions go bankrupt — and bank runs can be contagious. What's the answer? One answer is to have a central bank — which can't run out of money bc it prints it — lend to cash-short banks in a crisis 6/
Another answer is deposit insurance, which reassures people that their money is safe. However, both answers create moral hazard — a temptation for banks to take on excessive risk, and/or engage in fraud 7/
So if you're going to have a financial safety net, you also need effective financial regulation; if you don't, you can get massive moral hazard-driven losses like the S&L crisis. You see what I mean: Diamond and Dybvig made a huge range of stuff comprehensible 8/
The thing is, by the 1990s most economists thought this was a solved problem. We had deposit insurance plus bank regulation. Old-fashioned panics were supposed to be ancient history. 9/
What not enough people noticed was that a growing share of banking was being carried out by institutions that weren't big marble building with rows of tellers. "Shadow banking" came to make up a majority of the financial system 10/
Bypassing conventional banks also meant bypassing regulation, allowing slightly higher yields — but without a safety net. People (who no longer remembered old financial crises) didn't care, until suddenly they did 11/
So, for example, a lot of what used to go through regulated banks went instead through repo — overnight lending using stuff like mortgage-backed securities as collateral. All of which suddenly collapsed; all of us were wandering around muttering "Diamond-Dybvig" 12/ 
And at a sort of metaphysical level, once you read D-D you understood the possibility of various kinds of self-fulfilling financial panics, like the euro crisis of 2011-12 or the recent crisis in British gilts 13/
Speaking of which, I don't think the risk of two, three many gilt-like crises is the main reason the Fed should stop raising rates. But it is *a* reason 14/
Anyway, a richly deserved prize. As usual, a number of other people besides Bernanke deserved to share. (Would I say that about my own? Yes!) But this is a prize for work that really did contribute in an important way to understanding 15/
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