A macroeconomic model with financial intermediation is developed
in which the intermediaries (banks) can issue outside equity as well
as short term debt. This makes bank risk exposure an endogenous
choice. The goal is to have a model that can not only capture a crisis
when banks are highly vulnerable to risk, but can also account for
why banks adopt such a risky balance sheet in the first place. We use
the model to assess quantitatively how perceptions of fundamental
risk and of government credit policy in a crisis affect the vulnerability
of the financial system ex ante. We also study the effects of macroprudential
policies designed to offset the incentives for risk-taking.