Everyone knows -now at least- that the government considers some
banks too big to fail. But did the banks themselves know it, and
did it affect their behavior? If they were unaware they were too
big to fail, could a moral hazard still be present?  It has long
been a presumption that the existence of a central bank that
will bail out other banks in the event of a crisis creates a
moral hazard, wherein the banks’ knowledge that they will be
bailed out induces riskier behavior. For instance, here is Vera
Smith writing in 1936 summing up Walter Bagehot in 1873:  “It is
bound to happen that a central banking system being created by
State aid is more likely than a natural system to require state
help, and what it knows it can depend on, it will not hesitate
to utilise.”  Of course that argument presumes that the banks
believe they can depend on being bailed out. But did the largest
banks assume this? On Wednesday Jamie Dimon, the CEO of J.P.
Morgan, made the claim that Morgan’s internal analysis didn’t
assume they