Part 1Suppose you are applying for a mortgage loan. The loan officer tells you that if you get the loan, the bank will keep the house title until you pay back the loan.Part 2Which problem of asymmetric information is the bank trying to solve? A. Free-rider problem. B. Moral hazard in debt contracts. C. Principal-agent problem. D. Lemons problem.

Question

Part 1Suppose you are applying for a mortgage loan. The loan officer tells you that if you get the​ loan, the bank will keep the house title until you pay back the loan.Part 2Which problem of asymmetric information is the bank trying to​ solve? A. ​Free-rider problem. B. Moral hazard in debt contracts. C. ​Principal-agent problem. D. Lemons problem.

BlackTom AI · Accepted Answer

When evaluating which asymmetric information problem the bank is addressing by withholding the house title, consider how each option maps to lenders’ and borrowers’ information and incentives.
Option A: Free-rider problem. This typically arises when individuals benefit from a resource or service without paying for it, or when non-excludable benefits lead to under-provision of a good. In this mortgage context, the issue is not about others benefiting without paying, but about the borrower and lender misaligned incentives due to information asymmetry, so this option doesn’t accurately describe the bank’s concern here.
Option B: Moral hazard in debt contracts. This occurs when the existence of a contract changes the borrower’s behavior because the lender cannot perfectly monitor actions, especially after the loan is issued. By keeping the title, the bank imposes a stake in the property that aligns incentives and mitigates risk-taking, addressing the asymmetric information problem at stake in debt lending. This explanation fits the scenario well.
Option C: Principal-agent problem. This concerns misaligned incentives between a principal and an agent acting on the principal’s behalf, typically where the agent has more information or different goals (e.g., a manager vs. owner). While related to information asymmetry, the classic mortgage-tinancial-structure scenario in which collateral is retained to curb risk is more directly captured by moral hazard in debt contracts rather than a standard principal-agent dynamic between borrower and lender.
Option D: Lemons problem. This term describes adverse selection, where buyers cannot distinguish high-quality from low-quality goods before a transaction, leading to market inefficiency. In lending, the bank’s action is about post-contract behavior and risk control under information asymmetry, not pre-contract quality screening of an asset, so this option doesn’t precisely describe the situation.
In summary, the combination of post-contract behavior, risk-taking incentives, and the contract design in debt financing aligns most closely with moral hazard in debt contracts, rather than the other listed information problems, which address different mechanisms of information failure or market dynamics.

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