There are two types of firms – good and bad. Good firms have equity of 600 and a profitable investment opportunity requiring a loan of 400 to be put into effect. The extra value yielded by the investment is 100 and they will borrow and invest as long as they make a positive profit from doing so. The bad firm has zero equity and no investment project (equivalently an investment project that makes zero extra value) – it is determined to borrow come what may in order to satisfy liquidity requirements and survive the year. 

The posted rate of interest is 10%. If there are equal numbers of good and bad firms in the economy, what is the effective rate of interest the bank will make on its loan? In an attempt to raise its effective rate of interest, suppose the bank raises its posted rate to 25%. What is its effective rate of interest now? What market failure does this problem highlight? Does this problem relate to the financial crisis of 2008 in any way?